The Importance of Volume in Trading

December 12, 2010 / Emilu Bailes

Volume is an important indicator for technical traders because it confirms trends and chart patterns.

If price is advancing on strong volume the advance is seen as more relevant than if price is advancing on weak volume. If the trend is to the upside and volume is increasing, the trend is said to be strong. Consequently, when price is moving higher and volume is falling lower, it is said to be forming “divergence,” meaning that the strength of the move up is losing power and may soon reverse. The same can be said about the relationship of price and volume to a falling issue. That is, if price has fallen on strong volume and then the volume dries up as price moves lower, the trend may be at the bottom and near a reversal point. Other than demonstrating divergence on a price chart, are there other reasons for volume’s importance?

At OptionsAnimal we seek to trade equities with strong institutional sponsorship; at least 50% fund ownership. The reason behind this is that institutions buy (or sell) in large quantities and their buying (or selling) moves prices.

For example, Netflix has risen about 400% in 2010. Sixty-eight percent of its shares are held by institutions. One of those institutions who hold just under 2% of NFLX shares is Fidelity Adv Mid Cap II A (FIIAX.) The net assets under management in this fund are over $3,000,000,000.00. With 5.81% of their assets invested in NFLX, that’s approximately $175,000,000.00 of NFLX shares. As of the end of Q3, 2010, there were 799 funds reporting ownership in NFLX, which represents a 12.7% rise in fund ownership over the past year. With this magnitude of buying, is it any wonder that the price of NFLX has soared?

Emilu Bailes

OptionsANIMAL Instructor