Blog : Surprising Things Revealed by Trading Volume

by Peter Leeds on March 29th, 2016

Most people overlook the important clues which the stock chart can tell them.  For example, trading volume is a lot more than just an indicator of how many shares have swapped hands on a specific day.

Neatly connected to the bottom of a trading chart, you'll see how much buying and selling activity has occurred on each day.  The revelations which can come from this data are major, and can make all the difference.

In fact, trading volume can tell you as much, or in some cases more than, the actual share price movements!  You see, you'll get 5 additional insights, which are extremely important and that trading price alone does not reveal.

Sustainability of Recent Price Moves

When the price of a penny stock changes a lot, but that move is based on thin or light trading volume, the move is probably going to reverse.  

You will see this all the time with penny stocks.  The shares might jump up 30%, or drop 40%, but they'll often do it on very light trading.  In such cases, the stock typically is right back where it started within a day, if not hours.

Shareholder Turnover

With penny stocks, shareholder turnover is of paramount importance.  The idea is that newer shareholders are less likely to sell their shares in the near term (as compared to long term owners).  Many of these newbies have medium or long term outlooks, and expect higher prices compared to current levels.

When shares remain within a range-bound price, but trading volume stays high or increases, this typically represents a turnover of shareholders.  Those who want out are selling, while buyers are sweeping in to absorb that supply.

Ideally, you will see 20% or more of shares trade hands, while the price neither rises nor falls.  Once the last few sellers get out, and that supply dries up, the shares tend to pop higher.

Look at the daily trading volume during a span where the price barely changes.  Add each day together, and compare that total to the number of outstanding shares.  

For example, consider a penny stock with 1 million shares trading.  If they see trading volume increase to 50,000 shares on average, for a span of 10 days, you will know that 500,000 of the shares (50%) are new shareholders from within the last 10 days.

In other words, half of that penny stock's shares are very recently in the hands of investors who are not likely to sell any time soon.  That constrained supply typically leads to a rise in share price.

Support and Resistance Strength

You've heard of support and resistance levels.  In terms of penny stocks, these typically involve round numbers, like $1.00, $2.50, or $3.00 since a lot of people buy or sell at those ranges.  Most people don't say, "sell at $1.67," or "buy at 3.42."  

To put it simply for those who don't know, a support level is a price where buying activity increases, often keeping the shares above that level.  For example, every time a certain penny stock falls towards $2.00, trading activity increases as buyers swarm in, thus keeping the shares at $2.00 or above.

Similarly, a resistance level is where sellers come out of the woodwork.  For example, as a fictitious penny stock approaches $3.50, the shares may be increasingly weighed down due to shareholders dumping the stock.

Often a stock will fall towards its support level, reverse higher due to the increasing demand at that range, and bounce back towards higher prices.  In the case of resistance, the shares may try to get to, or break above, that level, only to fall back to lower prices under the deluge of selling.

Of course, not all support and resistance levels are created equal.  Some are very strong, and in the case of thinly-traded penny stocks, those technical ranges may remain in place for months or years. 

Trading volume is a great way to assess the strength of a support or resistance level.  As the shares approach, if the share's activity increases then the technical level is more likely to hold.

On the other hand, if trading volume is low as the penny stock nears support or resistance, that technical level may fail (meaning not hold up).

When a Price Run is Ending (Whether Up or Down)

Trading volume typically picks up significantly when the trend of a penny stock is about to change.  If the shares are climbing for a few weeks, but then the activity doubles the average amount, that penny stock is possibly about to fall.

Profit takers have made a few bucks at this new higher level, and as the climb slows, they are very willing to dump shares.  As they do this, the selling often pushes the penny stock lower.

The same can be said for shares which have been sliding.  You've heard, "don't try to catch a falling knife," but when the trading activity spikes higher, it often indicates a bottom in price.

The Trust Factor for TA indicators

Technical Analysis (TA) usually does not work with penny stocks, since the shares are so thinly traded.  Said another way, the more trading activity which helps generate a TA pattern, the more that setup can be relied upon to act as would be expected.

So if you see a perfect bottoming out pattern (for example), but it forms on only slight trading volume compared to the penny stock's average, you should not rely upon the indicator.  Wait for TA patterns which form on significant volume, because the more trading activity which helps form them, the more reliable the pattern.

At Peter Leeds, we put all these insights into action with our penny stock picks.  In fact, trading volume was a big consideration with today's selection, which is a $2 penny stock trading on the NASDAQ.