We have already explained that technical analysts use price actions to arrive at the direction of a stock (ie whether the counter is in uptrend, downtrend or sideways trend). However, these price actions are not complete without volumes and therefore, volumes are also usually plotted in these charts, usually below the price chart.
What is volume?
Traded volume is defined as the number of shares or contracts traded in a counter during a given time period. Hence, the volume chart is plotted depending on the time period selected. For example, hourly chart will carry the total volume traded in an hour, daily chart will reflect the volume during the day, weekly chart will show the entire week’s volume, etc.
Volume vs value
Traded value is calculated by multiplying volume with share price. Since most traders use shortterm charts, using volume or value won’t make much difference. However, value gives clearer picture if you are using long-term charts. If you look at the Asian Paints chart, you will realise that the traded value has multiplied over the years, though the traded volume remained almost flat. Another advantage of value is that it automatically takes care of events such as a split or bonus in the counter. For example, assume that the price of a stock fell from Rs 100 to Rs 50 after 1:1 bonus. Since the price has halved, people may buy double number of shares and therefore, an increase of volume from 1 lakh shared a day to 2 lakh a day should be treated as normal. Traded value will remain same in the above example (ie ?1 cr). However, this will ‘show as a jump’ in volume charts.
Use in fundamental analysis
Volume is important for all market participants. This is because it is very easy to manipulate a counter with very little traded volume (popularly known as an illiquid counter). Long-term investors, especially institutional investors like mutual funds, usually avoid stocks that don’t have sufficient traded volume.
Use in technical analysis
Since technical analysis tools are designed to measure the mass psychology of participants, it can work only if the stock has a large number of investors. That means before trading in any stock, investors need to make sure that the trading volume is sufficiently high.
Use average volume
Unlike stock prices, volume can move up and down drastically within a short time period. While the traded volume in a counter is only a few thousand shares on a particular day, the volume can be in lakh on some other day. By using the average, say 10 day average, investors can get a fair idea about the liquidity of the counter. Please note that the 10 day average is relatively stable in both volume and value charts.
Source: Economic Times