Trading using a Stocks Volume

When demand for something increases in relation to supply its price increases. When supply increases over demand its price decreases. This is called the law of supply and demand and is a fundamental economic law. A stock functions according to this same law. When there are more buyers than sellers demand increases and the price eventually increases. When there are more sellers than buyers supply increases and the price eventually decreases. What we want to do is find ways of using the trading volume of a stock to find its supply and demand levels. Let's talk about how we can do that.

The first thing to look for is whether a stock has more buyers or sellers. If a stock has more buyers we say it is being accumulated and if it has more sellers we say is being distributed. To gauge whether a stock is being accumulated or distributed we look at the daily trading volume closing price. If the stock closes at a price higher than the previous day on larger relative volume it's a sign of accumulation. If it does the opposite and closes down on price on large relative volume it's a sign of distribution. For both the greater the volume more significant action. For example, low volume selling doesn't necessarily mean you need to run for cover because your stock is being distributed..
Looking at a stock chart over the course of a few days or weeks can show you whether a stock is being accumulated or distributed. When looking at stock charts look for days where a stock closes up in price on daily trading volume significantly higher then it's average trading volume. Next time you're looking at a stock chart count the number of days a stock closes up on significant volume versus down on significant volume. This will give you a general indication of whether it is being accumulated or distributed. If you're in IBD reader you have access to the accumulation/distribution rating. This is an A to D scale telling you if the stock is being accumulated or distributed. This can be a big timesaver in determining a stocks supply and demand..
When a stock breaks out you have a rapid increases in demand and a shortage of sellers. You can use volume to identify the strength of breakouts when they do occur. Stocks breaking out will have trading volumes 50% or more than there averages. If a stock has a rapid increase in price without a significant increase in volume it will often fail as it doesn't have sufficient demand to sustain the selling that gets triggered by the breakout. However it is more important to know about demand before a breakout occurs rather than in the middle of it. Let's talk about how to do that.

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To find stocks that are getting ready to breakout you want to look for areas of price consolidation. This is a time during which significant buyers are slowly building their positions in a stock. This takes at least a few days and often a few weeks. There will be multiple days of higher volume trading or the stock closes up in price but not with a significant advance. This is also called tight trading. When the breakout happens look for trading volumes 50% or greater than there averages. This is a good indication of a healthy breakout and if other factors are inline is the time to buy.

The biggest source of accumulation is large institutions such as mutual funds and pension funds. William J O'Neil investor and author points out in his book How to Make Money in Stocks the enormous buying power of institutions. "If a single fund has $ 1 billion in assets and wants just a 2% new position in a stock, they must buy $20 million worth of it. That's 500,000 shares of a stock selling at $40 per share! Funds are just like elephants jumping into a bathtub. They are simply so big the water rises and splashed all over the place." You want to buy stocks which institutions are buying to benefit from the momentum they carry.
As we talked about earlier when an institution wants a position in a stock it does not do it all at once. It builds up over the course of a few days or weeks to try and buy into it without increasing the price significantly. This gradual buy will show up as accumulation on the stock charts. Even in small amounts institutional buying is hard to hide.
Another way to spot to accumulation is to see what better performing institutions already own. Institutions are required to disclose their purchases by the SEC. The easiest way to check this is by viewing the ownership section on financial sites like Google finance. If you're IBD subscriber you have access to the sponsorship rating which does this research for you. IBD also tells you the percentage change of ownership over the past three quarters. This tells you if more funds are buying in or selling out. William O'Neil says that "if none of the better performing funds has bought a particular stock, I would stay away."

The value of a stock's or an index's trading volume is not of any significance unless we compare to previous periods to see the change over time. The Wall Street Journal and other financial papers list a stocks trading volume for the day. However it can be cumbersome to mentally track a stocks daily trading volume mentally over a period of days. Investors Business Daily's (IBD) stock tables have a helpful feature which is listing the stocks daily trading volume as a percentage of its 50 day average volume. With this you can at a glance tell when a stock is behaving abnormally.
Stock tables can help up pick out erratic changes in volume however they don't help you for tracking a stocks volume changes or seeing past movements. The way to do this is using stock charts. Charts give you price and volume action over time and make it easier to identify trends, accumulation and other indicators. I use IBD's charts because I prefer the display and a link to other features I use (See my IBD review for more information on this).. These are available without a subscription to the paper but you can also use Google finance and other such services are free as well.

That is a pretty good primer on how to utilize volume to identify stocks with increasing demand. For more in-depth information I would recommend William O'Neil's book How to Make Money in Stocks. As well I am a big proponent of IBD for saving time on research and analysis. Subscribe to the digital version and get 4 weeks free. If you want to learn more about it's benefits check out my review here. If you like William J. O'Neil sign-up for Investors Quotes Daily. They send out a free daily quote from William J. O'Neil. Sometimes it's one of his investing strategies and other times a piece of sage wisdom but it's always a great piece of knowledge on being a successful investor. I use it myself and find it a great tool for keeping myself constantly encouraged.