You watch every wiggle of the Dow Jones industrial average. Ditto for every stock you own. That's all well and good. But if you really want to know what's going on, you have to watch not only the price of the shares but also how many of them change hands.
Price movements may give you bad signals unless you read them in tandem with trading volume. Typically, volume is heavy when stocks are surging and lighter during the final stages of their decline. "It's all psychology," says Phil Roth, chief technical market analyst at Miller Tabak, an institutional brokerage firm in New York. "At the top of the market, investors are ebullient, and at the bottom, they withdraw into a shell."
What's most telling is when trading volume departs from usual patterns. If volume wanes, say, as a hot stock hits a 52-week high, that could be a signal that the price trend isn't sustainable. "Changes in trading volume typically precede changes in prices," says Bernadette Murphy, chief technical analyst at Kimelman & Baird, a New York investment firm. "Volume acts as an early warning system."
In this first installment of Market Measures, an ongoing series on analytical tools to help you parse the stock market, we'll show how trading volume can help you identify investment opportunities and avoid traps.
LOOK TO THE WEB
With the Internet, monitoring trading volume is a cinch. Most sites that provide stock price quotes also list daily trading volume, as well as some historical data. One free Web site that offers detailed volume data--and is easy to navigate--is Clearstation (clearstation.etrade.com), a unit of online broker E*Trade (ET ). The New York Stock Exchange's Web site, nyse.com, also provides reams of historical volume data. Many professional investors monitor NYSE volume closely, seeing it as a proxy for the overall stock market.
When analyzing volume, it's useful to compare daily trading volume with trading volume over a longer period of time. One way to do that is to use a 30-day "moving average," which is calculated every day from the volumes of the most recent 30 days. You can also calculate a moving average for trading volume with other periods; many pros like to examine 150-day and 200-day moving averages to gauge longer-term volume trends.
Look at a price-and-volume chart for IBM (IBM ). Like most technology stocks, Big Blue has taken a beating during the bear market, sinking to a five-and-a-half year low of $54.01 a share on Oct 10. Since then, IBM has rebounded smartly, reaching a high of $88.58 on Jan. 14 and closing at $78.20 on Jan. 31. At first glance, the recent months' price movement seems positive for the stock. But the trading volume tells a gloomier story. As the stock has risen, trading volume has largely remained below the 30-day moving average of 8.4 million shares.
What would set the stage for a stronger move? If IBM's upward march had been consistently accompanied by daily trading volume that was 50% to 100% above its 30-day moving average, Roth would have been convinced the stock was on the mend. The technical analyst now figures that at some point, IBM will retreat toward its October lows, dropping to around 55 to 60.
This analysis tells a happier story for Mylan Laboratories (MYL ), where share volume is confirming bullish price moves. From August to December, the generic drugmaker's share price held steady in a narrow range of $19.74 to $22.50, adjusted for a 3 for 2 stock split on Jan. 27. So far this year, however, Mylan's shares have climbed higher on heavy volume, with trading activity on many days two to three times greater than the 30-day average volume. On Jan. 29, Mylan shares reached a record price of $26.76.
Mylan's rising volume indicates that buyers are willing to pay higher and higher prices for the stock. Kimelman & Baird's Murphy believes Mylan's share price could retreat somewhat in the weeks ahead as investors take profits. But heavy investor demand for the stock, as indicated by high trading volumes, makes her think its share price will eventually rise further, perhaps to $35, over the next 6 to 12 months.
Analysts also look to volume for clues to where the broad market is heading. For instance, Merrill Lynch Chief Market Analyst Richard McCabe isn't too worried about the recent downdrafts in the major market indexes. That's because the volume of NYSE exchange trading has been holding fairly steady at an average 1.4 billion shares daily over the past month. Heavier volume, however, could be a signal that investors were stampeding for the exits. "If the daily volume goes into the 2 billion to 2.5 billion range, I'll reassess the decline," he says.
McCabe also compares the daily volumes of the NYSE and NASDAQ to get a sense of the level of speculative activity. During the height of the bull market, volume on the tech-laden NASDAQ often was twice as heavy as volume on the more staid NYSE, McCabe says.
Today, the daily volume on both markets is roughly the same on average--1.4 billion on the NYSE in January and 1.5 billion on the NASDAQ. The last time the NYSE and NASDAQ had somewhat equivalent volume was October, 1998, during a pause in the bull market. If the stock market indexes start to rally, McCabe would be wary of a big spike in NASDAQ volume. "You don't want to see speculative activity build again too quickly," he says. That would mean investors were getting too bullish too fast.
NASDAQ provides daily and historic volume data on its Web site, nasdaqnews.com. To access this data, click on Indexes & Statistics, then Historical Statistics.
Many Wall Street pros look at NYSE exchange turnover--volume divided by shares outstanding. Turnover adjusts for the fact that an exchange's volumes increase when new companies are listed and stocks split. The NYSE lists historical turnover data on its Web site. Annual turnover was 105% on the NYSE in 2002, vs. 94% in 2001 and 88% in 2000. At the end of bear markets, turnover typically declines, says Miller Tabak's Roth, adding that he has yet to see that happen. A potentially bullish sign, he says, would be if NYSE monthly turnover started to fall below 2002's 105%.
By tracking trading volume along with stock prices, you'll be able to gauge the intensity of investor sentiment. That intelligence will allow you to make smarter buy and sell decisions.
By Susan Scherreik