A recent headline in The Wall Street Journal says that U.S. Stocks Slip on Light Volume. Just how does trading volume impact a company’s stock and how does trading volume affect stock trading. Is it different for swing trading than for day trading? First, here is what the Journal says.
U.S. stocks slipped in light trading Monday, with the fewest shares changing hands in nearly two months.
A lack of enthusiasm for stocks has plagued the market recently. After a sharp drop and bounceback in the first three months of the year, stocks have plodded along with little fanfare.
The slowness in trading “can be frustrating,” said Justin Wiggs, managing director in equity trading at Stifel Nicolaus, adding that in such times it’s hard to find money managers to take different sides of a trade.
When trading volume is low it is not just that there are no buyers. There are no sellers either. There are times when the market is not going up or down but is still volatile. This is not the case in a stock world of low volume. How does low trading volume impact a company’s stock?
Low Volume Risks
There are risks when a stock trades a low volume. Investopedia writes about risks of trading low volume stocks.
One risk of low-volume stocks is that they lack liquidity, an important criteria in stock trading. Liquidity is the ability to be easily bought or sold in the market without a change in price. This means that a stock which is trading at $25 per share should be easily bought or sold in large amounts (say 100,000 shares) while still maintaining the price of $25 per share. For stocks, a good measure of liquidity is the average daily trading volume. In general, any stock that trades at fewer than 10,000 shares a day is considered a low-volume stock.
Low-volume stocks are harder to buy or sell quickly and at the market price.
Factors related to low trading volume include difficulty in determining a fair stock price, potential for price manipulation and possibility that the company picture is deteriorating.
Day Trading Low Volume Stocks
Online Trading Concepts discusses the price volume trend as a cue in technical analysis of stocks.
Price Volume Trend combines percentage price change and volume in an attempt to confirm the strength of price trends or through divergences, warn of weak price moves. Unlike other price-volume indicators, the Price Volume Trend takes into consideration the percentage increase or decrease in price, rather than just simply adding or subtracting volume based on whether the current price is higher than the previous day’s price.
This approach helps highlight divergences and predicting trends. But when trading volume is too low technical stock analysis becomes progressively less accurate. Also it can become increasingly likely to get trapped on the wrong side of a trade in the thinly traded stock if genuine news hits the market and drives the stock steadily in one direction. In that case the only choice is to take substantial losses.