There is old saying that volume is a necessary weapon of the bulls. The theory being the market or individual stocks can fall of their own accord, simply by a few people selling existing holdings to send prices lower. But for a market to move higher, especially after an extended move up and near highs, it will take fresh buying to keep powering shares up.

The recent run in stocks to all-time highs has come on relatively low volume. Which could mean there has been a lack of conviction leaving the market susceptible to rolling over. Or it could mean there is still the plenty of the ubiquitous but elusive “money on the sidelines” just waiting to put to work.

I’d lean towards the latter on the belief there are money managers who simply need to buy the dip. But rather than make predictions, let’s drill down into what we mean by volume and why it is gets so much attention. In fact, almost a universal standard that when you look at a stock quote it will contain three main components; last, change, and volume.

Put simply, volume is the fuel behind a stock move and comes in the form of simple transaction, no different than selling an old iPhone on eBay. But not as many people understand how to interpret the volume behind those buys and sells.

“Volume” is the term used to describe the total amount of shares traded – bought and sold – during a given time period. Volume is cumulative, meaning it continues to add up as the day goes on. So if you check a quote for XYZ at 9:00am, the volume might be 500K shares. If you check it two hours later and it’s then 750K shares, that means 250K more shares have been bought or sold in those two hours.

Understanding the Different Types of Volume

A stock transaction is a zero-sum event, meaning for every buyer, there has to be a seller on the other end. Because of this, in almost every case, when shares are traded between two parties – the buyer and the seller–they are only counted once in terms of volume. For example, if you buy 100 shares of XYZ, somebody is selling you those 100 shares, but for the purpose of volume count, the transaction is considered only 100 shares, not 200.

So how does this information help you as an investor? This is where the concept of up or down volume comes into play.

If a stock ends up in price for the day, that day’s trading volume is considered “up” volume. Conversely, if the price of the stock ends down for the day, that day’s trading volume is considered “down” volume. This concept can be also be applied to other time frames.

If a stock moves higher during a one-hour time period, the volume during that hour would be considered up volume. And if a stock moves up over the course of a year, the volume during that year would be considered up volume.

Now that we understand the idea of up and down volume, let’s talk about how that can help you in your investing decisions by introducing the idea of relative volume, meaning, taking a snapshot of volume during any time frame and comparing it to other similar time frames.

Stocks, like any commodity, derive their value from supply and demand. If there are more buyers for a stock, it’s price will go up, and if there are more sellers in that stock, the price will go down.

By looking at relative volume, you can see the tracks those buyers and sellers leave behind and use them to your benefit.

It’s All About the Theory of Relativity

Let’s say you’ve been watching a stock for a long time, which has been trading between $15.00 and $20.00, and you determine it’s a buy if it can break above the top end of that range. Then one day the stock breaks out and goes to $21.00, so you buy it, only to take a loss when it drops back down into that same range. Understanding the concept of relative volume could have given you a clue as to if that breakout would hold.

The reason the stock had been trading in that $5.00 range is because every time it got down to $15.00, there were buyers at that price level – enough of them to support the stock and drive the price back up. But when it got to the $20.00 level, there were enough sellers – who unloaded their positions – to drive the price back down.

If you were to look at the average daily volume during the time the stock was in that range – the total volume during the range divided by the number of days in that range – it would in all likelihood be the same, because buyers and sellers were evenly matched. So when the stock broke out of that range – to $21.00 in our example – noting the volume on that day relative to the previous average volume could give you a clue as to if the move would hold.

There are many sites that can provide “volume by price” within their charting tools. This can help you see at what levels volume surged and indicate where support or resistance might occur.

A break below a long Volume-by-Price bar signals increasing supply or selling pressure that can foreshadow lower prices. Long bars below prices show elevated interest areas and potential support. A break below this support zone signals a significant increase in selling pressure and lower prices are then expected.

If there was a surge in up volume when the stock broke out, that would indicate that new buyers were coming into the stock, who were willing to pay a higher price to own it. And the higher the breakout volume was in relation to average volume, i.e. the more fuel the move had, the higher the likelihood that it would hold and continue higher.

But if the volume on the breakout was the same or less than the average volume, that would be a warning that the breakout didn’t have much conviction behind it, i.e. was low on fuel, and most likely would fail– dropping back into the previous range.

As with everything in the stock market, there are no certainties and definitely no “holy grail” to determine what a stock will or won’t do, but understanding how volume works and being able to identify its patterns gives you an advantage in your trading and investing.