When you trade in the stock market, one of the most important factors you may focus on is the share price movement. Sure, this is important. However, it is often a secondary metric — meaning that it is influenced by various other factors. By monitoring these aspects, you can anticipate how the share price may move and implement trading strategies accordingly.
To track these factors, you need access to a dynamic trading platform that gives you live market updates accurately and promptly. Samco’s trading app is one such solution. Available to anyone with a demat and trading account from Samco Securities, this app offers access to advanced trading tools and live market data — all of which make it easy to track share price movements and the factors that affect them.
One such factor is the average daily trading volume. In this article, we discuss the meaning of this metric and how it can be used to analyse share price movement.
What is the Average Daily Trading Volume?
The average daily trading volume (ADTV) is the average number of shares traded over any specific period. You can find this trading volume for any period, like one week, ten days, a month, six months or even a year. Generally, however, the average daily trading volume is computed for 20 days or 30 days to measure short-term market activity.
The formula for computing this trading volume is simple because it is derived from the term’s definition itself. Check out the ADTV formula here:
Average Daily Trading Volume = Total Trading Volume During ‘N’ Days ÷ N
For example, say 12 lakh shares of a company were traded over 5 trading days. This means the average daily trading volume is 2,40,000 per day (i.e. 12,00,000 ÷ 5 days). Similarly, you can also calculate the ADTV for different time frames like hours or even minutes.
The average daily trading volume is important because it helps assess liquidity and aids in price discovery. You can also use this technical indicator to better understand share price movements. Let’s see how the two metrics are connected.
The Link Between the Average Daily Trading Volume and Share Price Movements
Price and trading volume are two key aspects of any trading decision. Often, traders simply look at the share price without paying much heed to the trading volume. This may lead to incorrect estimates of the market sentiment and result in less-than-optimal trading decisions. So, let us understand how the average daily trading volume and stock prices are linked.
Movements in stock prices indicate volatility, while the average daily trading volume measures the level of trading activity. Both the volatility and trading activity can be strong or weak at the same time. Alternatively, they may also display opposing strengths.
Typically, if the average daily trading volume is high and the share price also moves significantly in either direction, it indicates a strong and trending market. However, if the average daily trading volume is high but the volatility is low, you may be looking at a consolidation phase or a sideways market. If the ADTV is low, irrespective of share price movements, it indicates that market participation has decreased. This may make it harder to implement trades because of poor liquidity in the markets.
Let us delve into what high and low average daily trading volumes mean in greater detail.
What Does a High Average Daily Trading Volume Mean?
A high average daily trading volume typically indicates a liquid and active market. When more shares are traded daily, it often signals strong market interest in a particular stock. This could be due to several reasons like major news about the company, earnings reports or sector-wide trends.
A higher ADTV also means that buying and selling shares is easier because there’s more participation from traders. As a result, you can execute your trades with minimal price slippage and get closer to your intended price.
Moreover, when the share price also shows significant movement alongside a high ADTV, it often reflects strong market momentum. This could be either bullish or bearish, depending on the direction of the price movement. You can use this information to time your entries and exits more efficiently.
However, it is important to keep in mind that a high ADTV without significant share price changes could indicate consolidation. This situation could suggest that while traders are active, the market is awaiting a major breakout or external trigger.
What Does a Low Average Daily Trading Volume Mean?
A low average daily trading volume suggests that fewer shares are being traded daily. This usually indicates reduced market interest or participation in the stock. There are various reasons why the trading volume might drop, including a lack of news or external factors influencing the market.
Stocks with a low ADTV are generally considered less liquid, meaning that it may be harder to buy or sell these shares without impacting the price. This makes it more difficult to execute large trades and may lead to higher price slippage.
When share price movement is accompanied by low ADTV, it may be a warning sign for traders. For example, a price increase with low trading volume could suggest that the move is not supported by strong market sentiment, making it more susceptible to reversal. Similarly, a price drop alongside low ADTV may indicate a lack of conviction. In such cases, you will have to wait for a confirmation using the trading volume before acting on price trends.
Additionally, low ADTV can point to reduced volatility. This can be an opportunity for you if you are a conservative trader. However, it may be a limitation if you are seeking quick profits.
Trading Strategies Using the Average Daily Trading Volume
Now that you know how to decode share price movements along with the average daily trading volume, let us delve into some common strategies that use the ADTV values.
Breakout Confirmation
When a stock breaks through a key resistance or support level, you can confirm the breakout with a high ADTV. Increased volume alongside the price movement indicates strength. This reduces the chances of being misled by a false breakout.
Volume Spike Reversal
If the ADTV suddenly spikes during a price reversal, it may indicate a potential trend change. You can use this signal to enter the market early if you anticipate a shift in the share price momentum.
Low Volume Pullbacks
During an uptrend, if a stock experiences a price pullback with low ADTV, it may indicate a temporary pause rather than a reversal. This provides a buying opportunity before the trend resumes in the same direction again. The same is true for bearish share price moves too.
Divergence Analysis
When the share price rises but the ADTV decreases, it suggests weakening market interest. You can use this divergence to prepare for a potential price correction or reversal.
Liquidity-Based Position Sizing
You can also use the ADTV to gauge liquidity and adjust your position sizes accordingly. Higher ADTV supports larger trades with minimal slippage, while lower ADTV requires smaller positions to avoid the impact of large price swings.
Limitations of the Average Daily Trading Volume as an Indicator
While the average daily trading volume is a useful indicator for assessing market liquidity and share price movements, it has some limitations. Here are some key drawbacks to keep in mind:
- Ignores Market Sentiment: The ADTV shows you the market activity but doesn’t reveal the market's overall mood (bullish or bearish).
- Lagging Indicator: Since it is based on historical data, the average daily trading volume may not always reflect real-time shifts in market conditions.
- Potentially Misleading: A high ADTV doesn’t always confirm a strong trend. It may also indicate consolidation.
- Short-Term Focus: ADTV is less effective for long-term investment decisions.
Conclusion
To overcome these limitations, you can combine the average daily trading volume with other technical indicators that also help you assess share price movements. This way, you get a comprehensive overview of the price movement, direction and strength. If you are looking for a unified portal that can help you track various technical indicators simultaneously, the Samco trading app is just what you need. Equipped with real-time market data and free access to advanced TradingView charts, this app from Samco Securities helps you improve your trading technique and understand share price movements better.
Easy & quick
Leave A Comment?