Buying and selling stocks based on volume spikes is a proven short-term trading strategy. Sudden upsurges in the number shares of a stock traded usually indicate that an existing upward or downward price trend is about to reverse direction. The reason for such a spike in trading is that buyers and sellers of a stock tend to switch their positions at the same time, Buyers start selling a stock that has been trending upward or sellers of a stock that is trending down conclude it has hit bottom and start buying. This causes the number of shares traded in a day to shoot up to double the recent daily average or even more.
Distinguish between unusual trading volume and volume spikes. According to NASDAQ, when you see gradually increasing volume accompanying an upward or downward trend in a stock’s price, this indicates strong support for the trend, so it is likely to continue. Conversely, declining volume indicates weak support for an existing price trend, indicating it may change soon. A volume spike is a sudden large increase in volume. Spikes show that a lot of traders are shifting their money into or out of a stock, making it likely that the existing trend is about to reverse direction.
Examine the stock charts each day for the stocks you hold or are considering buying. Charts are available from your broker and from online charting services. Some websites offer free tools so you can generate your own charts. At the bottom of a stock chart is a bar graph of daily volume. Volume spikes show up as a bar that is much higher than the bars indicating volume for the days preceding the spike. You can also see at a glance whether the daily volume and price are increasing or declining.
Avoid making a trade on the day a volume spike occurs. Extremely high trading volume is often accompanied by high volatility (price fluctuations). The website Chartfilter suggests that you wait until at least the next day to buy or sell shares.
Monitor news about the company. This is important because some events can trigger a volume spike that does not signal a price trend reversal. For example, a high-technology firm whose stock is currently trending upward might announce it has secured a lucrative research contract. Excited investors rushing to buy the stock can produce a volume spike that does not signal the beginning of a downward price trend. In fact, the stock price is likely to make a big move upward.
Buy shares after a volume spike indicates reversal of a downward price trend. If you own shares and the stock price has been trending upward, consider selling when a volume spike indicates the stock price is reversing to a downward trend.
- BananaStock/BananaStock/Getty Images