The trading volume of a stock can affect its market price. However, trading volume is not necessarily a predictor that the stock price will increase or decrease based on heavy and light trading volumes. The affect trading volume has on stock price relates to investor supply, demand and liquidity.
About Trading Volume
Trading volume is the number of shares bought and sold between investors over a particular period. If the trading volume is described as being high, then many investors are buying and selling the stock. If the trading volume is low, that means fewer investors are buying and selling the stock. Trading volume can be reported as an average trading volume over a short period, such as one day or over a longer period such as three months.
Supply, Demand and Liquidity
High trading volume is an indicator that there is a lot of interest in a particular stock. This is often an increase in demand and can push the stock price upward. The increase demand induces investors that currently own the stock to sell. This is an increase in supply. High trading volumes also increases the stock’s liquidity. An increase in liquidity means that owners of the stock can easily covert their shares into cash. The opposite is true for stocks with low trading volumes. These stocks have decreased demand and decreased liquidity. This can often lead to a decrease in stock price.
Stocks with high trading volumes tend to have narrower spreads. The spread is the difference between the ask and bid price of a stock. The bid price is what investors are willing to pay for the stock, and the ask price is what sellers are willing to accept for a stock. This narrower spread also increases demand for the stock, which can lead to an increase in stock price. Stocks trading at lower volumes often have wider spreads. This tends to decrease demand, therefore, decrease the price of the stock.
Stocks that trade at a high volume tend to be less volatile than those trading at lower volumes. Stocks with higher trading volumes are less volatile because investors can buy, sell and trade large amounts of the stock without the transactions having a significant effect on the stock price. For long-term investors, stocks that are less volatile are more attractive than those that are more volatile. This decreased volatility tends to increase the price of the stock. Stocks with lower trading volumes are more volatile.
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