What trading volume can say about a stock

What trading volume can say about a stock

Are you disappointed with equity returns? For some time now, experts have been suggesting that this is a stock-specific market and not all shares are giving negative or flat returns. There are, in fact, quite a few stocks which have delivered over 10% (absolute) return in the last three months. So, is this reason enough to cheer, and identify these stocks and invest in them? Well, don’t forget that with return comes risk and vice-versa and in that context an important part of price gain is looking at the traded volume.

Why volume matters

Sandeep Bhatnagar/Mint

Now, if you have narrowed down on a stock on fundamentals or if you have been recommended a stock based on that, checking the volume will give you an idea about whether other investors are keen too. Says Phani Shekhar, Fund Manager, Angel Broking Ltd, “If you are going to buy a fundamentally good stock, check volumes, if they are consistently low, ask yourself what is the reason. Is the promoter holding high or are other investors not interested—what is the reason?" A stock that trades on low volume is more exposed to sharp price movements.

A classic example is the stock of Unitech Ltd. This stock price witnessed serious pressure in the first half of 2009 and lost most of its value. From its lows, it then gained 61% in May 2009, but on low delivery volume with an average of around 25% for the month. The next month too delivery volume remained low at around 21% and the stock declined nearly 14%. It is not unusual for this stock to move 5-10% positive or negative in one month. The average delivery volume for the stock continues to remain low at around 18-20% and that is what makes it vulnerable to large moves in either direction in a short span of one month. The stock is currently trading close to its all-time low at Rs20.

Volume moves up close to market peak

There is another way to look at this. Even in case of fundamentally strong stocks trading volume and delivery volume tend to move up significantly close to market peak and fall back a lot when markets are near their bottom. This indicates that investors do tend to follow general market euphoria. Not to say that doing so is a mistake, but remember if you are buying a stock close to its peak then it will take a long time before you make reasonable returns as you have to allow the stock to correct first and then maybe pick again in the next bull cycle.

How can you use volume information?

One thing is clear, volume alone says little, you should additionally take into account fundamentals and the actual price movement of the stock. Always look out for sudden drop or pick up in volume and see if it is because of some event or change in fundamentals for the company.

If the rise or fall of a stock’s price excites you, do these three volume checks before you make that buy decision:

• Check the average delivery volume two-three months prior, any sharp price movement accompanied by very small volume may not be sustainable for long. Keep in mind, if stock prices have rallied substantially and volumes are also at the highest it could be close to a market peak.

• To further confirm your position compare the average delivery volume in the month with historical monthly average stretching back one year or till the previous peak or bottom as the case may be.

• Lastly, compare the overall market delivery volume with the stock volume to see if there is any extraordinary interest or lack of it in the stock verify this against recent news and stock fundamentals to see if a volume pick up or fall is in line with what’s happening in the company.

Remember, looking at stock delivery volume is only an aid to your buying decision and none of the rules here are cast in stone. Just like stock prices, volume doesn’t always move as expected. They do, however, indicate investor sentiment towards the stock and that’s what you should keep an eye on. As an investor, you also need to have a comprehensive picture of stock fundamentals before you invest.

lisa.b1@livemint.com

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