The interest in buying or selling a security (i.e. demand) is defined by the volume of shares being traded. When that demand is measured over a certain period of time, the volume can be averaged to give investors additional information for technical analysis. This article will help you understand what the average daily trading volume is, how you can look for it, what causes it to change significantly, and how it can be used as part of a trading system.
What is average daily trading volume?
The average daily trading volume (ADTV) is a calculation that identifies the amount of individual securities traded over a specified amount of time, divided by the number of days in that time period. Monthly and annual averages are the most common time frames used for calculating average daily trading volume. Average daily trading volume is one statistic investors use to predict the enthusiasm that traders have for buying or selling a security.
On any given day, a security may experience higher or lower volume for a variety of reasons. Investors can use average daily training volume to compare against its current volume. If the average daily trading volume is significantly higher or lower than the current volume, it is a clue that something may be happening that is creating buying or selling demand.
An informed investor can and should, at the very least, be aware of what an average daily trading is and what it may be saying about their investment. But the extent to which it impacts their trading habits really depends on what kind of investor they are.
When evaluating a security, investors will tend to be in one of two camps: fundamental analysis or technical analysis. If you're not an active trader, then you probably lean towards fundamental analysis to make your investment choices. In that case, the average daily trading volume may not be that important to you. That's because many investors who rely on fundamental analysis are taking long-term positions with their investments. Price movement over 30 days or 50 days is not likely to sway your opinion.
ADTV is firmly in the technical analysis camp. Technical analysis is a trading strategy that is used by active, aggressive traders to determine when to enter (buy) or exit (sell) a position they have in a security. These investors are typically looking to buy and sell a security, often times in the same day. For that reason, they use average daily trading volume to select securities.
How to find the average daily trading volume
The average daily trading volume can be found by viewing the summary quote for a given security. You might see it listed as a “30-day or 50-day average trading volume”, although it could be measured over any length of time. To get a better indication of what that volume means in relation to the value of that security, most summary pages will let you look at a chart for that security. The volume will be plotted along the horizontal axis and above the volume, you'll see price movement. The chart will allow you to see the specific dates when trading activity was most active.
What will cause the trading volume to change?
Like a hashtag on social media, the volume of trading for a given security will change when it’s trending. There are many things that can cause demand for a security to fluctuate. A few examples of situations that may affect the average daily trading volume of a given security:
- When a company launches a new product, its stock will typically experience heavier trading volume as investors anticipate increased sales which makes the company more desirable to investors.
- Here in the United States, when an election puts one political party in a position to replace the opposing party, it frequently leads to enthusiasm (desire to buy) in certain sectors and anxiety (desire to sell) in others.
- As consumers, you know how weather events such as a hurricane can affect the price you pay at the pump. This is because investors fear supply disruptions. However, that same event is usually good news for the stock of oil and gas companies and can cause the trading volume of those companies to jump above their average.
What an increase in trading volume means
Since average daily trading volume tells investors how much interest a security is generating it helps them determine the liquidity of that security (i.e. how easy it is to trade). Simply put, an average daily trading volume that is increasing means there is a significant commitment by traders. This tells traders that there are many available buyers and sellers, making it easy to execute a trade.
What a decline in trading volume means
Typically a downturn in average daily trading volume means that there is less enthusiasm about a particular security. This means that, for trading purposes, there are fewer committed buyers, meaning there is less liquidity in that security. If you’re a day trader looking to enter and exit a position quickly, a security that is seeing a downturn in average daily trading volume may be more difficult to buy and sell quickly.
How to use average daily trading volume in your trades
An important takeaway for investors who want to use annual daily trading volume in their trading is that an increase in average daily trading volume does not always directly correlate with price.
As a consumer, you understand that for a sale to be made there has to be a buyer and a seller. You also understand that how much you pay for something has to do with supply and demand.
To illustrate this, imagine you’re a collector. You find an item that you’ve been eyeing for a long time. The only problem is, the seller only has one and you are not the only one interested.
What happens? The buyer is in control and the price of that item goes up.
But what would happen if there wasn’t demand for that item, yet the seller was interested in getting rid of it? The advantage goes to you, the buyer. In order to attract buyers (i.e. create demand), the seller has to lower their price.
It’s the same way when you’re looking to buy or sell shares in a security. When you look to buy, there have to be investors on the other end of that trade who are willing to sell. The average daily trading volume can signal to an investor that an event has occurred that is causing trading demand to increase.
But simply knowing that there is trading demand is not sufficient. While average daily trading volume can help confirm to a trader that a security is being actively traded, it does not, by itself, indicate price movement one way or another. There can be both high buying volume and high selling volume.
This is why, as part of a trading system, the average trading volume is always secondary to price. To make a more informed decision about what the average daily trading volume means, investors will look at price movement. Here are a few ways that investors use volume in their trading:
- They use daily trading volume to confirm convergence.
When the price is moving in the same direction as volume (that is the price is rising when volume is increasing or conversely the price is falling as demand is decreasing), that is called convergence and it is a good indicator that a trend is likely to continue and prices are likely to continue in the direction they are going.
- They use daily trading volume to confirm divergence.
Likewise, when the price of a security is moving in the opposite direction from its volume this is called divergence and it generally means that any trend that was associated with the security is weakening. If the price is rising as demand is falling it may mean that support for a price is losing steam. If the opposite is happening and the price is falling but demand is rising, it could be a clue that the stock may be ready to rally.
- They use daily trading volume to observe what happens when the price meets resistance.
In any rally, prices will reach a level where buyers take a breather. This is called a resistance level. In order for prices to continue to go higher, there has to be significant volume. Therefore, traders look at securities that have high average daily trading volume because they are more likely to push past a resistance level.
- When the price continues to advance beyond a resistance level and the security continues to have an above average volume, which is considered to be more significant than if the price advances but volume turns lower. This is because it implies that investors continue to be enthusiastic. And enthusiasm leads to more buying and a price that will continue to climb.
- Conversely, if the price continues to fall below a resistance level and continues to have an above average volume, it is considered to be more significant than if the price declines but volume also decreases. This is because the combination of negative price movement with advancing volume signifies a high level of investor anxiety which is likely to produce more selling and a price that will continue to decline.
The bottom line
Average daily trading volume can be one part of a trader’s technical analysis for a security. It can help them minimize risk by pointing out securities that have a committed group of buyers and sellers, allowing traders to quickly enter (buy) or exit (sell) a position they may take. It is not, however, a stand-alone measurement and should always be secondary to price movement when deciding whether or not to trade a given security.