How to Use Clues from Trading Volume for Penny Stocks - dummies

How to Use Clues from Trading Volume for Penny Stocks

By Peter Leeds

Specific technical analysis (TA) indicators can be highly successful with penny stocks. These will be easy to spot, and if trading volume is high enough, they will also help you predict upcoming price moves.

Trading volume is one of the most important considerations for any TA investor. By watching how many shares are trading hands and changes in that activity, you can spot trading opportunities and have a better understanding of the reliability of other TA indicators on that penny stock.

Compare a penny stock’s daily trading volume for the last few days or weeks to the daily average for the previous weeks or months. Daily trading volume and average trading volume are available through many free websites, such as Yahoo Finance. By comparing the average to the current activity levels, you can easily see if buying and selling activity is increasing or decreasing, and to what degree.

A significant increase in trading volume means that more than double the average amount of shares are trading hands. You can ignore anything less than a significant increase. Likewise, when trading volume experiences a significant decrease, such as cutting down by more than half, it may imply an issue that shareholders should watch.

The sustainability of the change in trading volume also matters. If buying and selling activity doubles for a day but then returns to normal the next day, the activity may be a unique and meaningless event. When trading volume dramatically increases or falls for days or weeks on end, you can conclude that specific events are causing the unusual trading activity.

You can draw a lot of conclusions about the shares of a penny stock based on its trading volume. Here are some volume indicators and what they may be signaling:

  • Increases suddenly: A sudden increase in volume may be due to a specific event or issue, such as the release of financial reports, FDA approval, CEO resignation, or any other material event. Be aware of the cause for the investor interest, whether based on optimism or pessimism, so that you can make appropriate trading decisions.

  • Increases gradually: If the increasing activity coincides with rising prices, the penny stock may be getting increased attention by investors, gaining market share for its products, or producing improved financial results. Alternatively, gradually increasing trading volume with falling prices may imply that shareholders are dumping their positions and going for the exits.

  • Neither increases nor decreases over time: Consistent trading volume over time does not reveal much from a TA standpoint.

  • Decreases suddenly: A sudden decrease in trading volume is a rare event. If a material issue scared investors away, you would expect it to come with an increase in trading volume, rather than a decrease. While the cause for a sudden drop-off in trading volume may be hard to understand, the situation generally is negative for the shares in the longer term simply because there is less investor interest.

  • Decreases gradually: When a penny stock falls out of favor with investors, you’ll see a gradual decrease in trading volume over time. This can warn you that shares may drop next, if they haven’t already, as fewer traders are interested in buying and selling the shares.

Trading volume is simple to monitor and can provide you with more clues about future prices of a stock than most other TA factors. Of course, when combined with some of the other TA indicators, trading volume really demonstrates its importance.