- August 21, 2022
- Posted by: CoachShane
- Category: Trading Article
When trading stocks, it’s important to use all the tools at your disposal to make informed decisions about what stocks to trade and when to get involved with a certain ticker. One of those tools commonly used by traders is relative volume.
What Is Relative Volume and How To Find It
Relative volume is the volume today compared to (relative to) an average of the past X periods of volume activity in a ticker. The common method of finding RV is to overlay a moving average over the volume indicator at the bottom of your chart.
Depending on your trading style and strategy, you would select anywhere from a 5-period SMA to a 50-period moving average to quantify if the current volume spike is large enough to indicate a strong demand for the stock. You’d be looking for, as an example, “current trading volume is higher than the average 5 days”.
The chart above shows the 50 period SMA overlayed on the stock. When price breaks above the moving average, we are looking at price breaking the 50 day average volume. When we see big spikes (black arrow), that leaves little doubt that many shares were either bought or sold.
What does it mean when a stock shows higher volume?
If the current volume is much higher than what’s been seen in the past, that means there’s more demand for the stock at this price and it’s more likely to move.
This is exactly what traders want to see when getting involved with a particular stock.
When this occurs, it could be a good time to buy or add to a position as long as other technical indicators are also in line with a bullish move. There is no guarantee that the move will last however trading is about probabilities, not certainties.
Using the RVOL Indicator
The RVOL indicator (relative volume indicator) is an indicator that cites the relative volume with a number that is considered a threshold. It is a more quantifiable way to determine whether a move, for you, is extreme enough to take action on (with an accompanying setup of course)
A reading of 1 will indicate that the current volume is in line with the average volume over the specified period (1 times the average volume. A reading above 1 is considered above the average and below 1, is below the average.
Traders that use the RVOL indicator will generally be looking at a reading of two: 2 times the average volume over the period.
This chart has the RVOL set over 10 periods and a threshold of two (the horizontal line). When price breaks the horizontal line, I know with one glance that the current volume is 2X the previous 10 days volume. Depending on my trading approach, that may be something to take not of.
You can see price broke the down trend line (and held for the upside) with a reading of almost 4X the average of the previous 10 days.
There are other indicators and factors you may use in addition to relative volume, but it is a very helpful tool if volume plays a role in your trading strategy. Some traders will prefer using the moving average technique and others find the RVOL indicator more useful.
Identifying Breakouts and Trend Reversals
High relative volume ratio can be used to identify and quantify breakouts and trend reversals. When a stock breaks out of its trading range, it often generates a surge in relative volume. This can be used to confirm the validity of the breakout. Remember, low relative volume in a breakout (during and after), can be a sign that price is not going to advance.
Likewise, when a stock reverses a trend, it too can generate a surge in relative volume giving you some confirmation of the price reversal.
For instance, if a stock is trading in a range between $50 and $60 and it breaks out to the upside through $60 on above-average volume, that would be considered a bullish breakout. As long as the volume remains strong, the breakout has a high probability of being successful.
If that same stock reversed the main trend direction and dropped below $50 on higher than normal volume, that would be a bearish sign.
With this stock, price not only breaks a down trend line but also a previous area where price rejected. It did this on just over 2X the average volume and traders would implement their trading plan. For instance, some traders would use a lower time frame on the next day, look for weakness, and then buy into this stock.
Time Entries and Exits
When a stock is starting to trend, you can use relative volume to find buying opportunities. Likewise, when a stock is starting to reverse the trend, you can use relative volume to find selling opportunities.
If you are a trader whose trading strategy includes buying reversals out of pullbacks, you would be looking for a surge in relative volume on the move back up through prior resistance, a trend line break, or a reversal candlestick such as a hammer or doji.
This stock breaks a low and sets up a reversal candlestick on high relative volume. It also breaks the rhythm of the downtrend ( break of the line ) and follows up with a very strong bullish candlestick. This is a buying opportunity – reversal off of lows on high relative volume.
On the other hand, if you are a trader who likes to fade breakouts (trade against the breakout), you might use a similar setup but look for a bearish reversal candlestick at the prior resistance level along with above-average relative volume.
Finally, relative volume can be used to track institutional buying and selling. When a large institution is buying or selling a stock, it will often generate a surge in relative volume. This can help you gauge the sentiment of the market towards that stock.
Tracking Institutional Buying and Selling Sentiment
Money moves the market and the institutions are the ones that can push the markets around. When a trader is entering a position, it is reassuring to know there is a high probability of the big players entering the market.
Relative volume that shows large current volume (large being subjective of course) when you are looking to enter your trade, can be the institutions helping it along.
I wrote about a volume price relationship called Pocket Pivots. This is where we want to see a up volume of the current day to be higher than the down volume of any of the previous 10 periods. It may be worth your time to add in a RVOL requirement of 2 or greater before you would be interested in taking a trade.
How Do You Find Momentum Stocks
One of the simplest ways to find a stock that is moving on high relative volume is through the use of a stock screener.
Using Finviz, I can set the average volume to whatever and then look for a relative volume of over 3. This scan gave me 58 stocks to review.
Traders would then scan through the stocks to see if any are setting up a chart pattern you can trade.
The relative volume indicator is an important tool that every trader may want to consider using to help make better trading decisions.
Using relative volume and knowing when the current volume has increased compared to previous and by a quantifiable amounts, can give you an edge in the market. If you know volume is showing different characteristics than previous, it can help you confirm breakouts, reversals, and institutional buying and selling sentiment.
Use it to find better entry and exit points for your trades and increase your chances of success in the market.