What Is Volume Analysis?

Volume analysis is the examination of the number of shares or contracts of a security that have been traded in a given time period. Volume analysis is used by technical analysts as one of many factors that inform their trading decisions. By analyzing trends in volume in conjunction with price movements, investors can determine the significance of changes in a security's price.

Key Takeaways

  • Volume analysis involves examining relative or absolute changes in an asset's trading volume in order to make inferences about future price movements.
  • Volume can be an indicator of market strength, as rising markets on increasing volume are typically viewed as strong and healthy. When prices fall on increasing volume, the trend is gathering strength to the downside.
  • Various tools, such as the positive volume index (PVI) are employ volume in technical analysis.

Understanding Volume Analysis

Volume analysis is done by all types of analysts following specific securities in the financial markets. Generally, volume refers to the number of shares transacted per day. Having an understanding of the entire market’s trading volume versus the volume of a single holding can be one important comparison that helps analysts to discern volume trends.

Oftentimes, high volumes of trading can infer a lot about investors’ outlook on a market or security. A significant price increase along with a significant volume increase, for example, could be a credible sign of a continued bullish trend or a bullish reversal. Adversely, a significant price decrease with a significant volume increase can point to a continued bearish trend or a bearish trend reversal.

In general, it can be important for technical analysts to include volume charts in daily charting diagrams. Volume charts are usually available below a standard candlestick graph. These charts will also usually display moving average trendlines. Incorporating volume into a trading decision can help an investor to have a more balanced view of all the broad market factors that could be influencing a security’s price which helps an investor to make a more informed decision.

Volume Indicators

In technical analysis, there are two popular indicators designed specifically to support investors that incorporate volume into their trading decisions. The Positive Volume Index (PVI) and Negative Volume Index (NVI) were developed by Paul Dysart in the 1930s. These indexes increased in popularity in 1975 when they were discussed in a 1976 book titled "Stock Market Logic" by Norman Fosback.

The PVI and NVI are both based on the previous day’s trading volume and a security’s market price. When trading volume increases from the previous day the PVI is adjusted. When trading volume decreases from the previous day the NVI is adjusted. These basic index calculations show how volume is affecting price.

When PVI increases or decreases, it means that price changes are being driven by high volumes. Conversely, when NVI increases or decreases it means that prices are fluctuating with little effect from volume.

Calculating the Positive Volume Index

If current volume is greater than the previous day's volume:

 PVI = PVI p r e v i o u s + ( CP t o d a y CP y e s t e r d a y CP y e s t e r d a y ) PVI p r e v i o u s where: PVI p r e v i o u s = The previous PVI CP t o d a y = Today’s closing price CP p r e v i o u s = The previous closing price \begin{aligned} &\text{PVI} = \text{PVI}_{previous} + \left(\frac{\text{CP}_{today}-\text{CP}_{yesterday}}{\text{CP}_{yesterday}}\right) * \text{PVI}_{previous} \\ &\textbf{where:}\\ &\text{PVI}_{previous} = \text{The previous PVI}\\ &\text{CP}_{today} = \text{Today's closing price}\\ &\text{CP}_{previous} = \text{The previous closing price}\\ \end{aligned} PVI=PVIprevious+(CPyesterdayCPtodayCPyesterday)PVIpreviouswhere:PVIprevious=The previous PVICPtoday=Today’s closing priceCPprevious=The previous closing price

If current volume is lower than the previous day's volume, PVI is unchanged.

Negative Volume Index

If current volume is less than the previous day’s volume:

 NVI = NVI p r e v i o u s + ( CP t o d a y CP y e s t e r d a y CP y e s t e r d a y ) NVI p r e v i o u s where: NVI p r e v i o u s = The previous NVI CP t o d a y = Today’s closing price CP p r e v i o u s = The previous closing price \begin{aligned} &\text{NVI} = \text{NVI}_{previous} + \left(\frac{\text{CP}_{today}-\text{CP}_{yesterday}}{\text{CP}_{yesterday}}\right) * \text{NVI}_{previous} \\ &\textbf{where:}\\ &\text{NVI}_{previous} = \text{The previous NVI}\\ &\text{CP}_{today} = \text{Today's closing price}\\ &\text{CP}_{previous} = \text{The previous closing price}\\ \end{aligned} NVI=NVIprevious+(CPyesterdayCPtodayCPyesterday)NVIpreviouswhere:NVIprevious=The previous NVICPtoday=Today’s closing priceCPprevious=The previous closing price

If current volume is higher than the previous day's volume, NVI is unchanged. Many investors believe that noise trading is a significant factor for the Positive Volume Index. Therefore, the Negative Volume Index is often followed for its insight into professional traders' market activity.