Using average volume as one of several data points for investing decisions was popularized, in part, by William O’Neil’s How To Make Money In Stocks. O’Neil stressed two reasons to pay attention to ADTV: to make sure a stock is liquid enough to get in and out of it quickly and to make sure the current supply and demand of stock traders was on your side. When a stock’s price is falling, you want its daily volume to be less than the average daily volume—to signal that the selling pressure is going down. When a stock price has consolidated and is not rising much, you want to see rising volume as the price starts to increase to signal more buyers entering the market. When the stock price is rising, you want increasing volume to signal that it will keep going.
How Average Daily Trading Volume Works
To understand how daily trading volume works, it’s best to go look at a stock’s volume numbers through a website like Morning star. Take Best Buy’s (BBY) volume numbers on the Morningstar website, for example: You can see on the right side of the page that Best Buy’s volume on this day was 1.6 million shares and its average is 2.2 million. Morningstar calculates the average based on the trailing twelve months—other websites may use different lengths of time. According to this page, Best Buy’s current volume is more than 25% less than its average. Let’s take a look at the chart and see what’s going on. We can see on the chart that, at one point, the stock price fell from around $125 to $112 a share. We can also see on the volume chart on the bottom that the start of that fall was on a high volume day. Now that the volume has stabilized you can wait for the price to consolidate and volume to start moving up with buying pressure (if you think the stock is a buy). The other thing to look for with average volume is whether the stock is liquid enough. The more thinly traded the stock is, the riskier it can be—if there aren’t a lot of shares trading just one seller can push the price down. Traders who aren’t looking to hold onto a stock for the long-term look for 100,000 to 500,000 shares trading each day on average, although that number isn’t set in stone and can vary depending on what your investing goals are. In the above chart, Best Buy’s ADTV is around four times that volume. Note that this rule of thumb is intended for traders and speculators who don’t intend to hold stocks for the long term. If your goal is a five-year holding period, you will only need to worry about the average daily volume if it is close to the position you’re trying to start. You can also find historical volume data on financial websites and use it to calculate the ADTV in any term you want. Simply export the numbers into Excel and use the average formula.
