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Understanding Your Trading Volume

Volume has always been an important part of trading. In general, high volume means more price movement, and thus faster profits. Volume, because it is a measure of how much of an asset is changing hands, allows you to see the level of popularity that a particular asset is currently experiencing. However, although it’s important, high volume is not necessarily a good thing. For example, if you are a long term trader, high volume can set back years of progress in just a few hours.
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The real truth is that you don’t need to overly worry about volume in most instances. Instead, focus on direction and momentum and the volume part will take care of itself. Yes, it’s great to hop onto something when a huge volume is moving it in the direction that you want it to go. This will inevitably bring bigger returns for you, and that’s never a bad thing. But in all honesty, this seldom happens. If you look at a chart comparing the price of the S&P 500 with a volume chart overlaid upon it, you will see that volume has been consistently dropping since mid-2006 and current volume is below where it was in 2000, 14 years ago. And if you read the news, you also know that this index just hit an all-time high. In other words, price can go up regardless of how much is being traded.

Obviously, you want to capitalize on high volume when it does happen, but you shouldn’t just be sitting around waiting for this. Your trading should be pointed and direct, but if you wait for only the very best opportunities, you will probably never make a single trade. For one, it’s impossible to tell when something like this is going to happen before it does with 100 percent accuracy. And two, it is going to lose you money over the long run–something that is to be avoided at all costs. Let’s see why this is.

Assume you are making only the very best trades–the ones where movement is guaranteed to happen because you KNOW that there will be a high volume. It is possible to predict this, although not with complete accuracy. But if you think there will be something like double or triple the regular volume of trading, odds are it will at least be a little higher, even if it’s not as high as expected. How often do you think you will be right with your prediction? If it were a big number, there would be many more traders out there making money, but in actuality, most people lose money trading. So even if you are extremely skilled, an accuracy rate of 80 percent is unbelievable. So you are investing $1,000 every time something like this happens–and we’ll be generous and say that it happens 10 times per year. So you are risking a total of $10,000, but you are correct only eight of the ten times. Let’s assume a 50 percent change in every instance. So you are losing $1,000 off the bat, and gaining $4,000, for a profit of $3,000. This is not a big number.

If you were to make, instead, 1,000 little trades of $100 each, with only a 15 percent change every time and a 65 percent chance of success (very doable!), would things be different? Your losses would be $5,250. Your profits would be $9,750. So in this instance, where you have many more trades at smaller prices and with far less profits per trade, you are actually gaining a total of $4,500. That’s $1,500 more over the course of the year. Again, this is not a big number, but it’s also way better than the previous example. As you can see, if you do it right, simply by grinding out trades with realistic certainty on a consistent basis, you give yourself the potential to make a lot more money.

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