Volume and sentiment indicators: reading the crowd behind a price move

Volume and sentiment indicators try to answer one question: how many people stand behind a price move, and how do they feel? A rise on heavy trading, across many shares, is read as stronger than a rise on thin trading in a few.

They are clues, not forecasts. In thinly traded shares, after one big block trade, or when the whole crowd already agrees, they can point the wrong way.

Volume and value traded

Volume is the number of shares that changed hands in a period. Value traded (turnover) is the money that changed hands: shares times price.

The CMT Association, which certifies technical analysts, describes technical analysis as studying patterns in market data such as price, volume and momentum. Volume is the part that tells you about participation.

Every trade has a buyer and a seller. So high volume does not mean "more buyers than sellers". It means many people disagreed strongly enough about the price to trade.

"Normal" means compared with the same share's own recent average. A busy day for a small company can be a quiet day for a large one.

Turnover matters because share prices differ a lot. A million shares at $1 is $1 million; a million shares at $50 is $50 million.

On-Balance Volume (OBV)

OBV was developed by Joe Granville, who explained it in his 1963 book Granville's New Key to Stock Market Profits. It keeps a running total of volume with a simple rule, as StockCharts describes it:

• Close higher than the day before: add that day's volume.
• Close lower: subtract it.
• Close unchanged: OBV stays the same.

Granville's idea was that volume comes before price. A rising OBV is read as buying pressure; a falling one as selling pressure.

Worked example (example, not market data)

A made-up share over six days. The first day is the starting point, so OBV starts at 0.

The price rose from $20.00 to $20.80, or 4%. Up days carried 200,000 shares; down days only 50,000. OBV climbed to 150,000, so it "confirms" the rise.

Day 5's value traded was 120,000 × $21.00 = $2,520,000. Day 3's was 30,000 × $20.30 = $609,000.

The catch. Now add day 7: the price closes 10 cents higher at $20.90, but one block trade of 500,000 shares went through. OBV jumps to 650,000. A 10-cent rise, from one buyer and one seller, outweighs all six days before it.

StockCharts notes that the level of OBV is not important, only its trend, and that volume spikes can throw it off.

VWAP: the day's average price, weighted by volume

VWAP (volume-weighted average price) is the value traded divided by the shares traded, within one trading day. It resets each morning.

Example, not market data: three trades of one share in a day.

VWAP is 102,200 ÷ 5,000 = $20.44. A simple average of the three prices would be $20.47, but most shares traded at $20.40, so VWAP sits closer to it.

VWAP was built for institutions placing large orders without disrupting the market. Traders also read price above VWAP as an up day. StockCharts warns that VWAP lags, like any average, and is meant for intraday charts only.

Market breadth: how many shares join in

A stock index is often weighted by company size. A few large companies can lift it while most shares fall. Breadth counts heads instead.

• Advancers vs decliners: how many shares closed up and how many closed down.
• Advance/decline (A/D) line: a running total of advancers minus decliners each day.

Worked example (example, not market data)

Say the index still rose on day 3 because a few large companies went up. The A/D line falls while the index rises. Analysts call that a divergence, a sign the rally is narrowing.

The limit: every share counts the same, whatever its size or volume. Most listed companies are small, so breadth leans toward them.

Sentiment: how the crowd feels

Who bought and who sold

Some exchanges and data providers split trading by investor type, such as institutions and individuals, or local and overseas investors. Reports then say one group was a "net buyer".

Example, not market data. Say institutions bought a net $50 million of shares in a day. Then the other groups together sold a net $50 million. Net flows always add up to zero, because every share bought was sold by someone. "Institutions were net buyers" only means another group sold to them.

The put/call ratio

Options give the right to sell (a put) or buy (a call) at a set price. StockCharts explains that puts are used to hedge against or bet on a fall, and calls on a rise. The ratio is put volume divided by call volume.

Example, not market data. If 1,200,000 puts and 1,500,000 calls trade in a day, the ratio is 1,200,000 ÷ 1,500,000 = 0.8. Above 1 means more puts than calls traded. Relatively high readings are read as excessively bearish, and relatively low ones as excessively bullish.

Volatility indexes and fear gauges

A volatility index turns option prices into a gauge of expected swings. The best-known is Cboe's VIX. Cboe says it measures the expected volatility of the S&P 500 over the next 30 days, implied by S&P 500 option quotes. A higher reading means options are pricing bigger moves, which often happens when markets fall.

Blended gauges go further. CNN's Fear & Greed Index, launched in 2012 for US shares, combines seven measures, including volatility, price strength and safe-haven demand, into a score from 0 (extreme fear) to 100 (extreme greed).

Sentiment is read two opposite ways:

Capital.com notes such gauges have given false signals. Neither reading is reliable alone.

Where these indicators mislead

• Low liquidity. In thinly traded shares, one order can create a "volume spike" and move the price. The SEC warns that thin trading makes it easier for fraudsters to manipulate a small share's price or volume.
• Block trades. One large negotiated trade shows up as huge volume and value, and swings OBV, without telling you about the crowd.
• Event days. A new listing, an index change or an options expiry can inflate volume for reasons unrelated to demand.
• Hindsight. Divergences look obvious on old charts. In real time, many never lead anywhere.

Limits: speculation and costs

Using these signals to buy and sell over days or weeks is short-term trading, which is speculation, not long-term investing. Each trade can carry a brokerage commission, small exchange fees and the bid-ask spread. FINRA reminds investors that "zero-commission" trading does not mean free investing.

Volume and sentiment describe what the crowd did. They say nothing about whether a company is worth its price.

Your plan

1. Read the market report. When you see "the index rose", check the advancers vs decliners. Was it broad or narrow?
2. Check the turnover. Compare it with recent days. If it jumped, look for a block trade, a new listing or an index change behind it.
3. Read the flows calmly. Remember that net flows add to zero. "Institutions bought" is one side of a trade, not a forecast.
4. Treat extremes as context. A high volatility index or "extreme fear" tells you about mood, not timing.
5. Keep your plan separate. Use these to understand market news, not to trigger trades. Your long-term plan should rest on your goals, costs and diversification.

What to watch out for

• Sudden volume in tiny companies. The SEC lists unexplained jumps in price or volume as a red flag in small, thinly traded shares.
• "Smart money" headlines. A group's net buying is one side of a trade, not a forecast.
• Gauges as triggers. A fear reading is a snapshot of mood. Selling into fear can lock in a loss you would otherwise ride out.

This guide is for education only. It is not advice to buy or sell any share or fund.