How To Use Volume To Identify The Best Momentum Stocks

Volume is something you see mentioned everywhere in the trading world. But very few people explain how to interpret it, and what to actually look for.

If you are wondering how to use volume in your trading to find the best momentum stocks, you should read this article thoroughly. It is a crucial variable for determining a potential momentum stock, for day trading and swing trading.  

What Is Volume?

Volume is the number of shares that is bought and sold of a stock over a given time period. When you using candlestick charting, you will see the number shares traded on one candle stick, usually at the bottom of the chart, of whatever time frame you are looking at.

For example, if you look at daily chart time frame, you will see the number of shares traded each day of a stock. If you switch to the 5 minute chart, you will see the number of shares traded every 5 minutes of a stock.

The Importance Of High Relative Volume

The best momentum stocks have high relative volume. This means they are trading well above the typical number of shares they trade per day. Stocks will usually trade at above-average levels of volume when they are gapping up or down due to some type of catalyst, like earnings reports, FDA approval, or analyst upgrades or downgrades. Check out the daily of TWLO:

You can see on all of the days when it is gapping with higher than normal volume. TWLO usually trades about 3-4 million shares per day. However, on those days where it was gapping up or down with a catalyst, it trades between 10-20 million shares that day.

Notice that it also trades larger than its typical daily range that day as well, which is exactly what you want as a day trader, because this means you are likely to capture a big move in the stock if you get the right entry.  You can learn more about the characteristics of the best momentum stocks in this article here. 

How To Know When A Stock Will Have High Relative Volume

New traders will not only ask about how to use volume, but also how to know beforehand when a stock will trade at above-average volume. A stock that is gapping up or down more than 4% with a catalyst will usually be trading with higher than average volume that day.

However, another big indicator is to pay attention to how much volume comes into the stock at the market open in the first candle. Let’s look at the TWLO intra-day chart on 5/9 when it was gapping up in reaction to strong earnings:

You can see that it traded almost a million shares on its opening 5 minute candle, about a quarter of what it typically trades in a whole day in just 5 minutes. When you see this much volume come in this early in the day, there is a very high probability that it will trade at well above average volume that day.

Compare it to the opening 5 minute candle of a typical trading day. When you see a stock trading with that much volume at the open, is it a strong candidate to have momentum and go on a strong trend that day, especially when it has a breakout on the daily chart.  

Technical Breakouts and Breakdowns

Momentum stocks can still trade at above-average volume without a catalyst. Another cause of a stock trading at above-average volume is a technical breakout on the daily chart. Look at the SQ daily chart when it broke out in March:

You can see the volume that came into the stock after it broke out above that 48 level. Stocks just having technical breakouts will usually not experience as large of a volume increase compared to stocks gapping with some type of catalyst. However it is still a good indicator of when a stock could be beginning a strong trend intra-day, or on the higher time frames for a swing.

The best momentum stocks are stocks that are gapping above resistance (or below support for a short play) on an earnings catalyst, and are trading at above-average volume pre-market and at the market open.