When Stock Volume Matters and Why

Companies and their shares of stock come in all shapes and sizes.  The amount of stock that trades hands daily also varies.

Contrary to convention, stock volume isn’t just about the size of the company.  Berkshire Hathaway (BRK-A) A shares are worth more than $210 billion, but only 509 trade hands on an average day.  Meanwhile, Coca-Cola (KO), which is valued at more than $180 billion has average daily volume of 6.7 million share.

Both of these are large cap stocks, but volume for Berkshire’s A shares is anything but large.

So, let’s take a look at two extremes – high and low volume stocks – and see how to approach each.

Low Volume Stocks

Here are a few common attributes of low volume stocks:

• Volatility – When a company sees very little daily trading volume, the price of the company’s shares tends to be more volatile. Remember that the whole business is priced on the last shares traded. If only a few thousand shares trade each day, then the price is more likely to bounce up and down, rarely making small advances or declines. Coca-Cola’s stock might move by .01% between each trade, whereas Berkshire Hathaway Class-A shares might move by 1-2%.
• Greater Opportunity – I think there is more opportunity for investors in low-volume companies. Because trades are few and far between, and there are usually fewer shareholders invested in low-volume stocks, low-volume stocks are more likely to move wildly on news events. Panics are frequent, as are undeserved bull runs. Investors can capitalize on mispricing opportunities better in low-volume stocks because small orders have more influence on a company’s stock price.

How to Approach Low-Volume Stocks

Always be sure to place a limit order when you buy or sell shares in low volume issues. A limit order is an order that is processed only if a buyer or seller is willing to accept the price that you want. Placing a market order in a low volume issue often means that you’ll overpay for your shares, since a market order is an order to acquire shares at any price immediately.

High Volume Stocks

Here are a few attributes of higher volume issues:

• Less Volatility – High volume stocks are less volatile. Prices change fluidly as several transactions are processed every minute, or even every second. Stocks that change hands rapidly tend to move slowly as the price makes “steps” up and down, rather than large percentage “jumps.”
• Smaller Spreads – Expect much smaller spreads between the bid and ask prices for high volume stocks. When so many people are buying and selling, and there are literally thousands of orders waiting to be filled at any minute, the difference between the bid price and ask price for any given stock is much smaller. For example, Coca-Cola might have a bid price of $80 per share and an ask price of $80.01 – a spread equal to .0125%. Low-volume Berkshire Hathaway Class-A shares often have spreads of .5% or more.
• Fewer Opportunities – High volume stocks won’t move as quickly as small volume stocks on news events. Trading tends to be more efficient, since there are more investors in the market for the stock at any one time.

How to Approach High Volume Stocks

It’s much safer to place market orders in high volume stock issues. Because so many shares are available for purchase at any one time, a market order will be filled at an average price very close to the current market price.

Do you look at the volume for a stock or ETF before placing a trade?