What is Average Daily Volume?
Updated on 24 Feb 2020
When it comes to stock trading, average daily volume is kind of a big deal. How does this affect your portfolio? Let us explain!
What is Average Daily Volume?
As the name suggests, Average Daily Volume is the average number of shares traded within a day in a given stock. Due to this, it is also called the Average Daily Trading Volume. In the case of an average weekly trading volume, It is basically the average of all 7 values of the Daily Trading Volume. In terms of investment or finance in general, ADTV is an important metric as it gives an idea about the way the stocks have been performing, thus attracting different types of traders and investors.
The preferred ADTV value is high because it enables investors to enter and exit the trade with ease but it is not the same when the value is low. For lower values of ADTV, it becomes a lot more difficult for you to enter or exit at desired times. However, getting in during at the time of declining volume can benefit you when the volume increases the prices soar as well.
How does knowing the Average Daily Trading Volume in the market help you?
When there is fluctuation in average daily trading volume, it just shows how people have been reacting to a particular asset over the period of a week. The higher the value of volume, the less volatile it is and better for you to enter the market.
The fluctuations are not rapid and drastic. However, it does not mean that it stays this way all the time. If there is a big trade made then there will definitely be a fluctuation, either upwards or downwards.
The basic idea behind the concept of a higher average volume being the ideal scenario is the fact that it tells the market about the liquidity of the overall security. The higher the trading volume is for security more buyers and sellers will take part in the trading and hence result in an easier trade. When the volume is low, that is when there are larger spreads, which leads to a hike in transaction costs.
One of the biggest advantages of ADTV is that it helps you analyse the price action of an asset. An increasing volume gives you a hint or two about a possible breakout and conversely if there is no significant movement in the volume, it just says that the breakout will fail. It also tells you about the price of the share as well. Simply put, if the volume rises the prices should also rise and if this is not the case then it means that there is not enough interest for this rise in volume.
Another important trend that you need to keep in mind is that a steep price with steep increase in volume means just one thing that there is a strong possibility of price reversal. It is because at that price point and volume point, there is no one else to further increase the stake.
What is the difference between Average Daily Trading Volume and Open Interest?
With both ADTV and Open Interest telling us about contracts or trades made in a day, it is important to understand what makes them different. When we dissect both the factors, we can see how totally different they are. While ADTV tells us about the average of the daily trading volume with respect to a day in a particular stock, Open Interest tells us about how many open contracts are left at the end of opening and closing of various contracts to make transactions.
ADTV is basically just a raw number that tells you about the number of contracts exchanged whereas Open Interest gives you more information in terms of explaining how the transactions have affected the open contracts.
Are there any limitations of using ADTV?
The biggest limitation of using Average Daily Trading Volume is the fact that it is just an average and not an exact value. An asset can underperform or outperform other assets dramatically on any given day and hence ADTV does not give you a clear picture of how things are working. This is why you should always monitor the fluctuations of the trade to understand the trade and stock you are interested in. If it stays within your desired range of volume then you can keep investing in it.
Another significant limitation with ADTV is that when the volume goes higher or lower, it does tell you that there has been a major change in the asset or stock but it won’t tell you the exact change that caused this fluctuation. You will have to further check in detail to get the exact cause.
Now that you know that the average daily trading volume is of considerable importance and it does help you in your risk assessment and investment options. It sure is a great indicator of when to invest in a particular trade and when to not but it should not be the only factor that you keep track of.
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