Don’t Ignore a Stock’s Volume

Chart School: Why Volume is Vital

While many investors these days are familiar with charts in a general sense, too few pay attention to one key aspect of stock charts—volume. That’s why we’ve written about volume on this page before, and now is a good time to do so again.

Simply put, when the market finally gets going on the upside, paying special attention to outrageous volume spikes among individual stocks and sectors will allow us to clue in on the advance’s best stocks, and help us avoid (or quickly sell) the losers. Huge volume spikes are unmistakable signs that huge institutional investors are at work; they are so big they can’t hide their massive buying and selling actions.

And the good news for us is that these institutions generally accumulate (or distribute) shares over a period of weeks and months. So large increases in volume are your first clue that the deep-pocketed big-money crowd is beginning to jump onboard.

Where are we seeing volume spikes in the current environment? Honestly, not that many areas … which is one reason you should go slow when the time comes to wade back into the market. If we saw dozens of stocks exploding to new highs (or new multi-month highs) on big volume, it would be a different story. But that’s not yet the case. (All charts are from 2009.)

Back to individual situations, earnings gaps are always a good place to look for new, potential winners. Myriad Genetics (MYGN), is a leader in cancer predisposition testing, taking personalized medicine to the next level, reported an outstanding quarter last week, and the stock jumped 17% to new highs on volume that was nearly five times average.

Another example is Knight Securities (NITE), a company that has its hands in a couple of Wall Street-related pies, including market making and trade execution services. The growth numbers aren’t compelling (sales and earnings up 28% and 12% in the fourth quarter), but volatility in many markets helps the company, and the stock has enjoyed a few weeks of strong-volume gains this year after releasing earnings.

We also like to find big volume increases across an entire group, which gives you confidence that the move is for real. An example these days is the for-profit education group; many have reacted well to their earnings reports, but the breakouts in this sector came a few weeks ago. The weekly chart of Corinthian Colleges (COCO), shown here, displays five straight weeks of mushrooming volume as the stock explodes higher. ITT Educational Services (ESI) has a similar pattern.

You can even use volume to spot potential turnaround situations. Homebuilders, for instance, are far from our favorite group, yet many stocks in the sector have leveled out for months, and just last week, volume spiked as investors looked ahead to (another) government banking plan, as well as possible housing help in the stimulus package. Meritage (MTH) is one example, though the stock has plenty of work to do before we can say it’s in an uptrend.

On the flip side, investors who ignore volume messages can hang on to a broken stock far longer than they should … and lose big money in the process. Sequenom (SQNM), for instance, has unbelievable potential with its prenatal test for Down syndrome, but the enormous selling volume over the past two weeks means, at best, the stock needs weeks and months to rebuild a new launching pad.

If there are going to be big winners emerging, we expect volume clues to lead us to the best stocks to buy in the weeks ahead, as institutions rush to build positions in the market’s next batch of leaders.

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