How to Use Volume to Avoid Small Stock Disasters

Analyzing volume can prevent you from making a huge mistake when you’re looking to buy a smaller stock.

In fact, other than price action, volume is one of the single most important indicators you should analyze before trading or investing. Volume can tell you so much about a stock’s potential that it should be the very first thing you look for when you pull up a chart.

Today, I want to use a couple of charts you have sent in to show you why proper use of volume data can make the difference between a good trade and a bad one.

But before I move on to our first chart, I want to remind you to keep sending in your tickers, charts and questions for me to review at editor@pennysleuth.com. I read all of your emails. Unfortunately, I have not been able to address every request. However, I am trying to find a better way to give you timely trading advice. I’ll be putting some plans into motion over the next week or two– so keep an eye on this space for details…

Let’s get back to our volume conversation…

Volume is simply the number of shares exchanging hands over any given time period. Here’s the go-to chart I use to show where you can find the data:

On most free charting websites, you can find volume bars located below the price (red box), with a separate legend indicating the values located on the left side of the chart opposite the stock’s price (blue box).

Volume is crucial because you’ll want to seek out liquid stocks for trades and investments. Let’s break down some reader mail to find out just how crucial volume can be when buying and selling smaller names:

When I had just started to invest I bought two stocks that I probably shouldn’t have… Coyote Resources (OTC:COYR) and Liberty Energy Corp. (OTC:LBYE).

Do I just sell them or hold with the possibility one or the other may go up at some point so I can recoup some of the loss?

- J.S.

I want to concentrate on the first stock, COYR. Here’s the chart:

The very first thing you should notice about this chart is that the stock hardly trades at all. There is absolutely no demand for this stock, which is what causes the erratic price swings.

Even if the price action looks bullish, you should avoid buying any stock that doesn’t trade regularly. If you buy an illiquid stock, chances are you will have difficulty selling your shares. That’s because there’s no one looking to buy shares. A lack of buyers creates all kinds of problems, including a wide bid/ask spread and inaccurate price information. You simply can’t trust the price of the most recent trade– you probably won’t be able to sell your shares without offering them for a much lower price.

I’ve been watching ASTI closely. Thoughts?

–F.P.

Here’s a chart for Ascent Solar Technologies (NASDAQ:ASTI):

Here we have a small stock that has attracted some attention. ASTI’s average daily volume is a little more than 200,000 shares. That’s pretty solid for a smaller company.

Now look at the chart. I’ve circled the big volume spikes. They’re appearing in all the right places. The volume is coming in on the big days when the stock is moving higher. So the volume is moving with the trend– a bullish sign. Also, notice how the volume began to dwindle in mid-July as the price consolidated. This also bodes well for ASTI. If volume again increases with a price breakout, you’ll have solid confirmation that shares will probably continue to move higher.

There’s a startling difference between the COYR chart and the ASTI chart– and it all comes down to volume. The next time you’re looking to buy a small-cap stock, don’t forget to make sure plenty of shares exchange hands each and every day. It will keep you from making a potentially costly investing error.