TIP Academy
LESSON SUMMARY
In this lesson, we understand the importance of stock volume. Although the volume won’t help intelligent investors learn the intrinsic value of a company, it can be used as a tool to help predict market behavior.
Investors are often fooled into believing that the market price of a stock is determined by all the shareholders. This idea is false. When we look at the volume of a company on any given day, we can quickly get a sense of how many traders are actually determining the price of a stock when we compare this number to the shares outstanding. This ratio – volume/shares outstanding – provides a good idea about the number of traders moving into and away from the company. When the company trades at a very low volume, we can generally say that the shareholders agree with the market price. Likewise, if the volume is very high, we can generally say that the shareholders disagree with the market price.
In the video, we demonstrate this principal with Wells Fargo (WFC). When you look at the historical market price for WFC, you will learn that on the day the volume was the highest in ten years, the market price was at an all time low. This idea of shareholders disagreeing with the market price when the volume is relatively high is an important point that stock traders can use to their advantage. Always remember, volume can mean that the stock is overpriced or underpriced. The peak or valley is for you to discern.
The takeaway from this lesson can be summed up to the following:
- Remind yourself that traders only determine the price of the stock, not the value
- Stock volume can be an indicator for when to buy stocks or adjust your portfolio in general
LESSON TRANSCRIPT
Many don’t understand what volume actually shows about the current position in the value of the business. To understand volume, we will use a company on the stock exchange. It’s been in the news a lot, because of exemplary performance under stressful condition for finance companies. That’s Wells Fargo.
The current market price for Wells Fargo on July 6, 2012 was $32.99. In the video is a chart of the market price for Wells Fargo.
If you’ve been taking all these lessons, you probably noticed that I never showed you a market price chart for any stock. That’s because I don’t care what the market price of a stock is. I care about the value of the stock. This chart tells what other people have traded this company for and where it’s at right now.
Pull up the stock ticker of Wells Fargo, WFC, in MSN money to see the number of outstanding shares in the business. It takes you to the top level page for the company. To find out their shares, scroll down until you see “shares outstanding”. Wells Fargo has 5.31 billion shares.
In the video is a graphical representation of how many shares there are in Wells Fargo. The circle represents the entire company. The dots are symbolic of the shares. There are 531 dots inside the circle, and each dot represents 10 million shares. That’s a lot of shares, but keep in mind that there are 5.31 billion shares inside.
The volume the shares traded from one owner to another in a single day. Wells Fargo’s volume is 17.9 million shares traded on this day. This might make anyone who comes to the page and just goes straight to the volume to say, “Oh, wow! Almost 18 million shares were traded!” Actually, the number doesn’t mean a lot. It just sounds a lot, but you need to put that in context. What percent is that of the company that was actually traded?
The symbolic representation of all the shares in the company is the one little dot highlighted in red. Think about this. It’s just one dot out of all the 531 dots inside of that circle. Those people determine the market price. When you take steps back and think about that, that tiny dot is the group of people determining the market price for the entire company for all those other shareholders that are holding their shares of that business. Only that small group is actually determining that price. Keep in mind that they aren’t determining the value of the company. They’re just determining the short-term price of the company.
How can you use the volume to your advantage?
March 2, 2009 was the height of the stock market crash. The volume of shares traded on that day for Wells Fargo was 1.1 billion shares. Almost 1/5 of the entire company changed hands to new owners. That was the highest volume that Wells Fargo had in 10 years. How can you use this bit of information to your advantage as a stock trader?
When you go to the chart of Wells Fargo over the last ten years, right there is the lowest point of their market price. That should raise some interest for you. A large volume means the price is at peak or valley.
Now look at the numbers on Wells Fargo back on that day where they had enormous volume traded for the company. The market price was $7.50. The book value was $23.43. The EPS was $1.75. It wasn’t even in negative EPS situations as a bank stock. It was in positive situations. They’re also paying a dividend not listed in the video. There is 2.17 of debt for equity. Just to remind you, companies with debt to equity of.5 are recommended to be invested in. This debt to equity of 2.7 is extremely low for a finance company. However, it’s fine, because that’s their business.
When you view this while hitting all-time highs, you would’ve known this was probably not the bottom of the time for Wells Fargo. That’s easy for me to say 3 years later, but when you look at the number and volume being traded, a professional stock trader would identify this. The number of people selling shares far exceeds the number of people buying! It shows there are few people out here who aren’t scared and know the value of the company. They buy the shares of scared people who didn’t know the value of the company.
Use volume to your benefit!
Remind yourself that traders only determine the price not the value.
Use the volume to predict the right time to buy more assets or change into a better position.
LESSON VOCABULARY
Stock Volume
The stock volume is the number of shares that are being traded on any given day. This number should be compared to the shares that are outstanding. While it is hard to provide a stock volume threshold, a good indicator is to look at how the stock volume has developed over a period of time.
Shares Outstanding
The shares outstanding are the number of shares that are held by all shareholders. In the event that the company has bought back its own shares, those shares are no longer included in the number of outstanding shares.
