Crank up the volume

Price, Float and Volume

What does price mean to you? How is price determined and what influences the direction it travels? For every buyer there is a seller, and for every seller there is a buyer but how is the price determined? Mass psychology is ultimately what influences the price of anything in life. Whether you are buying a car, house, tulips, or concert tickets, price is determined by supply and demand. Perception of value is determined by the greater fool. As long as demand outpaces supply, prices will continue to rise. When demand dries up and supply is plentiful prices start dropping to attract buyers.

An extreme example of this is the recent housing bubble that we experienced in 2007-2008. Housing prices skyrocketed because there was limited supply to satisfy the overwhelming demand. Everyone wanted to own a home and people that already owned were using them like piggy banks as prices hit stratospheric values. Eventually the bubble burst and prices came crashing down to earth bringing prices to ridiculously cheap valuations as fear took over and no one wanted to own a home. People were underwater and walked away from their homes damaging their credit and losing substantial amounts of personal wealth. The whole crisis nearly bankrupted our country and it was all created by supply and demand accompanied with a large dose of fear and greed.

On a smaller scale this battle occurs every day in the stock markets / individual stocks. With stocks there is a float. This is the total number of shares available for trade. Float is derived by subtracting closely held shares by insiders and institutions by the total number of outstanding shares. A small float would be anything under 100 million shares and would be considered a “Thin stock”. A really “Thin Stock” would be anything under 20 million. and liquidity is scarce meaning they are difficult to get in and out of because supply is not there. These will be the socks that have really wide spreads on the bid and the ask. They are also the stocks that can make a 20% to 100% move in a single day. They are extremely volatile and if you’re not careful you can get burned. Many of these stocks are often associated with “Pump and DUMP” campaigns where paid advertisers send out really fancy publications with all these potential scenarios that could possibly someday amount to a company becoming a huge behemoth because of their new product, technology or industry they are involved in. We will go over advertising campaigns, and press releases more in depth later.

It’s important to note that many penny stocks have a large float with hundreds of millions or even a billions of shares. When it’s trading @ .001 cents liquidity is still a problem and the price of the security can be easily manipulated with a relatively minimum amount of funds.You have to look at the market capitalization. Which is the number of shares outstanding multiplied by the current price. Pay close attention to the average daily volume. Chasing one of these stocks can be a very painful experience so caution is advised. You don't want to buy a couple hundred thousand shares of a penny stock that you are unable to sell 

     

A “Thick stock” is when you have over 500 million shares in the float and they are big corporations> not penny stocks. While these stocks are extremely liquid they are often less likely to make big percentage moves in a single day since there is too much supply. These are often huge corporations that have already experienced significant growth and have become so big that it becomes difficult for them to move the needle in earnings or growth. That is why these big companies start paying dividends or begin share buyback programs to reduce the float and try to attract value investors. They are slow movers but they provide a certain level of security since they often have tremendous balance sheets with very predictable earnings. This is the ideal type of stock for the long term investor that just wants to buy a stock throw it in his IRA collect the dividend and look at it again in a few years; Microsoft, GE, IBM, CSCO would all be good examples of “Thick Stocks”.

Getting back to price, what indicator can we use to help us determine mass psychology? What is it that can give us some insight into whether or not the price of a stock is being impacted by something substantial?

Let’s imagine there is a house going to auction. You pull up to the auction and there is a huge crowd out front of the property. A frenzy of bids start flying as soon as the auction begins, offers are coming in from all over the place the price is climbing at a rapid pace. People get bid out of the process because they hit their limit and the rise in price starts to decelerate. Attendees of the crowd begin packing it in and start heading towards their cars. There are just a handful of bidders left in the game and eventually the greater fool locks in the price and walks away with the keys. In their mind they are not a fool at all because they got what they wanted at a price they were willing to pay. Maybe they plan to live there for the rest of their life and they love the house so much it doesn’t matter to them if they overpaid a bit.In the stock market the last person to buy the shares at the highest price often becomes the"Bag Holder". That can change over time. They may be the "bag holder" in day trading terms but they could be huge winners on a swing trade or long term investment.

The more volume there is, the stronger the conviction is when it comes to the direction the price is moving. Volume is used to confirm trends and chart patterns. When a price moves up or down dramatically with high volume; it confirms the strength or relevance of the move. Volume can also help identify a trend reversal. Let’s say a stock has been trending down for several months or years and then jumps up 10 percent on 20 times its normal average daily trading volume. This could be the sign of a major trend reversal. If the price were to jump 10 percent on below average volume then the move clearly lacks conviction and should probably be viewed as a potential bull trap.

Volume should move with the current trend. If the price of a stock is in an upward trend then volume should increase and vice versa. If the price continues to rise but the volume is declining it could be a sign the trend is losing steam and weakness is starting to set in and the end of the run may be near. Divergences are created when a stock continues in a clear trend up or down but the volume is declining.

Example of volume confirmation