Does high trading volume indicate a good or bad stock?

ByMatt Krantz, Usa Today
April 04, 2012, 8:43 PM

— -- Q: When a stock is actively traded in terms of volume, does that mean it's a good or a bad investment?

A: Used car buyers often take comfort knowing they're buying from the original owner. And sometimes house buyers like to know that the selling family has lived there awhile.

When it comes to cars or houses, constantly flipping might indicate there's something wrong. There's a reason why the property is being dumped. And buyers don't want to buy another person's problems.

But stocks are much different. Just because a stock is bought and sold frequently, and has high trading volume, doesn't tell you much about the quality of the investment.

There are many factors that determine how frequently a stock trades. Stocks with lower per-share prices, for instance, tend to have higher trading volumes simply because the same dollar investment translates into more shares. And just because a stock has a higher per-share dollar price doesn't mean it's a better investment than a stock with a lower per-share price. Similarly, large companies with many shares outstanding tend to have high trading volume.

Trading volume can also spike around the release of news, as investors scramble to buy and sell as they digest the new information. And other stocks tend to have high trading volumes because they're in the news or of special interest to investors.

Don't confuse trading volume with long-term intentions by investors either. A bulk of the market's trading volume is simply buying and selling done by computers programmed to fire off trades. These computer programs don't even know what the companies do, nor do they care. They're just trading in nanoseconds trying to make a quick buck on short-term moves.

Some investors combine trading volume with price moves to glean insights. For instance, some investors might look at a big price move, either higher or lower, as more meaningful if it comes on big volume. Conversely, some investors would distrust a big move higher, and think it's a fake rally, if it is done on low volume.

Heavy stock trading can present some benefits to investors. For instance, the more buying and selling in a stock, the closer the bid and ask price of a stock gets. That's a technical way of saying that when investors buy or sell a heavily traded stock, they tend to get a more fair price. It's just as when you sell an item on eBay. If many people are bidding on the product, as a seller, you're more likely to get a price that's closer to what the object is actually worth than if only one person is bidding.

But overall, the fact some stocks are more heavily traded than others doesn't tell you much about the future prospects of a stock, but is a key aspect of short-term trading.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz

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