Use This Indicator to Increase Profit Potential

If you're new to trading, you must admit that all the information out there can be overwhelming. You have fundamental analysis, technical analysis, swing trading, day trading, and premarket trading tips for beginners to help ease the stress in getting started. If you try to pay attention to everything and apply what you have learned, you will not get anywhere. As is the case with most things in life, you're going to find the best results when you keep it simple. In this instance, we'll focus on one indicator, which is the relative volume. It's often referred to as RVOL by professional traders. These traders sometimes use relative volume to predict home run trades and so can you.

What Is RVOL?

Technically speaking, Relative Volume is a ratio that calculates the current volume to the average volume another day. In other words, is there more or less activity for that position on this day compared to other days? This indicator can tell us if flows are increasing or decreasing. If flows are increasing, it can indicate increased demand for a stock. The big advantage here is that institutional investors might know something before you do, which is why you're seeing increased action. If you go along for the ride, you can make money. On the other hand, you have to watch out for pump-and-dumps. This is when large players buy up stock to move the price higher, short it at its peak, and then leave you holding the bag.

In order to avoid this situation, it's highly recommended that you stick with large-cap stocks. They are bigger ships to turn and even big-money players can't influence those equities as much. In fact, even if they did, that can be good for you because you can buy more shares of a quality company at a lower price point.

Watch the Big Money

In most cases, you won't have to worry about a pump-and-dump. Most of the time, if you see a spike in relative volume, that's a pension fund or mutual fund buying or selling a position. If volume significantly increases when a stock is well below its 3-month or 6-month moving average, that might be an institution buying up shares. You want to jump in right away because once news gets out of this purchase, the momentum is likely to move higher, at least for a little while.

If you see a significant increase in volume when the stock is well above its 3-month of 6-month average, this could be an institution selling part or all of its position. In this instance, you might want to sell. Then again, you might not. If it's a company you believe in, hold firm, wait until the selling is exhausted, and buy more shares. You're taking a contrarian approach, which is often profitable.

The Home Run Trade

If your goal is to pull off the home run trade, then you can use relative volume as a key indicator. Whether it's institutional investors or not, if you see a spike in activity, there is a reason for it. If that activity is driving the stock price higher, it could be a positive sign for the future. The only problem with these moves is that they usually exhaust quickly. In order to protect yourself from that, set a price to sell half your position. If the price moves lower, you locked in some profit. If it's a situation where the momentum continues, you're still along for the ride. That's a win/win.

(Disclaimer: Devdiscourse's journalists were not involved in the production of this article. The facts and opinions appearing in the article do not reflect the views of Devdiscourse and Devdiscourse does not claim any responsibility for the same.)