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Investment basics: why stock volume matters. A lot

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When first starting out investing, no matter what your time horizon at some point you'll be staring at your computer screen with an online broker stock screener, wondering what criteria to use. If it's a robust screener you could looking at dozens of choices. Stock volume is possibly the most important. Here is where the KISS method (Keep It Simple Stupid) comes in handy. Keeping in mind that you want a diversified portfolio of five or at most six stocks or ETFs. Any more than that as a beginner can be overwhelming until you fine-tune your trading style, risk tolerance, and refine your homework approach.

One of the things you need in any investment, whether its stocks, artwork, or classic cars, is a seller and buyer on each side of the deal. Assuming you are willing to part with the investment, once you have purchased it, it's worthless unless you can sell it. It may be 'worth' a million dollars but if you can't sell it -- no green will be in your pocket.

This holds true for equities. One of most important elements in any screen is stock volume. Volume = liquidity, and liquidity makes it easy to get into and out of positions. There's no arena more important when it comes to stock volume in emerging markets. Emerging market ADRs and ETFs' liquidity in particular can be as low as zero shares traded, with otherwise attractive ETFs like EMFN ( quote ) and FGEM ( quote ) falling into this category.

In some of these names a seller could be waiting for days before a buyer comes along, and by that time the price a buyer is willing to buy at could be far below your asking price.

Stock volume can be also be used to determine copulation on the sell or buy side of a big move. It can help you determine if all the sellers have been shocked out of their positions before a stock begins to recover.

Stock volume is what helps bring the bid/ask spread to the smallest delta; highly traded equities will have large volume and small bid/ask spreads.

Low volume ETFs also have a funny habit of being shut down. Just because it's listed doesn't mean it will remain if there is no interest.

You as the trader need to determine what your comfort level is for stock volume and how easy you want to get into and out of a trade. Remember, you could be sitting in a low volume name for a long time while the market falls apart. When I started out I made this mistake once, thinking 50,000 in volume was enough. The name moved higher, well into double territory, only to then find everyone attempting to exit at the same time. I watched the bid price drop 30% lower than my asking price.

Bottom line: Do yourself a favor and stay away from low stock volume names. Every broker and yahoo will give you the daily and 30-day average volume, and some will tell you the volume right next to the quote if its below average, average or above average. Professional traders stay away from low volume traps for very good reason.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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