Understanding the meaning of internal and external markets to interpret short-term capital flow directions

When analyzing stocks, do you often see the terms “internal volume” and “external volume” but not understand their meaning? Or have you heard investors discuss the “internal-external volume ratio” but feel confused? Actually, understanding the concepts of internal and external volume isn’t complicated. These indicators directly reflect the initiative level of buyers and sellers in the market, helping us quickly judge short-term capital flow and price momentum. This article will guide you step-by-step from a practical perspective to understand the meaning of internal and external volume and their specific applications in trading.

What are internal and external volume? The logic behind active buying and selling

To understand the meaning of internal and external volume, first, you need to grasp the core logic of “who actively drives transactions” in the stock market.

Before a trade occurs, there are two types of orders in the market: the “ask price” (sell order hoping to raise the transaction price) and the “bid price” (buy order hoping to lower the transaction price). Actual transactions happen when investors break this balance—

When buyers don’t want to wait and purchase directly at the “bid price,” it indicates buyer initiative to chase the price. This transaction is recorded as external volume, representing active buying and signaling bullish sentiment.

When sellers don’t want to wait and sell directly at the “ask price,” it indicates seller initiative to cut prices. This transaction is recorded as internal volume, representing active selling and signaling bearish sentiment.

For example, in TSMC: suppose the bid side shows 1160 yuan / 1,415 lots, and the ask side shows 1165 yuan / 350 lots. If you urgently want to sell and execute a trade at 1160 yuan for 50 lots, these 50 lots go into internal volume (seller actively matching buyers). Conversely, if you urgently want to buy and execute at 1165 yuan for 30 lots, these go into external volume (buyer actively matching sellers).

In simple terms: internal volume reflects seller urgency, external volume reflects buyer willingness to chase the price.

Level 5 quotes: the intersection of orders and transactions

Most investors open their brokerage app and see the Level 5 quotes, but many don’t understand their true meaning.

Level 5 quotes consist of two parts: the top five bid orders (usually shown in green) on the left and the top five ask orders (usually in red) on the right. The bid side lists the five highest current bid prices, and the ask side lists the five lowest current ask prices. Each entry shows the price and the number of lots.

For example, “Bid 1 at 203.5 yuan / 971 lots” indicates the highest bid is 203.5 yuan with a demand of 971 lots; “Ask 1 at 204.0 yuan / 350 lots” indicates the lowest ask is 204.0 yuan with 350 lots available.

Important: Level 5 quotes only show pending orders, not actual transactions—they can be withdrawn at any time. Only when an investor actively executes a trade does the transaction appear as a deal, which then enters internal or external volume. Only then does the meaning of internal and external volume truly manifest.

The internal-external volume ratio: a key indicator of buying and selling strength

Now, let’s move to practical application. Short-term traders are most concerned with whether the main transaction volume flows into internal or external volume, which is the core value of the internal-external volume ratio.

The calculation is simple:

Internal-External Volume Ratio = Internal Volume ÷ External Volume

Based on the ratio:

• Ratio > 1: Internal volume exceeds external volume, indicating market bearish sentiment, sellers actively cut prices, a bearish signal. If accompanied by increased trading volume, short-term upward momentum is stronger.
• Ratio < 1: External volume exceeds internal volume, indicating bullish sentiment, buyers actively chase prices, a bullish signal.
• Ratio = 1: Buying and selling forces are balanced, market is in stalemate, lacking clear direction; wait for stronger signals.

Practical applications of internal and external volume: three key scenarios

Once you understand the meaning of internal and external volume, the key is to apply it in actual trading. The following three scenarios are most common:

Scenario 1: Healthy bullish or bearish signals

• External volume > internal volume + price rising = buyers actively pushing up the price, a healthy bullish sign. If combined with increased volume, the short-term upward momentum is even stronger.
• Internal volume > external volume + price falling = sellers actively offloading, driving the price down, a healthy bearish sign. Increased volume indicates greater downward pressure.

In these cases, the internal-external volume signals align with price movement, making them the most reliable basis for trading decisions.

Scenario 2: Beware of main players inducing buy or sell traps

• External volume > internal volume but price sideways/down, with fluctuating volume = potential “bull trap.” Major players may deliberately place ask orders to attract retail buyers, secretly offloading. Usually shown as: price consolidates, external volume dominates, but ask orders (sell side) 1-3 continue to increase, then the price suddenly drops.
• Internal volume > external volume but price sideways/up, with fluctuating volume = potential “bear trap.” Major players may deliberately place bid orders to induce retail selling, secretly accumulating positions. Shown as: slight price increase, internal volume dominates, but bid orders 1-3 keep piling up, then the price continues higher.

In these situations, it’s necessary to combine volume changes and order book anomalies to judge; relying solely on internal/external volume signals can be misleading.

Scenario 3: Complex market environment

Sometimes, internal volume exceeds external volume, yet the price continues to rise. This is often due to other factors like market sentiment, news, or fundamentals influencing the trend. This reminds us that internal and external volume alone cannot fully explain price movements; they should be used alongside other analysis tools.

Support and resistance zones: combining with internal and external volume strategies

Besides buying and selling strength, technical analysis also focuses on support zones and resistance zones.

When the price drops to a certain level and stops falling, it indicates strong buying interest at that price—support zone. Investors here believe the price is cheap and expect a rebound, so they may consider long positions.

Conversely, when the price rises to a certain level and stalls, it indicates a resistance zone. This often occurs when stocks decline from high levels, and those holding at that price are reluctant to sell at a loss. When selling pressure accumulates, even strong buying may struggle to break through.

Practical trading strategies:

• Buy near support zones, sell near resistance zones
• Trade within support and resistance ranges

Breaking below support or above resistance often signals trend reversals—either a downtrend or uptrend continuation. Combining internal and external volume analysis helps confirm the validity of these zones, greatly improving accuracy.

Why you shouldn’t rely solely on internal and external volume: pros and cons

Advantages of internal and external volume:

• Real-time updates: Data is synchronized with transactions, reflecting active market behavior instantly.
• Simple to understand: The concepts are straightforward and intuitive.
• Supports order book analysis: When combined with pending orders and volume, it enhances short-term trend judgment.

However, there are clear drawbacks:

• Susceptible to manipulation: Major players can artificially create internal/external volume data through placing and withdrawing orders, leading to potential deception if used alone.
• Only reflects immediate behavior: It shows real-time activity but doesn’t indicate long-term trends.
• Lacks context: Without considering volume, technical, or fundamental analysis, it can lead to misinterpretation.

Therefore, internal and external volume are just tools in the technical analysis toolbox, not standalone decision-makers.

Investment advice and summary

Understanding internal and external volume is fundamental in stock trading, but investing involves more than that. A comprehensive decision should include:

1. Technical analysis: internal-external volume ratio, support/resistance, volume, chart patterns.
2. Fundamental analysis: company financials, industry outlook, valuation.
3. Risk management: stop-loss points, capital allocation, emotional control.

You can practice trading with Mitrade’s demo account, which offers $50,000 in virtual funds, allowing you to experience the practical application of internal and external volume concepts without risking real money.

Mastering internal and external volume is just the beginning. Applying it flexibly in real trading, continuously adjusting strategies, and building your own trading system are the true paths to becoming a successful investor.