FOREX TRADERS CAN BENEFIT FROM FUTURES MARKETS INFO – Volume & Open Interest

FOREX Traders can integrate Futures data to help in trading decisions, such as taking a trading signal based on chart patterns in the Futures and translating it into a trading trigger signal in a FOREX market. Spot FX and Futures trade in tandem, and any price difference is called the “Basis”; it is generally geometrically equal on a day to day basis (within a few PIP’s). As we discussed previously, FOREX markets are decentralized, so there is not a collective data base to measure two distinct studies such as Volume and Open Interest. These are important tools so let’s review the basics.

Volume, the definition is, the number of trades for all the total contract months of a given future’s contract, both long and short, combined. For example, the Futures Foreign currency markets trade on quarterly expirations, the March, June, September and December contract months; the volume will represent the total for all the trades in each contract month. Most technical analysts believe that volume is an indicator of the strength of a market trend. It is also a relative measure of the dominant behavior of the market. Here is a further explanation; volume is the measurement of the markets acceptance or rejection of price at a specific level and time. There are several theories and so-called rules when using Volume analysis on price charts; the first one is, if a market is increasing in price and the volume is increasing, the market is said to be in a bullish mode and can indicate further price increases.

The exact opposite is true for a declining market. However, if a substantial daily market price increase or decrease occurs after a long steady up-trend or downtrend, especially on unusually daily high volume, it is considered to be a “blow off top or bottom” and can signal a market turning Point or trend reversal.

Here are some guidelines to use when using volume analysis.

• Increasing volume in a rising price environment signals excessive buying pressure and could lead to a substantial advances.
• Increasing volume while prices are falling may signal a continual fall in prices or a prolonged bearish trend.
• Decreasing volume while prices are climbing may indicate a plateau, and can be used to predict a reversal. Especially when prices make a higher high such as occurs with Divergence patterns, a decline in volume with a rise in prices is extremely bearish.
• Decreasing volume with a weaker price environment shows that fresh sellers are reluctant to enter the market and could be a sign of a future downtrend.
• Excessive volume while prices are high indicates that traders are selling into strength and often creates a price ceiling.
• Excessively low volume while prices are low indicates that traders are buying on weakness and often creates a floor.

Open Interest on the other hand reveals the total amount of open positions that are outstanding in existence and not offset or delivered upon. Remember that in Futures trading, this is a zero sum game, so that for every long, there is a short or for every buyer, there is a seller. The open interest figure represents the longs or shorts, but not the total of both. So when examining Open Interest, the theory or general guidelines are that when prices rise and open interest increases, this reveals that more new longs have entered the market and more new money is flowing into the market. This reflects why the price increases. Of course the exact opposite is true in a declining market.

Chartists combine both the price movement and the data from Volume and Open Interest to evaluate the “condition” of the market. If there is a price increase on strong volume and open interest increases, then this is a signal that there could be a continued trend advance. Of course the opposite is true for a bear market when prices decline. Also, if prices increases, volume stays relatively flat or little changed and open interest declines; this then reflects a weakening market condition. This is considered to be a bearish situation because if open interest is declining and prices are rising, then this shows that shorts are covering by buying back their positions rather than new longs entering the market. That would give a trader a clue that there is a potential trend reversal coming. Here is a guide as to how to identify an opportunity when there is a major top or bottom in the spot FOREX markets using this information.

• When observing a continued long term trend in a spot FOREX currency, if it trades as a Futures contract, whether it is in an up or down trend, when prices start to fluctuate with wider than normal daily price swings, or ranges, or is in an extremely volatile condition, if it is combined with unusually strong volume and a decline in open interest, this is referred to as a climaxing market condition. The market is getting ready to turn or reverse the trend.

In figure 3 the graph is a split chart with the Futures Euro Currency with the volume and open interest study. The Bar graph represents the Volume with the Open Interest overlaid by plotting a line measurement.

Notice after the peak in prices the volume was increasing as was the Open interest; this was warning that a trend reversal was forming rather than a small correction. Therefore, Spot FOREX traders would have a better decision making process that selling rallies and looking to take sell signals at resistance would be a more fruitful and profitable course of action.