TraderNovice.com
No matter how new a trader to the profession, he or she still usually has an understanding of technical analysis. Understanding the movement of price over time is key to making assessments about future price changes. But often new traders, though familiar with trading volume analysis, will not always take the time to assess volume changes and incorporate them into the decision making process. This is a mistake.
Robert Rhea is credited with being one of the first to recognize the importance of trading Volume. His writings date from the 1920's and 30's.
Rhea commented on volume as follows:
Volume analysis applies to all markets. This is simply a measure of participation. When using technical analysis of any sort and charting stock and futures prices over time, it is important to include volume (and open interest) as a measure of participation at any given price level and with any given price directional movement. Price is certainly of the utmost importance. But volume should not be overlooked as a clue to the strength of a move.
Open interest, applies to contracts, and is therefore applicable to the futures market and not to spot markets like stock prices. It is important further to understand that the purchase and sale of a futures contract involves a buyer and seller. Not every purchase and sale will affect open interest. If one holder of a contract simply sells that contract to a new buyer, then the open interest has not changed, only the holder of the contract changed. However, if two new participants come to the futures market, one a new buyer and the other a new seller, then the open interest goes up because a completely new contract was created.
The volume of a given market, within a particular price movement, is thought to represent the urgency of that move, as it reflects participation. Higher volume indicates more pressure for the move to persist or continue, whereas lower volume represents the opposite. Though volume may be assessed in absolute terms, the most common method of interpreting volume is to assess it relative to other volume measurements. For example, if a market is stable and trading in a range, then on a given day breaks out and moves higher, we compare the volume on the breakout day to the volume over any of the stable trading range days and assess what happened. Did the volume on the breakout increase, decrease or stay the same, relative to the trading range days? By using such comparative measurements we can then make assumptions as to the strength of the move. Breakouts on higher than average volume indicate new participation and suggest that such a move will persist.
Any good trader will attest to the fact that the most money can be made by discerning the change of trend. In other words, those who recognize a new bull market early, for example, stand to make much more money than those who recognize the same thing late. Volume will always preceed price change in the change of a trend. Early clues that such a change is coming, will come from volume change,before price change.
If one is a stock trader it is of prime importance to understand the major averages, note whether they are trending or balancing, and recognize where in trend they might be. Much of the move of any stock is related to the movement of the overall indices. So if stock trading is your game, it is of primary importance that each and every day you take a minute to plot the movement of the major indices. And, just as importantly, you need to plot the volume associated with any day's move. A bull market that breaks to new new highs, but does so on lower than normal volume, suggests quite a different thing than a bull market breaking out on much higher than normal volume. The same is true for individual stocks
There are many ways to look at volume. Granville developed the idea of On Balance Volume, which essentially keeps a running total of volume on up days as positive minus the volume on down days (which is viewed as negative). The slope of the line created thus suggests accumulation or distribution. The chart below depicts price over time (upper graph) and on balance volume (lower graph).
In years past analysis of volume in the futures markets was not as simple as it is in stocks. Delayed volume figures release and limit days in commodities (which might show very light volume, but indicate very strong demand ........no sellers for example) could confuse the situation in the futures markets. Changes in reporting and in futures limits have made this less of an issue.
Many trading programs now are so sophisticated that real time volume can be assessed. Is this an advantage? An example would be in trading the long bond futures contracts. Programs like WindoTrader can not only plot price over time in market profile appearance, but can give real time contracts traded figures for each and every one of those prices. How is a trader to use this information? Is such information valuable?
Volume information is important and must be assessed. But in the situation of the futures market, and real time contract data on a second by second basis, sometimes more information is not necessarily better. Many times I have watched a bond contract increase in value and break out to new levels, only to see second by second contract volume reporting show low total volume. This might lead me to believe that the move would not persist, and I might go short, only to see volume slowly increase (and price continue to rise) as minutes passed. Sometimes more information may be too much information. This is one of those situations where each trader has to decide for himself what is, and what is not, helpful. But it bears mentioning that in the days when stocks and futures trading in the pits during very specific hours, with almost no trading outside of those hours, a trader had to trade by the end of the pit session or wait until the next day when sentiment and opportunity may have changed. Now that is no longer the case. Markets around the world trade at almost any hour, any day, and we are slowly moving towards round the clock trading in most instruments. With that in mind, an individual or business may not feel quite the push to force a trade during "pit"hours, and volume may enter the market in a slightly different fashion than in years past.
Open Interest as stated above, is the net number of contracts outstanding at the end of a given time period. It too measures participation. The interpretation of open interest is quite similar to that of volume, and is indicative of interest in the market being assessed. The higher the interest in that market, the more likely that the movement of that market will persist (ie bullish trends continue). Should the interest in that market began to wane with open interest falling, it would suggest that the movement of that market may slow or reverse. A fall in open interest preceeds a fall in price, only 15-20% of the time. But it does happen.
Interpreting open interest can also give a clue as to the cause of price movements. For example in a bullish trend, should price move sharply higher but open interest fall, this might indicate that higher prices are being caused by short covering (Those short are having to cover their contracts at higher prices.....thus those higher prices are not being caused by new interest, but by old shorts getting out).
On the other hand should a market start to fall, and move lower sharply as open interest is increasing significantly, this would suggest that new players are coming into the market and opening new short positions. This would suggest that such a move would persist.
Open interest can also be quite important in markets within a trading range. Should Open Interest be rising, yet the range persist, it may indicate that the breakout move, once it comes, will be of great strength.
Volume and Open Interest should be studied. One author who has spent much time and effort detailing these factors is Ken Shaleen in his book VOLUME AND OPEN INTEREST. You can find his book here on Amazon. I have the book, have read it, and have found it to be a valuable asset. Any trader would do well to have this in his library.
Mr. Shaleen makes many pertinent points in his book. I will review a few here, but you would do well to purchase the full text.
The past several years have seen dramatic changes in the way markets trade. Screen trading has become much more common than pit trading and the more computerized our systems have become, the more readily available volume and open interest figures have become. Any good trade recognizes the need to incorporate these figures into his technical analysis. Do not let a trend change find you lazy and unprepared. Review volume daily (and in the futures markets open interest) daily.