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Friday, March 13, 2009

Interpreting Volume and Open Interest for the Futures Market

VOLUIME & OPEN INTEREST
The Beginning and End of the Day
It should be noted that volume is expected to be clustered on both ends of the trading day. In the morning, orders are entered into the market early as traders are reacting to overnight news and events as well as the previous day's data that is calculated and analyzed after the close. The end of the day is active due to traders juggling for position based on today's price movements. Closing price is typically the most dependable value of the day.

Chart Patterns
The volume of intraday trading displays typical chart patterns, such as a rounded bottom formation demonstrating lowest volume in the late morning when the traders take their breaks. The patterns of individual issues, however, may differ from these patterns. European currencies, for example, show more sustained high volume through late morning due to the prevalence of European traders in the markets at that time. To account for such patterns, compare today's 30-minute volume for a specific time period with the previous average volume for the same period.
Interpreting Volume using Open Interest
Open interest is the measurement of those participants in the futures market with outstanding trades. Open interest is the net value of all open positions in one market or contract and portrays the depth of volume that is possible in that market. A market with a low number of contracts per day but also a large open interest tells the trader that there are many participants who will enter the market only when the price is right.
New interest in a market brings new buyers or sellers, which increases the value of open interest. When the open interest increases with a correspondingly quick rise in prices, more traders are likely entering long positions. That said, for every new buyer of a futures contract there must be a new seller, but the seller is likely to be looking to hold a position for a few hours or days, hoping to profit from the ups and downs of price movement. The open interest is attributed to the position trader, but such a trader is willing to hold the long position for a much longer period of time. If the prices keep rising, the longs will have the ability to hold their position for a greater period of time while the shorts are more likely to be forced out of their positions.

Some rules of thumb for interpreting changes in volume and open interest in futures market are as follows:
  • A rising volume and a rising open interest are confirmation of a trend.
  • A rising volume and a falling open interest suggest position liquidation.
  • A falling volume and a rising open interest point to a period of slow accumulation.
  • A falling volume and a falling open interest depict a congestion phase
Volume and open interest can be used in a practical sense to guide one's trades as follows
  • Open interest increases during a period of an exhibited trend.
  • During the accumulation phase, volume may decline while open interest builds, but volume occasionally spikes.
  • Rising prices and a declining volume or open interest indicate a pending change of direction.
These rules, however, have exceptions, especially on days or at times when volume is expected to differ from the "norm". For example, volume is usually lighter on the first day of the week, on the day before a holiday, and during the entire summer period. Also volume may actually be heavier on Fridays and Mondays during a trending market. Liquidation of positions often occurs before the weekend, with positions being re-entered on the first day of the week. Finally, volume is heavier on a triple witching day, when stock-index futures, stock-index options and stock options all expire on the same day.
In a nutshell
Volume and open interest are integral measures to guide one's trading decision on the futures markets, but as always, these indicators should be considered in relation to extraneous market events.
All the very best in your trading endeavors!

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