The Neglected Essentials
Volume represents the activity of traders and investors. Each unit of volume represents an action of a trader selling a contract and another trader buying a contract. Changes in volume can show us how bulls and bears react to price swings, which can be used as clues for identifying trend reversals. Comparing the volume of 2 markets can show us which is more liquid than the other.
Trading rules on volume:
- When the volume reaches a new high, and prices reach a new high as well, the prices are likely to rise.
- If the volume reaches a new high and the markets reach a new low, it signals a selling opportunity.
- If volume shrinks and a trend continues, then we can expect a trend reversal.
- When volume dries up while prices are falling, it shows a reaction to a particular stock is nearing an end, it signals a good buying opportunity.
There are several volume-based indicators which a trader can use:
1) On - Balance Volume – This indicator is designed by Joseph Granville. OBV can be used as a leading indicator because it often falls and rises before prices do. A new high in OBV shows that bulls are powerful, and prices are likely to rise.
Trading signals for OBV:
- When OBV reaches a new high, it indicates that the markets are about to rise even higher, giving a buy signal.
- OBV can give its strongest trading signals when it shifts from prices.
- When prices are in a trading range, OBV breaks to a new high, it gives a buy signal, and vice – versa.
2) Accumulation/Distribution - This indicator tracks differences between the opening and closing prices, along with its volume. It was initially developed as a leading indicator but most traders apply it to futures. The greater the spread between opening and closing price relative to daily change, the greater the change in Accumulation/Distribution.
1.When A/D reaches a lower peak, but prices rise to a new high, it gives a short sell signal.
2.When prices fell to a new low but A/D stopped at a higher low than during its previous decline. It signifies that a rally is coming.
3) Open Interest:
Open Interest is the outstanding number of contracts that have not yet expired/squared off by traders on a given day.
Most exchanges release open interest data one day later than their price information. If open interest does not drop during a rollover, it shows a strong commitment among traders for an existing trend, which is likely to continue.
A 10% change in open interest requires serious attention. The higher the open interest, the more active the market, and the less slippage we will risk while getting in and out of positions.
Trading rules for open interest (OI):
- When OI rises during a rally, it is a signal of an uptrend, which indicates a buy signal.
- When OI rises while prices fall, it means that bottom pickers are active in the market, it is a short sell signal.
- If OI rises while prices are relatively constant, it is a bullish sign, meaning hedgers are currently shorting the market and vice-versa.
- If OI is falling majorly, a short sell signal is generated.
- If markets are declining and the OI’s are falling, then we should cover our shorts and prepare to buy.
- If OI’s are constant but the markets are rising, it shows that the majority of the gains have already been made.
4) Herrick Payoff Index (HPI):
The HPI detects accumulation and distribution and tracks open interest as well as prices and volume. HPI confirms valid trends and helps to catch reversals.
The author then says that traders need to keep a measure of time when planning trades. A market analyst who is aware of time can see a dimension hidden from the mass universe.
Long term price cycles can help us in understanding an economy. The U.S stock market generally runs in 4-year market cycles because the U.S presidential election runs every 4 years, during which the markets get inflated.
Major cycles in agricultural commodities are due to the mass psychology of producers and production factors.
Generally, long term cycles are better than shorter-term cycles because they identify major tides. A good method for finding a market cycle, such as MESA or Fourier Analysis is extremely useful.
Trading rules for HPI:
- A bullish divergence is created when prices fall to a newer low and HPI hits a new lower bottom, this is a buy signal. When an HPI turns up from its second bottom, we should buy the stock and place a protective stop.
- A bearish market occurs when prices rally to a new high and HPI goes to a lower top. The signal to short sell is when HPI goes down from its second top. We can place a protective stop above the latest high price.
The author briefly touches on the point of time for a trader and says, “A market analyst who pays attention to time is aware of a dimension hidden from a market crowd”
The idea of seasons can be put to the financial markets. A trader can look to buy in spring and look to sell in the summer.
The author provides a course of action for seasons:
The concept of season indicators shifts the focus of a trader's attention on the passage of time in the market. It helps in planning a season instead of making sudden decisions with a crowd.