VOLUME INDICATORS: A KEY MISSING ELEMENT IN SPOT FOREX

Volume information is one of the most important components of technical analysis of
markets. Volume indicates the quantity of money flow into a particular investment instrument.
An increase in volume often precedes an increase in price, and a decrease
in volume is considered early identification of weakness. The best equity traders could not conceive of trading without volume data. Yet there is no volume data for spot forex
prices when trading through spot forex firms.
This lack of volume data makes many indicators offered irrelevant. Because volume
and changes in volume are highly related to indicators of sentiment and market psychology,
the forex trader needs to rely on technical indicators that act as a substitute for
volume data. For example, knowing that a currency pair is probing a daily support level
for a few days represents a great deal of volume at that daily support level. The position
of the currency pair price in relationship to support and resistance and how close it is
to either level becomes a good substitute for volume. Additionally, when economic data
releases comes out, the entire market focuses on the report, and the trader knows that
maximum volume is at these news events. Therefore, one of the best ways to overcome
the lack of volume data is to trade where there is certainty on maximum volume.
However, for those traders who want the best of all worlds, there is a way to obtain
volume data for the spot forex trader. Futures on currency trading include volume data in
the form of open interest contracts. This means that all of the technical indicators on the
futures side that include volume are valid. While trading the euro-U.S. dollar (EURUSD)
through the spot market, a serious trader could also observe the volume data of the
futures on the EURUSD contract. While this is cumbersome and involves extra cost,
those traders who favor using volume data to gain an edge in their trading are able to
overcome this gap. The limiting factor is that the maximum benefit of such volume data
occurs during U.S. trading hours only.
An additional volume-related data involves the Commitment of Traders (CoT)
Report. This is a weekly report from the Commodity Futures Trading Commission
(CFTC; available at www.cftc.gov/cftc/cftccotreports.htm) providing a breakdown of
each Tuesday’s open interest for markets in which 20 or more traders hold positions
equal to or above the reporting levels established by the CFTC. Open interest is broken
down by aggregate commercial, noncommercial, and nonreportable holdings. While
the data provided by the CoT Report is lagging (the Friday report reflects the previous
Tuesday’s data), when extremes are reached in positions by the noncommercials, it is
a situation that is especially noteworthy for the forex spot trader. The trader can gain
greater confidence in aligning his or her next trade in the direction of the noncommercials,
which are representative of the sentiment of the “smart money.”
Until Forex firms provide the CoT data more conveniently, spot traders need to access
this information on their own. It is available at many web sites, as well as from
third-party software providers. One such provider, Track ’n Trade, generates CoT charts
with effective visualizations of the data. Lan Turner, the developer of Track ’n Trade
software, observed the following :
Following the Commitment of Traders, as it relates to the March U.S. dollar
contract traded on the New York Board of Trade, you can see how the large speculators, depicted in the indicator windows below our chart [Figure 12.2], has
been following the ebb and flow of the market as the value of the dollar increases
and decreases. The large speculators, as represented by the histogram, consist of
large banks and hedge funds, organizations who manage large amounts of money
for speculative investment. It’s often asked: Is this a case of the dog wagging the
tail, or the tail wagging the dog? Because these organizations manage and control
such large amounts of cash, do they react to the market, or does the market react
to them?
What we’re seeing represented in this graph is the percentage of large speculators
who are long versus short the market. For example, looking at the above
chart, you notice that the large speculators represented by the high point during
mid-October is over 85 percent, which means that over 85 percent of reported large
speculators were trading long or had long positions during that time frame. Also
notice that as the market begins to drop, how quickly the large speculators reverse
their positions, where we then see a pictation where the majority of large speculators
are now short the U.S. dollar during the month of December. Also take a close
look at the open interest line as it increases in volume; this is an indication of an
increased number of short positions being added to the market. It is very common
to see the open interest line increase in relationship to the market trend during a
strong downtrend, and decrease during a strong uptrend.
An emerging source of volume data is exchange-traded funds (ETFs) on currencies.
One of the leading traders in the country, John Person, effectively uses these volume data
sources. ETFs on currencies are fairly new opportunities for forex and equity traders.




By ABE COFNAS