A narrative preview of “Mentor” Mike Bridges’ all-new webinar to be given live on Saturday, October 12th at 9 A.M. Pacific Time
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If you’ve attended my webinars or followed my Market Movies in the past, you know that I’ve been on medical leave for the past three months. Well, I’m happy to report that I’m still among the living and back on duty. I’ll be taking it easy for a while yet, but I’m trading part-time and able to mentor a limited number of students.
For those who don’t know me, I am a California attorney at law specializing in financial, retirement and estate planning. To better serve my clients, I also obtained these securities licenses: FINRA Series 3 (commodity futures & options), Series 7 (general securities) and Series 66 (investment advisor); and the following licenses from the California Department of Insurance: Life Only, Accident & Health, and Variable contracts.
I have been trading futures since 1984 and mentoring since 2000. In 2003, I formed Fortune Forecaster, Inc., a family-held California corporation that is registered with the NFA and CFTC as a Commodity Trading Advisor. I have traded virtually every market with every method, on every time frame. My favorite M.O. for the last decade has been day trading the Standard & Poor 500 Index futures aka the “S&P E-mini,” ticker symbol: ES. My favorite platform is Ninja Trader 7 and my favorite broker is Trenton Kimminau at Global Futures in Encino, CA.
MY PRIOR RELATIONSHIP WITH VOLUME
I came to appreciate the value of Volume somewhat late in the game. When I began trading in the mid-80’s, electronic trading had not been invented and the only day traders were on the floor in the trading pits of Chicago and New York. Volume and Open Interest were always added to the daily charts a day late so I viewed their predictive value as distinctly limited.
Back in those days, about the only time I used Volume was to confirm the validity of a breakout from a sideways consolidation. Conventional wisdom has generally held that when price breaks up or down from a consolidation channel, if Volume is at or below its recent average, the breakout is probably a fakeout. But, if Volume is above average, there is a higher probability that the breakout is genuine.
Since the advent of electronic trading, we can now count the number of buy-sell transactions as they occur. Still, old habits die hard and I was reluctant to clutter my charts with an indicator I considered to be of marginal utility. But, during my recent recuperation, I decided to use my down time to take another look at real-time Volume in the S&P Emini. I want to share my findings and insights on Volume with my students and fellow traders with this narrative and in my upcoming webinar. Let’s start with. . .
WHAT VOLUME IS AND ISN’T
Let’s assume we’re using a time-based price chart where each bar or candlestick represents a 5-minute interval. Volume IS the number of buy-sell transactions that occur within each 5-minute period. Volume IS NOT a meter of money flow into or out of the market.
WHAT OPEN INTEREST IS AND ISN’T
Open Interest IS the total number of open, outstanding contracts (each with a buyer and seller) as of some point in time. When Open Interest increases, money is flowing into the market; when it decreases, money is flowing out of the market.
Unfortunately, Open Interest IS NOT a useful day trading indicator because it cannot be effectively calculated on the fly in real time. Ninja Trader 7 has a variety of indicators for depicting Volume in real-time, and none for Open Interest.
HOW VOLUME AFFECTS OPEN INTEREST
Imagine a single buy-sell transaction involving one contract. The buyer is doing one of two things: 1) entering a new long, or 2) exiting an existing short. Likewise, the seller is either: 1) entering a new short, or 2) exiting an existing long. There are four possible combinations. All four increase Volume. One increases Open Interest, one decreases it, and the other two produce no change.
If the buyer is entering a new long and the seller is entering a new short, Volume increases by one (because of the buy-sell transaction), and Open Interest increases by one (because a new contract has been created that did not exist before). If the buyer is exiting an existing short and the seller is exiting an existing long, Volume increases by one (again, because of the buy-sell transaction), but Open Interest decreases by one (because both halves of an existing contract have left the market). If one party to the transaction is entering and the other is exiting (it doesn’t matter which is which), Volume will increase, but Open Interest stays the same (because the total number of contracts did not change).
Now imagine that one buyer wants to enter a new long position by buying ten contracts. He/she might get matched up with a single seller of ten contracts who could be entering or exiting. Or, there could be two sellers of five contracts each – one entering and one exiting. Or, there could be ten sellers of one contract each, some entering and some exiting. The possible combinations become astronomical. Thus, while each buy-sell transaction can be logged on the fly, the changes to Open Interest take more time to sort out. Perhaps as the technology of high-frequency trading continues to evolve, real-time OI will become a reality, but it isn’t yet.
HOW DO WE MAKE PRACTICAL USE OF VOLUME?
When Price is heading in a clear vertical direction, as confirmed by an oscillator (like MACD), and Volume is increasing, then there is a higher probability that the Price move will continue in that direction. In other word, the best trades occur when two specific conditions exist: 1) there is definite Price directionality, and 2) there is increasing Volume.
HOW DO WE CONFIRM PRICE AND VOLUME DIRECTION?
There are numerous indicators, but personally, I prefer the MACD for confirming Price direction and the MACD-like Volume Oscillator for observing Volume quantity. The MACD gives two levels of bullish strength and two levels of bearish strength. Similarly, the Volume Oscillator gives two levels of increasing Volume and two levels of decreasing Volume. See the chart below.
Pacific Trading Academy | Mike Bridges, POV TRADING – PRICE, OSCILLATOR & VOLUME, Chart-1
In upper Panel One, the RED line is my “trend-defining moving average.” When Price begins to move up but is still below a down-sloping trend-definer, it is hard to know if the up move is the start of a new bullish trend or simply a corrective bounce before another selloff. Once the Price breaks above the trend-definer and the MA begins to level off and turn up, the balance of probability begins to tip in favor of a new up trend. The GREEN arrow represents the lesser bullishness below the RED. The GOLD arrow represents the greater bullishness above the RED.
In middle Panel Two, the MACD Oscillator confirms the start of the up move when the NAVY oscillator line crosses above the WHITE signal with both still below the RED zero line. As above, the GREEN arrow emphasizes the lesser bullishness at this point. When the oscillaor and signal lines cross above the RED zero line, the GOLD histogram and arrow symbolize the transition to greater bullishness.
Finally, in the lower Panel Three, the Volume Oscillator shows that Volume begins to increase when the NAVY oscillator line first crosses above the WHITE signal line. Again, the GREEN arrow represents the lesser increase in Volume. When the Volume lines and histogram all break above the RED zero line, the GOLD arrow shows the greater increase in Volume.
The above chart depicted a bullish up move so, conveniently, the Price, Oscillator and Volume were all pointing up in the same direction. But. . .
REMEMBER THAT IN BEARISH MOVES, PRICE AND OSCILLATOR WILL BE DOWN BUT VOLUME WILL STILL BE UP
Check out the chart on the next page. Notice that before the Price dropped below the RED trend definer, it drifted sideways for a short time. During that consolidation period, the MACD gave a bearish crossover, NAVY below WHITE. Soon after, the Volume Oscillator made a cross in the opposite direction, NAVY above WHITE.
Pacific Trading Academy | Mike Bridges, POV TRADING – PRICE, OSCILLATOR & VOLUME, Chart-2
Notice how the Volume Oscillator showed Volume increasing during the consolidation. Since the MACD was already bearish, there was a strong likelihood the market would drop, and indeed it did.
VOLUME AND NEWTONIAN PHYSICS
Volume topped out around the middle of the first leg of the Price selloff as the NAVY oscillator line crossed below the WHITE signal line. However, the Price continued to drop. Imagine a car on a level surface. If you punch the accelerator until the car reaches top speed, then immediately take your foot off the gas, the car’s momentum will continue to carry it forward. So it is with Price. “A body in motion tends to stay in motion.”
I’ll be discussing more aspects of Volume and showing many more examples during my webinar, Saturday, October 12th, 9am Pacific Time. Please join me by registering with the link below. See you there.
Register for the upcoming Free Webinar
