Benefits of Forex Traders from Future Markets

FOREX TRADERS BENEFIT FROM FUTURES MARKETS INFO         

         Forex traders can integrate futures data to help in trading decisions, such as taking a trading signal based on chart patterns in the futures and translating it into a trading trigger signal in a forex market. Because spot FX and futures trade in tandem, the price difference is called the basis. Generally, day-to-day, they are geometrically equal (within a few PIPs). Since, as we discussed, forex markets are decentralized, there is not a collective database to measure two distinct studies, such as volume and open interest. These are important tools, so let’s review what the basics are and how a forex trader can use this futures information.

Volume is the number of trades for the total contract months of a given future’s contract, both long and short combined. For example, the futures foreign currency markets trade on quarterly expirations—the March, June, September, and December contract months. The volume will represent the total for all the trades in each contract month. Most technical analysts believe that volume is an indicator of the strength of a market trend. It is also a relative measure of the dominant behavior of the market. A further ex-planation is that volume is the measurement of the market’s acceptance or rejection of price at a specific level and time. There are several theories and so-called rules when using volume analysis on price charts: First, if a market is increasing in price and the volume is increasing, the market is said to be in a bullish mode and can indicate further price increases. Second, the exact opposite is true for a declining market. If price is declining and volume increases, it is said to be in a bearish mode and indicates further price decreases. However, if a substantial daily market price increase or decrease occurs after a long steady uptrend or downtrend, especially on unusually high daily volume, the move is considered to be a “blow-off-top or bottom exhaustion” and can signal a market turning point or a trend reversal. Here are some guidelines to use when using volume analysis.

• Increasing volume in a rising price environment signals excessive buying pressure and could lead to substantial advances.
• Increasing volume while prices are falling may signal a bear move.
• Decreasing volume while prices are climbing may indicate a plateau and can be used to predict a reversal.
• Decreasing volume with a weaker price environment shows that fresh sellers are reluctant to enter the market and could be a sign of a future downtrend.
• Excessive volume while prices are high indicates that traders are selling into strength and often creates a price ceiling.
• Excessively low volume while prices are low indicates that traders are buying on weakness and often creates a floor.

Open interest reveals the total amount of open positions that are outstanding in existence and not offset or delivered upon. Remember that in futures trading, this is a zero-sum game so that for every long there is a short or for every buyer there is a seller. The open interest figure represents the longs or shorts but not the total of both. So when examining open interest, the theory or general guidelines are that when prices rise and open interest increases, this reveals that more new longs have entered the market and more new money is flowing into the market. This reflects why the price increases. Of course, the exact opposite is true on a declining market. Chartists combine both the price movement and the data from volume and open interest to evaluate the “condition” of the market. If there is a price increase on strong volume and open interest increases, then this is a signal that there could be a continued trend advance. Of course, the opposite is true for a bear market when prices decline. Also, if prices increase, volume stays relatively flat or little changed, and open interest declines, then the market condition is weakening. This is considered to be a bearish situation because if open interest is declining and prices are rising, then this shows that shorts are covering by buying back their positions, rather than new longs entering the market. That would give a trader a clue that there is a potential trend reversal coming.

Here is a guide as to how to use this information to identify an opportunity when there is a major top or bottom in the spot forex markets: When observing a continued long-term trend in a spot forex currency, if it trades as a futures contract (whether it is in an uptrend or a downtrend), when prices start to fluctuate with wider than normal daily price swings, or ranges, or are in an extremely volatile condition, if it is combined with unusually strong volume and a decline in open interest, this is referred to as a climaxing market condition. The market is getting ready to turn or reverse the trend.

In Figure 1.36, the graph is a split chart of the futures euro currency on top with the volume and open interest study in the middle. The spot forex euro currency is on the bottom. Notice that after the peak in prices, the volume was increasing, as was the open interest.

This was a warning that a trend reversal was forming, rather than a small correction. Therefore, spot forex traders would have a better decision-making process, that selling rallies and looking to take sell signals at resistance would be a more fruitful and profitable course of action.