Discover Profit Opportunities with Managed Futures

May 23, 2008

Complimentary Market Commentary

Written by Eric Reinholtz, director of retail futures and options trading and a senior market strategist for DAW Trading, whose market commentary is sought by individual traders, CTA's, professional traders, and many financial media outlets. Choose your markets of interest and how often you would like to receive it, and Eric will email the Market Commentary directly to your Inbox. Sign up today for your COMPLIMENTARY Market Commentary!

For years floor traders have been able to capitalize from seeing orders coming into the markets. They have been able to adjust their trades based on what they are seeing with 'order-flow', and utilizing this to prevent entering traders prematurely. With online trading platforms such as our DAW Edge, traders can see order-flow and market depth the same exact way professional floor traders have been able to monitor this essential information.

So how can traders take advantage of being able to watch market depth and trading volume? First, traders need to have an understanding of what trading volume and market depth.

Market depth is the size of an order needed to move the market. If the market is deep, that means a large amount of orders is needed to change the price. If a market is illiquid, meaning there is a lack of substantial bids and offers, smaller amounts of orders are needed to move prices.

Trading a market that lacks liquidity can be thorny. Traders in those types of markets are more prone to having to deal with erratic price behavior. Often times I hear from clients asking, "What the heck just happened in that market?" The answer is simply: It's a market that lacks the liquidity to absorb large orders. Orders came in and were able to 'push' the market while searching for others to take the opposite side.

By monitoring the market depth, traders are able to see how many buyers and sellers are currently trying to enter the market. By gauging how many bids and offers are in the market, traders can better understand what is needed to see substantial price movement.

I consider trading volume the single most important indicator for a market. Volume is a terrific indicator to measure the 'worth' of a market move. If the market has made strong price move, either up or down, the perceived strength of that move depends on the volume for that period. The higher the volume during that price move the more significant the move.

If you cannot view the Crude Oil chart, go here.
(Chart courtesy of FutureSource.com)

The chart above is a weekly Crude oil chart. Traders can clearly see how the volume grew significantly as the market continued to extend higher. In 2007, as the market began to gain momentum as it got back above the 50-week moving average, spikes in volume should have caught trader's eyes immediately. At that point, with such strong spikes in volume and open interest, there was little doubt that crude oil would stop its bullish pattern.

When a commodity's trading characteristic changes, (example: corn trading over $6 when historical prices have never been over five dollar only once.) Traders who became accustomed to seasonal tendencies in a contract have seen perversions to these predispositions, can seen this trends implode this year. Normally the more volatile a commodity is, the more traders' styles become narrower.

Researchers have found that there is abnormal trading volume following certain types of technical trading signals. This may indicate a significant presence of traders with technical trading rules. One such pattern is a 'head-and-shoulders' pattern. A historical pattern is for volume to dramatically increase immediately following this formation. Other researchers found that spikes in volume occur once a market breaks out from a previous trading range.

Since volume is more of a subjective tool, we need to go with undisputed facts when assessing the tool. On a very basic level, volume symbolizes the commitment traders have in a certain commodity. As the volume increases, the more interested traders have become in that particular market. An example of this is when poker players have a good hand they might be tipping you off if they start to bet big. Of course the opposite is also true. As volume decreases, traders are saying that they less confident in their position and therefore will be risking less.

Bottom-line: All traders should pay close attention to volume regardless of their trading style or strategies. By monitoring volume, traders should be able to better estimate when they should be buying, selling, or stay flat. After a trader receives buy/sell signal, they should look to volume for confirmation.

Eric Reinholtz is a Senior Market Strategist with DAW Trading. Mr. Reinholtz relies heavily on his expertise in charting markets for his exact entry and exit scenarios. Mr. Reinholtz's focus targets very realistic money-making strategies more so than cryptic buy & sell signals that can get flashy publicity, but have little to do with actual portfolio alignment. He believes a professional way of approaching the markets should emphasize scaling-in during serious purges (ideally after bases are built), and scaling-out gradually into strength (ideally into extended parabolic moves), happily not worrying about "milking" the last percent out of a move.

Complimentary Market Commentary

Written by Eric Reinholtz, director of retail futures and options trading and a senior market strategist for DAW Trading, whose market commentary is sought by individual traders, CTA's, professional traders, and many financial media outlets. Choose your markets of interest and how often you would like to receive it, and Eric will email the Market Commentary directly to your Inbox. Sign up today for your COMPLIMENTARY Market Commentary!