Thursday, 13 June 2013

Using Volume and Open Interest to Find Trades

Ralph Shell, Excel Analyst

As we approach the end of the quarterly trading activity in the foreign exchange futures markets, the trade usually picks up.  Part of this trade involves the spreading from the current to the next contract, in this case from June to September.  This spreading, or rolling of the position forward, may be either for speculators or for hedgers who need price protect for their commercial activity.  Another possibility for the elevated activity is using the price of the futures as the price for cross-border commercial trades.

The many different users during the period from the 1st of an expiration month until the third Wednesday make the futures activity hard to read.  On other occasions it is a bit easier, although we never really know for sure.  As an example, when the specs are very short, and the OI (open interest) goes up, this usually means, the specs are adding to their shorts.

Another clue to the future direction of the markets might be gleaned, combining the volume, the OI and the direction of the market.  If volume increases, and the market trades lower, this usually means the market is headed lower.  Should it be revealed the next day the OI went up, this even more meaningful.  A continuation of the same pattern the next trading day would be confirmation, this is the beginning of a move.

The flow of money is usually the most important fundamental when trading currencies.  However, this is not always the case.  Sometimes both the bulls and the bears double down on previously-established positions.  Eventually, a winner may emerge, but it is easier to trade a market once the direction is known.

Yesterday, Tuesday, the total open positions of futures and options went up 75,471 contracts.  Most of the 58,584 contracts eas in futures.  The OI was up 17.3K in the A$, up 15.8K in the pound, and up 10.6K in the euro.  Further, the total OI is 260K in the euro, 240K in the A$, and 219K in the pound.  Can we deduce a trading set-up from this?

Click to Enlarge AUDUSD Forex Daily Chart
AUDUSD Daily 12 June 2013, Excel Markets ECN Forex Broker

The A$ set up looks interesting.  Going back to May 6th, the AUDUSD was trading above the 1.02 handle.  At that time, the total futures OI was 154K.  According to the COT report, specs were long 5.2K contracts.  Now the OI is 240K and according to the last COT report the specs were short 83K contracts.  With this big build of the positions in the A$ it is tempting to be the contrarian and buy the A$.  The problem here is the shorts have profits in the trade and have no reason to exit.  This is not to say someone will make money picking the bottom, but generally this is a losing way to trade.

Click to Enlarge GBPUSD Forex Daily Chart
GBPUSD Daily 12 June 2013, Excel Markets ECN Forex Broker

The GBPUSD is another setup that has looked interesting.  As we discussed in our weekend projections, we felt the pound was due for further strength.  At that time, it was about 1.5555, and had the strongest week in three years.  Today the pair rallied to the cusp of 1.57 before relaxing.  The COT report showed the specs were short 101.2K, a big number for the size of the market.  I am perplexed by yesterday's big increase in the OI - up 15.8K - but this suggests the shorts have more to buy to get covered.

We are now at the 200-day SMA on the Pound/USD.  Take this out and there is a chance of a rally to the 1.5850 level.  As always, mind you money.
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