opportunities by analyzing economic information for a longer-term perspective.
Short-term traders should also understand which reports can
cause a shift in currency markets and know when they are released.
Knowing the best times to trade the markets will help you nail down
when a potential trade may materialize. The pie chart in Figure 1.4 showed
that the largest percentage value traded against the U.S. dollar was the
euro; therefore, that suggests that one of the highest-volume time periods
would be when the European session opens. The central place of foreign
currency dealings is in London, where the second-most-active trading volume
occurs (the U.S. session being the first). Therefore, London is where
there are likely to be large-range swings in the market granting day traders
an opportunity to profit. That session begins at 3 A.M. (EST) and goes until
11:30 A.M. (EST). So a euro to U.S. dollar (EU/USD) or euro to British pound
(EU/BP) or British pound to U.S. dollar (BP/USD) pair would be an appropriate
selection to trade during the European session. The U.S. session
opens at 8 A.M. (EST), which overlaps the European session; these two sessions
combined generate the bulk of trading activity. Most major U.S. economic
reports are released at 8:30 A.M. (EST); and, as expected, the
currency markets generally react off those reports. This offers traders the
opportunity to trade off violent price spikes when economic news is released,
especially when the news is a surprise.
Once the U.S. markets close at 5 P.M. (EST), the currency markets are
available to trade; but it is not until the Asian session opens at 7 P.M. (EST)
that markets will experience potential price swings as volume levels
rise. During the Asian session, traders would want to focus on the Australian
dollar and the Japanese yen and the trade opportunities offered by
the USD/JY or the USD/AUS or the cross pair trading the JY/AUS dollar. Notice
that the Asian markets overlap the European session as well, so the
Japanese yen versus the euro cross (JY/EU) is a popular pair to trade. Table
1.5 shows the time zones on which you want to focus when trading spot
forex markets.
Forex Traders Can Benefit from Futures Data
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 trans-
lating it into a trading trigger signal in a forex market. Spot FX and futures
trade in tandem, and any price difference is called the “basis”; both FX and
futures generally trade, pricewise, equally on a day-to-day basis (within a
few PIPs). As we discussed previously, forex markets are decentralized, so
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 the basics.
If you are just using your FX dealer’s trading platform for charts and
quotes, you will not be able to get the volume and open interest information.
However, you need only end-of-day data, and you can search the Internet
for end-of-day charting data for futures markets. If you do subscribe
to a charting software company, then it can add end-of-day charts for nothing
or a very nominal monthly charge.
Volume
At this point, it is important to define what the volume figures are that you
can receive and analyze in the forex market. The volume for forex pairs represents
the number of transactions or ticks and not true trade-size activity.
Forex does not have actual trade-size information because there is not a
central marketplace to tabulate and send the information out to traders.
The true definition of volume is the number of trades for all 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. Here is a further explanation; 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; the first one is that if a market is increasing in price and the
volume is increasing, then the market is said to be in a bullish mode and can
indicate a continued move in the direction of the trend.
The exact opposite is true for a declining market. However, if a substantial
daily market price increase or decrease occurs after a long steady
uptrend or downtrend, especially on unusually high daily volume, it is
considered to be a “blow off top or bottom” and can signal a market turning
point or 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 in a falling price environment might signal a continual
fall in prices or a prolonged bearish trend.
• Decreasing volume in a rising price environment may indicate a plateau
and can be used to predict a reversal. Especially when prices make a
higher high such as occurs with divergence patterns, a decline in volume
with a rise in prices is extremely bearish.
• Decreasing volume in a weaker price environment shows that fresh
sellers are reluctant to enter the market and could be a sign of a trend
reversal.
• Excessive volume in a high price environment indicates that traders
are selling into strength and often creates a price ceiling.
• Excessively low volume in a low price environment indicates that
traders are buying on weakness and often creates a floor of support.
I want you to study the chart in Figure 1.13; it shows the trends that occurred
in the Japanese yen futures contract. If you recall, earlier in the
book, I gave an example of the confusing aspect of the quotation of yen futures
contracts versus spot forex contracts. Figure 1.13 shows what I was
referring to. The futures contracts are quoted yen to dollar, FX is quoted
dollar to yen. Let’s go over how to interpret the data, and then I will explain
how you will apply that information to the forex market. Looking at the
chart from left to right, the first trend (point A) condition is down. The corresponding
volume levels are also trending lower. This indicates that, with
the decreasing volume in the weakening price environment, new sellers
are reluctant to enter the market and that a reversal is imminent. As the
market bottoms in late April (point B), the sharp price increase is followed
with a rise in volume, indicating prices can sustain an advance. Finally,
when the high of the move has formed (point C), it is made with a large
bearish engulfing candle pattern. The trend reverses as sellers enter the
market and longs liquidate their positions. Notice that this new downtrend
is on increasing or rising volume, which alerts you that a substantial move
is in the works.
Two Flaws in Volume
As with life or any aspect of trading, nothing is perfect. Collecting and analyzing
volume is no exception, especially in the futures markets. The first
flaw is that the data is delayed by one day. You can get real-time tick volume,
which shows how many times a price level was traded, but not realtime
contract size volume; the exchanges do not post this information until
the following day. There is a huge difference in the two concepts. The second
flaw is that as a futures contract month gets closer to expiration, it converges
with spot prices and becomes the cash market. At that point, it no
longer is a “futures” contract. For example, a September futures contract
expires around the middle of the month by late August traders moving their
positions out of the September and rolling over into the next contract
month, which would be a December contract. As this occurs, the volume
levels start to artificially decline in one month as the further-out contract
month starts to increase. This can be confusing and generate false signals.
HOT TIP
Stay ahead of the crowd! I have a solution and can help you possibly beat the
system! Remember the section on the currency ETFs? They trade in real time;
they track almost identically to the spot currency markets (perhaps even better
compared to forex dealers); and because they are listed on the New York Stock
Exchange, they report real-time transaction volume! The drawback here is that
they only trade during the U.S. equity market session—9:30 A.M.(EST) to 4:00
P.M.(EST).
Source: Forex Conquered: High Probability Systems and Strategies for Active Traders
