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~OUTTING EDGE
 T
Although the fundamentals of supply
and demand make a market move higher
or lower in the long run, in the short run
a host of variables-like greed, fear, hope
and panic--can change a market's direc-
tion. As traders or speculators in the fu-
tures markets know, the most primary
and profitable of goals is to understand
what makes the market move now. In
other words, how is the smart money re-
acting to the market? The classic method
of determining current market sentiment
is through tracking volume and open in-
terest.
Volume, the number of contracts
traded during a trading session, and
open interest, the total of all unclosed po-
sitions at the end of a trading session,
have been used as technical indicators of
market trends for over 140 years! Yet this
is the first book, ever, devoted solely to
these critical indicators. Written by Ken
Shaleen, internationally known futures
trader, educator and market advisor, Vol-
ume and Open Interest is the definitive
source for understanding how market
sentiment is reflected through volume
and open interest indicators.
Readers will develop a disciplined ap-
proach to using volume and open inter-
est by identifying discrepancies in
market behavior, specifically:

.Markets in Transition
.Seasonality
.Spreads
.Options Expirations
.And More!

~
T his book will relate the three variables of price change, volume level
and open interest fluctuation. The result will produce the direction of
the major price trend and a reading of that trend's strength. In many
examples, a classical bar charting price pattern will exist. The basic rami-
fications of these formations will be highlighted, but this book is not in-
tended to be a comprehensive study of price pattern recognition.
A technical approach to the analysis of any organized market uses
volume as an important input. The futures exchanges produce an addi-
tional vital statistic-open interest. The technical form that best lends it-
self to analysis of volume and open interest is the daily high-Iow-close
bar chart of a futures contract. Consequently, bar charts will be used to
illustrate the concepts.
Daily bar charting is heavily relied upon in "position" trading as
opposed to shorter term techniques (point & figure, 5-minute bar charts,
etc.) utilized by traders. Volume and open interest changes should be
important to all categories of market participants: short-term traders, for-
eign exchange dealers, hedgers and position traders.

vii
CHAPTER

T he fundamentals of supply and demand make a market move higher

or lower in the long run. In the short run {which can be hours, days,
or even weeks depending on the time scale used), a market can go in the
exact opposite direction of the larger fundamental picture. This is be-
cause many decisions are psychological judgments-based upon hopes,
fears, greed, moods, etc.
Volume and open interest can identify how traders are reacting to
changing conditions. Analyzing volume and open interest changes re-
suits in a determination of which contingent, the longs or shorts, is the .
"strong hand." The position of the strong hand is the direction of the
major price trend. The strong hands are deemed the "smart money." In-
terpretation of volume and open interest changes is an attempt to iden-
tify the smart money and determine what this contingent of successful
traders is thinking.
Critics of technical analysis have a myriad of reasons. One comment
often made is: The underlying "cash" or "spot" market is the dominant
market; therefore, why should the futures market, a derivative, be ana-
lyzed ? This is a valid question and merits a response.
The difference between a cash market price and a futures price is
the "basis." The more stable this relationship, the easier the analytical
task of determining the health of a price trend using a futures chart be-
comes.For a clear explanation of this link, refer to Appendix C -Basis.
There is no question that the cash or spot market is much larger in
total turnover than the corresponding futures contract. Accurate statistics
are difficult, if not impossible, to obtain in an "over-the-counter" market.
For instance, what was the turnover in spot Dollar-Mark dealing in the

1
2 Chapter 1

u .5. inter-bank market yesterday? Since data availability is not timely, an

exact answer is not possible. However, turnover (volume) figures are im-
portant inputs to a technical approach. Additional questions such as:
Were new positions opening, was it liquidation, or was the price rally
short covering-also cannot be answered sufficiently.
Futures markets, on the other hand, generate exact high-low-close
price data as well as open interest statistics that a trader can use effec-
tively. A futures contract that has achieved a "critical mass" becomes a
microcosm-diminutive but analogous to the large (inter-bank) system. CHAPTER
Thus, futures clearing house statistics can be used as a surrogate without
cash or spot market data. For example, if it was a high turnover day in
inter-bank Dollar-Mark dealing in North American spot and forward
transactions, it will be reflected in increased trading activity in the
Deutsche Mark futures pit on the International Monetary Market (IMM)
in Chicago. If positions are being retained or rolled in the inter-bank
market, no matter whether speculative or legitimate corporate hedges,
this phenomenon also should be occurring in futures. The premiseis that
changesin futures open interest reflect what is occurring in the larger cash V olume (turnove
market.This premise is central to the analysis of any futures market chart. during each trat
both sides of the tra
trading session, the
number of contracts
vails:

Published volu
"more buyers than :
volume (or open int
plain the rise in pI
"more potential buyei
For example, if
tures on the IMM w.
contracts bought, will
the 35,000 total conb
tract represents 125,
of trades is simply m

SIGNIFICANCE OF

Volume is a measur4
and investors to "do
 -

CHAPTER 2

Buy Volume = Sell Volume = Total Volume

Published volume figures represent one side only. The phrase
"more buyers than sellers" (or vice versa) is never true with respect to
volume (or open interest) statistics. A more representative phrase to ex-
plain the rise in prices during a particular trading session might be
"more potential buvers than ~1'J11'~"

3
4 Chapter 2

---
The ideal situation for a healthy bull market is volume moving up as the
bull market expands. A strong price uptrend is characterized by greater
volume on days when prices close higher than on days when prices set-

tle lower. Specifically:

Price Up -Volume Up
Price Down -Volume Down
 Volume 5

Figure 2-1 Ideal Bull Market

Price versus Volume Interaction

PRICE

VOLUME

after a fall." A low volume selloff is actually a very bullish situation. The
Plywood chart in Figure 2-3 illustrates this concept.

IDEAL HEALTHY PRICE DOWNTREND

The ideal situation for a healthy bear market is for volume to increase as
prices move lower. A strong price downtrend is characterized by ex-
panding volume on days when prices close lower and decreasing vol-
ume on price up days.
Examine the chart in Figure 2-4, where the overall price trend is
obviously down. Analyze a day in which quotes close lower than the
8 Chapter 2

Figure 2-4 Ideal Bear Market

Price versus Volume Interaction
moving ~
ideal relationship of p
in Figure 2-4; an actuj

PRICE

VOLUME

Volume: Increaseson PriceDownDays

Decreaseson PriceRallies

previous trading session. An increase in turnover associated with a price

decline is the sign of a healthy bear market. Specifically:

Price Down -Volume Up

Price Up -Volume Down

Even in a long-term bear market, prices will not continually decline.

Adverse moves against the direction of the major trend will result in
price rallies-some lasting several days, or, erratically, over several
weeks. If no urgency develops for the shorts to cover their positions,
what should happen to volume? It should decline: this is the proverbial
low volume rally. A low volume rally is bearish. This price vs volume
 Volume 9

signals to the technician that the direction of the major price trend
downward. The price would be expected to keel over and begin
down again. Then volume, ideally, would start to pick up. The
...in a healthy bear market is depicted
an actual example is found on the September 1984 T-Bond
..., ~..
A low volume rally in a bear market is to be expected and will con-
that the downtrend is still intact. Hence: "Don't buy a quiet market
, a rise." Figure 2-6 illustrates this situation on the November 1976
.Cattle chart.

VOLUME-A WARNING SIGNAL

is one amplification of the ideal price vs volume configuration that

importance and should not be overlooked. Losing posi-
-.ones (as opposed to legitimate hedges), often
that lead to excessive volume. The urgent need to close
produces "blowoff volume," a volume of an extremely
is a warning signal that the price trend is in the process
~ itself. Prices often move violently in the opposite direction
blowoff volume. Figure 2-7 illustrates the theoretical relation-
blowoff volume and price activity.

Caveat

in order: extreme high volume is the warning signal which

at least a temporarytrend change. This signal does not have to
with the exact extreme price day. Often blowoff volume will
.:trading session before the ultimate high or low price posting.

BULL CASE

~££.
volume can best be understood in the context of specific mar-
For instance, in a bull market, volume suddenly explodes. This vol-
happen during trading sessionsin which quotes close up,
or unchanged. When posting the volume bar on the chart, it will
the proverbial ":;ore thumb." The question then arises: Was
-during that session's trading? Obviously, yes. Some-
in more casesthan not, placed the shorts in consider-
12 Chapter 2

Figure 2-7 Examples of Blowoff Volume

~ ~ I

I
I
I
I

PRICE
~ EXTREME ( )EXTREME
HIGH HIGH
VOLUME VOLUME

VOLUME

.I I I I .I I I I I I I I

able difficulty. The short positions "buying in" caused the turnover to
explode. Whether short covering was truly responsible can be ascer-
tained from the change in open interest.
It is also possible that the blowoff volume was created by a panic to
"do something" as in a "flight to quality" (short-term interest rate instru-
ments). This can be seen in the December 1989 T-Bill chart in Figure 2-8.
Volume exploded as T-Bill prices surged following the "Friday the 13th"
U.S. stock market drop in October 1989. If the rally was net short cover-
ing, open interest should decline. In the T-Bill example, open interest de-
clined after the initial flight to quality .(See Chapter Three -Open
Interest.)
Blowoff volume signals the market top or the start of a correction in
a bull market. The warning signal usually precedes a reaction of signifi-
cant magnitude such that nervous longs may take evasive action by re-
14 Chanter 2

treating to the sidelines. Aggressive traders may even try to pick a top by Figure 2-9
initiating new short sales. For ideas on when the actual volume (or a
good estimate) is available, see Chapter Fourteen -How to Obtain the

nata.

THE BEARCASE

Technicians realize that high volume is a desired attribute on a breakout

initiating a new price thrust, especially to the upside. Confusion between
volume that is simply high and volume that is of blowoff proportion is
inevitable. The "location" of the trading session in question can often
provide a clue to the answer:
Breakout volume occurs at the beginning of a price move, often
1)
on the penetration of a trendline.
Blowoff volume is typically found after an extensive price move
2)
has occurred.
 Volume 15

74-00
T -BONDS MARCH 1985 CBOT
.16

.16

.16

.16

.16

BLOWOFF VOLUME --.,

""' 'v'
Total

Open Interest

~ Total
Volume

5 12 19 26 2 9 16 23 30 7 14 21 28 4 11 18 25 1 8 15 22 1 8 15

October November December January February March

1984 1985
16 Chapter 2

Thus, a graphic interpretation that includes price pattern recognition Figure 2-10
and trendline analysis is required. This is an art, not a science; but so is
the setting of volume parameters in the first place!
To illustrate where to expect breakout vs blowoff volume on a chart,
further examine the two January 1990 energy charts in Figures 2-10 and
2-11. In Figure 2-10, the high volume day in question occurred as quotes
were breaking a trend line on the chart. This is an example of the desired
high volume on an upside breakout. Figure 2-11 also contains a high
volume trading session. Note that prices were in new high ground after
a sustained price uptrend. This volume signal would be classified as
blowoff volume. The interim price high illustrated in Figure 2-11 was set
one trading session later with the key reversal high.

TIC VOLUME
Technicians accessingreal time futures bar charts with less than one full
day for each bar cannot obtain actual volume figures. When screen trad-
ing becomes more common, real time volume (as is available from the
U .5. stock exchanges) should be possible.
Quote vendors have developed software to monitor tic volume.
Each price change within the period increases the tic volume. Although
this is not ideal, it does provide a surrogate for volume. Figure 2-12 is an
example of a 30-minute bar chart with tic volume.
Most users of intraday charts have a very short-term trading hori-
zon. They are usually out of all positions by the close. They are nimble
traders who are only looking for quick price moves, and are not hin-
dered by the absenceof actual volume.

POINT & FIGURE CHARTS

A point & figure chart with its series of "X's" and "0' s" represents price
changes that are independent of time. Very responsive po.int & figure
charts are used by exchange floor scalpers and foreign exchange dealers
making two-way markets (stating both a bid and offered price). combin-
ing volume with this type of chart is impossible.
If the point & figure chart is designed to observe very short-term
time horizons, the absence of volume is analogous to the trader using a
five-minute bar chart. In this situation, quick reflexes in dealing are more
important than an analysis of volume.
20 Chapter 2

A point & figure chartist can blacken in the square that represents
the last trade of the "day." Then a date can be posted at the bottom of
the chart. Obviously, no regular distance interval will exist between the
dates on the chart. But this procedure will allow the chartist to cross
reference the point & figure chart to a specific date.
If volume statistics for the particular market being charted exist
some volume analysis would be possible via cross referencing. Addition-
ally, if the point & figure chart is of a Chicago Board of Trade (CBOT)
future, Liquidity Data BankTM statistics will be available. This important CHAPTER
source of volume information is covered in detail in Chapter Eleven -
Support and Resistance.

CONVENTION

The typical chart convention plots volume as a vertical bar on the bottom
of a chart; this is standard industry practice for any organized exchange.
Suggestions to construct a chart and select responsive volume scales are O pen interest «
found in Chapter Seven. at the end of
In grain and oilseed futures trading, volume (and open interest) fig- of open interest ca
ures are often expressed in thousands of bushels rather than contracts.
Each grain contract on the Chicago Board of Trade represents 5,000 bush-
els. Either figure (bushels or contracts) can be plotted on the volume
scale as long as the methodology is consistent and the graph properly Futures tradiJ
labeled. .out. Admitt
a little off tl1
...; has to be an
long open inte
, open in
is reported 1
is one sidE

OPEN INTE

interest chan;
fall into one
.Each of ti
.~-. For this j
down. What
.While no sI
it is safe to
CHAPTER 3

a pen interest (01) is the summation of all unclosed purchases or sales

at the end of a trading session. Confusion concerning the definition
of open interest can be avoided by remembering this simple equality:

Long 01 = Short 01 = Total 01

Futures trading is a zero sum game: for every dollar in there is a

dollar out. Admittedly, the exchange clearing house and member firms
scoopa little off the top; but, for every open position in a futures market
there has to be an opposite position. At the end of each trading session,
the long open interest, by definition, must equal the sho;rt open interest.
Published open interest figures are similar to those for volume in that
what is reported by the clearing house to the public, press, and quote
vendors is one side only.

HOW OPEN INTEREST CHANGES

Open interest changes from one trading session to the next; these fluctua-
tions fall into one of three categories: 1) Increase, 2) Decrease, or 3) No
Change. Each of the three situations will be examined in the following
example. For this illustration, it does not matter whether prices moved
up or down. What is necessary is that a "significant" price change oc-
curred. While no specific definition of what constitutes significant will be
given, it is safe to assume that the definition begins at more than five

21
 22 Chapter 3

minimum price tics. The technical ramifications of these changes will be

apparent later in this chapter when detailing the ideal healthy price up-
trend or downtrend.

Example: Prior Day's Total Open Interest = 180,000

Answer the question: Who is getting in or out of the market?

Case One: Open Interest Increases

Total Open Interest now at 3,000 New Long Contracts

183,000; a change of +3,000 and
3,000New Short Contracts

Case Two: Open Interest Decreases

Total Open Interest now at 2,000 Long Contracts Sold Out

178,000; a change of -2,000 and
2,000 Short Contracts Bought Back

Case Three: Open Interest Unchanged

Total Open Interest now at In this situation, the trader

180,000;unchanged would not know exac;:tly what
changing of positions occurred.

In Case One, new positions on both sides are increased. In Case

Two, both sides are liquidating. In Case Three, it is not obvious what
changes in the make-up of participants is taking place.
Case Three would be an unlikely occurrence in a market with this
magnitude of open interest. To illustrate the concept, an additional piece
of information can be introduced into this scenario that would not be
available to the analyst. If it was known that one new position (whether
long or short) was placed, what else had to happen during the trading
session?There had to be one liquidation.
Unchanged open interest means that the same number of partici-
pants (in terms of contracts) are in the market. There may have been
some changing of positions. Old losing positions may have been meeting

~
 OpenInterest 23

margins calls. New positions may have been initiated. What is important
is that "fuel" is available to sustain the price trend.

SIGNIFICANCEOF OPEN INTEREST

For every profit dollar in futures trading there must be a loss dollar.
Open interest is a reflection of this very important concept. If a futures
trader makes a correct market judgment, where do the funds come from
to payoff his winning position? The funds come from the loser. This
may sound harsh, but it is a fact of life in every futures market. A techni-
cian should be very interested in what the losers are doing. The change
in open interest is the key to this puzzle. The analysis of open interest
changes is important for at least three reasons:

Open Interest Provides Fuel to Sustain a Price Move

The analogy of fuel to the market is like that of fuel to a fire. If the fuel is
removed from a fire, the fire will go out. If fuel is removed from a price
trend, the trend will change. Fuel in a futures market is provided by the
losing positions. When open interest declines, fuel is being removed and
the prevailing price trend is running on borrowed time. For a healthy,
strong price trend (either up or down) to continue, open interest ideally
should increase, or at least not decline. This is so important ii concept
that rememberingthe word "fuel" as a surrogatefor open interest will placea
traderaheadof 80 percentof all futures tradersworldwide!

Open Interest Indicates the Existence of a Difference of Opinion

Thereis nothing that creates a market more than a difference of opinion.

This is reflected in a willingness to take an open position and hence an
increasein open interest.
Economists state that any market place searches for an equilibrium
price-the intersection of the supply and demand curve at a price that
"clears" the market. What if a futures market was at the theoretical equi-
librium and the entire dealing world knew it? What would be the level
of open interest? Zero. There would be no need for hedgers to shift risk
or speculators to put their hard earned money on the line to outguess the
market direction. But no one knows where equilibrium is; it is always
shifting. Open interest measures the difference of opinion and, more im-
portantly, how it is changing.
24 Chapter 3

For instance, a borrower of funds tied to a floating rate (a potential 3-1

short hedger) knows that if rates rise, financial difficulty awaits in the
form of higher costs. The borrower does not know which way rates are
going, but wants to shift the risk of increasing rates. A speculator may
think he can outsmart the market and decides rates are going down.
Both the borrower and speculator have a willingness to put on an open
position.
Increasing open interest is the signal that profits will be available
(from the loser) as fundamental supply and demand factors move inter-
est rates toward a new equilibrium. What is important to understand is
that the difference of opinion creates a market that can sustain a signifi-
cant price move.

PRICE
Open Interest Determines if the Losers are Being Replaced

Technicians do not care if a losing position is being financed by meeting

margin calls and throwing more money at the market or if one loser OPEN
steps aside and new blood comes in to take his place. What matters is INTERESI
that the funds are being posted at the clearing house. The losers are nec-
essary to payoff the traders with the correct market judgment. When the
losers decide that they "don't want to play the silly game any more" and
leave the market, open interest will decline. Obviously the losers pay the
price for their misjudgment, but what is of importance to the technician
is that declining open interest means the prevailing price trend has be-
come very unhealthy.
It does not 1
~-~"'.~ : uptrenc
Upon introducti
IDEAL HEALTHY PRICE UPTREND have difficulty 1
an equal numbl
Figure 3-1 represents a healthy price uptrend that is expected to con-
tinue: Both the bulls and the bears are increasing their positions; open .is i
interest is increasing. The longs, however, are in control. The longs are ~ and open interl
the smart money. of the early 198(
The technician always attempts to monitor what the smart money is .-' coincidj
doing. In an uptrending market, this is obviously the bulls. If the longs liked to tra
are increasing their positions and the losers (shorts) are being replaced, internal cha
open interest will be expanding. The price upmove is technically healthy. those in FigurE
When open interest increases along with price, existing longs may : is falling. Th.
be adding to their profitable positions and/ or new longs may be joining
the bull bandwagon. The additional short sellers may be existing shorts When open inte
adding to their losing positions and/ or new short sellers entering the They are se1li
, doing? The
26 Chapter 3

Figure 3-2 Healthy Bull Market

$
TON
300

?RO

260

01. 240
THS
CTRS

1nn
?20 PRICE

200
so VOl

THS
CTRS.
OPEN
60 411 INTEREST

4n 20

?f'J~
14 28 '1 25 9 23 6 20 4 '8 , '5 29 '2 26 '0 24 7 2' 5 19 2 '6 30 13 27
..
MAR APR MAY JUNE JULY AUG.. SEPT OCT. NOV. DEC. JAN. FEB.

OpenInterest: Increaseson Price Updays

Decreaseson PriceSelloffs assuming the
signal an imp
L interest ded
._£L,perhaps only 1:
Who has been correct in their market judgment all the way up? The Although the op
longs. Who has been dead wrong all the way up? The shorts. The techni- a high percentage
cian wants to side with the smart money. open interes
The smart money is saying that prices have gone high enough. The insight as to wl
losers are either so confused or do not have any money left (probably r what is/I
both) that they are throwing in the towel. The price upmove is coming
from poor buying; this is a weak technical situation. The price uptrend is
expected to reverse. Figure 3-4 shows the early warning signal of open HEALTHY
interest declining and the liquidation that occurred after a price run-up.
This was the signal that the bulls were no longer enamored with this ~ ideal healthy be,
market. increasing open i
 Open Interest 29

Figure 3-5 Helathy Price Downtrend

PRICE

OPEN
INTEREST

When prices settle lower than the previous close on increasing open
interest,the shorts are in control. The short sellers are pressing their win-
ning positions. The longs are bottom picking and adding to losing posi-
tions. The bulls are "long and wrong"-making cannon fodder of
themselves and providing fuel to sustain the price dowIltrend. This is
seenin the latter stages of the bear market in corn illustrated in Figure
3--6.
The ideal healthy bear market of price down on increasing open
interest would be expected to continue as long as open interest does not
begin to decline. When the smart money (the shorts) decides to take
profits, liquidation in total open interest will reflect this condition. Open
interest declining would mean there is less conviction concerning the
probable continuation of the price downtrend and less fuel to sustain the
 OpenInterest 31

price downtrend. If total open interest begins declining as prices move

lower, the early warning signal of an impending trend reversal is
flashed.This situation is analogous to the declining open interest signal
prior to a price top.

A Caveat

The ideal healthy bear market is found with far less frequency than the
ideal healthy bull market. This is due to the idiosyncrasy of the "public"
toward trading. They do not like a bear market and are reluctant to par-
ticipate in one.
Even if a salesman telephoned a potential client and explained he
could make just as much money on the way down and often in a shorter
time period because markets tend to fall faster than they go up, the
client's response would be, "Call me when it gets to the bottom and then
I'll buy it:' The public has a definite tendency to avoid a bear market!
The technical ramifications are such that a futures analyst is pleased
if he can find open interest at least remaining flat during a bear market.
In this situation, the losers are being replaced and the fuel is at least
remaining constant.
A more likely bear market scenario is finding open interest declin-
ing. Declining price and declining open interest are classic characteristics
of a liquidating market. This situation puts the prevailing price trend in a
weak technical condition. The "bottom line" is if traders wait to short a fu-
turesmarket only if open interest is expanding, they will not be on the short
sidevery often.
This is especially true of futures contracts that the public likes to
trade from the long side. These include the traditional agricultural com-
modities (grains and livestock) and the metals.
Traders must think about idiosyncrasies peculiar to the specific mar-
kets they trade. A price top on a spot Dollar-Mark chart in inter-bank
dealing would look like a price bottom on a D-Mark futures chart. The
price scales used are the reciprocal of each other. These, and other spe-
cific traits, will be addressed for individual markets in Chapters Eight
and Nine.

SIDEWAYSPRICE ACTIVITY

When prices are, in general, moving sideways in a choppy trading range,

what use can be made of open interest changes?Relatively flat open in-
terestalong with sideways price activity is the most neutral condition; no
32 Chapter 3

predictive price implication exists. Open interest increasing, however,

does create conditions that are important to note.

Price Steady, Open Interest Up

When open interest increases, new bulls are buying (opening new longs)
from new bears who are selling (opening new shorts). This is an aggres-
sive posture from both sides. Prices are not expected to remain stagnant.
Once prices breakout with a close outside a trading range, simply liqui-
dating the losers should carry quotes a considerable distance. The techni-
cal signal created when open interest increases as price moves sideways
is one of preparedness becausea breakout is eminent.
There is a general rule of thumb for anticipating the probable extent
of a price move that is often used by bar chartists: Once a breakout from
a rectangular or triangular trading range has occurred, quotes are ex-
pected to move beyond the breakout level by a distance equal to the
vertical height of the trading range. When open interest is building prior
to the breakout, it is safe to assume that this "height" measuring objec-
tive is likely to be achieved.

Price Steady, Open Interest Down

Open interest declining is the definition of a liquidating market. Together

with sideways price movement on the chart, the picture is certainly far
from dynamic. But the technician should not be lulled into a sense that
nothing is happening. This condition is most often associated with a
market trying to change direction.
If an upside breakout from a sideways trading range occurs, a tech-
nician must see increasing open interest. This is necessary to be comfort-
able in applying the height measuring objective.
If a downside breakout occurs, the long liquidation (open interest
down) often continues. Yet even in this technically weak condition, the
traditional height objective is most often reached to the downside. The
ideal situation is open interest expanding after the downside breakout;
but it is not a necessary condition. The propensity of the public to favor
the bull side of any market is once again th'e major influence.

An Example

The coffee futures chart in Figure 3-7 exhibits classic price and open in-
terest interaction.
34 Chapter 3

1) The bulls were in control on the two price rallies of April and Short interest is the
May; open interest expanded. to cover short sales.
2) Dips in open interest preceded the price declines in late April the lender .
and mid-June; this is the classic early warning signal. Two schools of
3) Note the normal long liquidation that occurred as quotes either traders expec
moved lower after a rally. 2) the shares sold sh
condition.
4) A healthy bear market developed from late June onwards;
Increasesin taki
open interest marched higher . issue of how to inter
5) Open interest held flat at a relatively high level during the tri-
angular consolidation from mid-August to late September; this
gave classical bar chartists confidence that enough fuel was
present to propel prices to the traditional height measuring ob-
jective once a breakout occurred.

CONVENTION

An open interest scale is constructed at the bottom of each daily high-

low-close futures bar chart. A dot marking the level of total open interest
at the end of each trading session is posted directly under the price activ-
ity .Connecting the daily postings yields a graphic portrayal of the
changes in open interest. The changein open interest, not the absolute
magnitude of open interest, is what is technically important.
The Commodity Exchange of New York (COMEX) gold futures con-
tract can be used as an example: Assume 180,000contracts are reported
as the total number of open positions. This 180,000figure does not reveal
how many separate entities are involved as large or small speculative
traders, futures funds, or legitimate hedgers. What is known with cer-
tainty is that 180,000long positions (each representing a 100-oz contract)
and 180,000 short positions are outstanding~and yet to be offset or ful-
filled via the delivery process.
Insight as to the category of participants can be obtained via the
monthly Commitmentsof TradersReport.SeeChapter Ten for a description
and use of this report.

SHORT INTEREST (EQUITIES)

The concept of short interest in the U.S. stock market is completely dif-
ferent from open interest in futures. In any equity market that allows
short sales using borrowed stock, a short interest situation might exist.
 OpenInterest 35

~-.interest is the number of shares that have not yet been purchased
cover short sales. The borrowed stock must eventually be returned to

Two schools of thought prevail as to what short interest implies: 1)

traders expecting a price decline could be initiating short sales or
; sold short must eventually be bought back-hence a bullish

Increases in takeover activity and arbitrage have further clouded the

i to interpret short interest statistics from an equity market.
CHAPTER

A nalyzing the strength of any given price trend can be done by com-
billing the ideal price, volume and open interest characteristics, that
is:

VOLUME AND OPEN INTEREST

SHOULD INCREASE AS PRICES MOVE IN THE DIRECTION
OF THE MAJOR PRICE TREND

According to this rule, the most bullish condition is price moving

up on increasing volume and increasing open interest; the longs are in
control and the price uptrend is expected to cont~ue. On a daily basis,
this rule implies that on price up days (when quotes close higher than
the previous trading session), volume should expand and open interest
should increase.
In a strong bear market when quotes close lower, volume will ex-
pand and open interest will increase. This "ideal/1 healthy price down-
trend does not often occur in those markets that the public prefers to
trade from the long side. These include the traditional agricultural com-
modity futures and metals. Conversely, other markets such as interest
rate futures (U.S. Treasury bonds in particular) often do exhibit the ideal
bear market characteristics of volume and open interest up on price
down days. The most bullish and most bearish technical situations are
shown schematically in Figures 4-1 and 4-2.

37
38 Chapter 4

Figure 4-1 Ideal Healthy Bull Market Figure 4-2 Ideal

PRICE /

UP

~ / 0.1. UP

VOl. UP
PRICE

0.1.

VOl. .III, , ..

A short coverir
WHICH IS MORE IMPORTANT can state that t
volume is bull
VOLUME OR OPEN INTEREST?
of blowoff pro'

While the generalization for a healthy price trend states that volume and '""
An example oJ
open interest should increase as prices move in the direction of the major .-4 ~. The Cor
price trend, what if the two variables are in conflict? Which is more im-
interest declir
portant, volume or open interest? Both variables should be weighted
of 52 contra4
equally. At times, however, a technician will want to give slightly more
" ~6. balance,
emphasis to one of the readings. Three of the most obvious situations in
An interesting
which volume and open interest are not given equal weight are found in
.in Figure 4-
a short covering rally, an upside breakout, and holiday trading.
'6. to show tha
, signal the start
Short Covering Rally Extrapolating from the general rule, price up Figure 4-4 sh<
with high volume is bullish. But, if open interest drops during this same
J
trading session, a bearish reading of that variable results. The internal simply continu
condition of the market during such a trading session would be that of subsequently s
short covering.
42 Chapter 4

Upside Breakout Volume is especially important in validating any up- Tab II! 4-1 Prir:~
side breakout on a chart. This is because of the propensity of the general
trading public to look for reasons to buy to initiate longs rather than for
reasons to sell to establish shorts. Since volume normally increases on
upside price moves as the public buys, it must show a more than normal
increase to assure traders that the breakout is actually valid.
There must be a fundamental factor that causes the volume to ex-
pand. Although this does not mean that the technician must ferret out
that fundamental; it does mean that the volume expansion must not be
due simply to technical traders activating an apparent price pattern.
Some new fundamental input must have entered the market-causing Markl!tc;

the volume to expand because of increased participation by fundamental

tr~cfpr~~~ wpll ~~ tp('hni('ian~.
T-B{)nd~

Thus, volume on a upside breakout is more crucial than the open interest
Et]r()d()11ar~
chanfl,e for that particular trading session.
S&P's
Holiday Trading When trading is curtailed due to a holiday, volume
usually contracts. In such situations, the change in open interest can be Cold
more instructive than volume.
In the financial instrument futures in particular, volume is low on
Deutsche Mark
business days in the U.S. when the Federal Reserve Bank is closed. Both
the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade
(CBOT) in Chicago have noon cl~ings on business days preceding fed- S'Wi~~ Pr:ln('
eral holidays and three-day weekends.
Table 4-1 depicts the price and open interest changes for Monday, ]apenese Yen
October 9, 1989. This day was Columbus Day in the U.S., Thanksgiving
Day in Canada, and Yom Kippur throughout the world. The Federal Re- British Pound
serve Bank was closed but the exchanges were open in the U.S. With the (Average Volume}
exception of the British Pound, volume was "low" in all eight financial
instruments surveyed; and all of the markets witnessed significant (5 or
more minimum price tics) price changes except for the Deutsche Mark
contract, which finished unchanged.
Open interest declined in all six of the markets that could be ana-
lyzed. Even though the rule for a healthy price trend could be applied
only in its most minute form (one day), the declining open interest meant
that the price changes that trading session should not be the direction of
the major price trend.

The premise is that open interest changes can still be used to "test" for the
direction of the maior price trend durinfl, holiday tradinfl,.
 General Rule For A Healthy Price Trend 43

Table 4-1 Price and Open Interest Changes on a U.S. Federal Reserve
Bank Holiday, Columbus Day, October 9th, 1989,
CBOT and CME

Worked
Price Next According to
Markets Price OpenInterest Trading Session General Rule?

T-Bonds + Yes

Eurodollars + Yes

S&P's + Yes

Gold No

DeutscheMark to + No Analysis
Possible

Swiss Franc
No

Japenese Yen No

British Pound No Analysis

(Average Volume} Possible

(Volume was "low" in all the markets.)

CHAPTER 5

W hen constructing a chart, total volume and open interest for all out-
standing futures contracts are plotted at the bottom of each chart.
Onespecific contract (usually the nearest to expire) is used to plot prices.
Why, then, use total volume and open interest if only onespecific contract
will be traded ? The answer lies in the ability to apply the guidelines for a
healthy price trend (Le., volume and open interest should increase as
pricesin the direction of the major price move).

Theoretical Behavior

Figure 5-1 shows the hypothetical plot of the open interest of a single
June xYZ futures contract. The expiration date for this contract is in
June,two years hence. On the day before the exchange lists the contract
for trading, the open interest in this individual contract month is zero.
When the exchange states it is legal to deal in that particular expiration
month, a speculator and hedger together make a trade. Open interest
slowly begins to increase, but the number of open positions in this dis-
tant month is relatively low becauseit is not the lead (nearby) contract.

47
48 Chapter 5

Figure 5-1 TheoreticalBehaviorof OpenInterestfor an long "cash" market

Individual ContractMonth tures and desires to
trader would look ti
PLOT OF JUNE In a mature ffi(
XYZ OPEN cally be expected t
INTEREST ONLY cycle. The shape c
shown in Figure 5-3
--- At any point iI
open interest (and V
the principles of a hj

ACTUAL OBSERVJ
OPEN
INTFREST A perfect market do
est do record a drop
- cific contract specifi
open interest curve.
The most pronc
.IAN FEB MAR APR MAY JUNE found in physical dE
an orderly rollover j
cash settled contract
terest at expiration. ,
be held through exp
ure 5-4 exhibits a S
actual open interest (
Assuming the xYZ futures have a quarterly expiration cycle, the Open interest i4
June future becomes the lead month with the arrival of April and May of amined in detail in C
that expiration year. Open interest in the June contract escalatesdramati-
cally. In the delivery month, open interest in the June xYZ future will
drop back to zero; this is true whether the contract specifications call for
physical delivery or cash settlement. ROLLOVER SURG
If a technician tries to measure a Eingle volume or open interest plot,
both variables would be increasing as the contract became the lead Studying the life cyc
month-no matter what prices were doing. The axiom used to determine sights. These are belli
the health of the price trend would not be applicable. or exit of positions tc
Assume the market in this example is used by sophisticated hedgers substantial rise in V(
and speculators. The hedger needs to transfer risk. If exposure to risk rollover surge.
will continue after the expiration of his June contracts, the hedger must The CME featu
"roll" his positions into the next month. The astute speculator, desiring Market Perspectives.F
to maintain a market view, also would roll positions forward. volume by individua
Rolling from one expiration month to the next is best accomplished futures. Volume has
by a spread order. Assume the hedger is short in futures to protect the serves to highlight th
 Why Total Volume and Open Interest Is Used 49

long "cash" market inventory and the speculator is currently long in fu-
tures and desires to continue with a bullish view. Spread orders for each
trader would look like the examples in Figure 5-2.
In a mature market, the level of total open interest would theoreti-
cally be expected to remain unchanged during an orderly expiration
cycle. The shape of the sequential expirations would resemble that
shown in Figure 5-3.
At any point in time, the summation of all the individual contract
openinterest {and volume) should be plotted on the chart. Application of
the principles of a healthy price trend then become feasible.

ACTUALOBSERVATIONS

A perfect market does not exist. In reality , most plots of total open inter-
est do record a drop as maturity of the nearby contract approaches. Spe-
cific contract specifications create unique and observable shapes to the
openinterest curve.
The most pronounced difference in the shape of the open interest is
found in physical delivery contracts vs cash settled contracts. Generally,
an orderly rollover is observed in the physical delivery contracts, while
cashsettled contracts exhibit a more pronounced drop in total open in-
terest at expiration. This is because positions in cash settled futures can
be held through expiration with no physical delivery consequences.Fig-
ure 5-4 exhibits a series of IMM Eurodollar expirations. Note how the
actual open interest curves resemble th~ hypothetical plot in Figure 5-3.
Open interest idiosyncrasies of particular futures contracts are ex-
amined in detail in Chapters Eight and Nine.

ROLLOVERSURGE

Studying the life cycle of an individual contract can produce technical in-
sights. These are beneficial to hedgers and speculators in timing the entry
or exit of positions to coincide with periods of good volume activity .The
substantial rise in volume in a single futures contract is known as the
rollover surge.
The CME featured the rollover surge in its August 1986 issue of
Market Perspectives.Figure 5-5 contains charts from that issue showing
volume by individual contract month of the S&P 500 and Deutsche Mark
futures. Volume has been smoothed via a 10-day moving average. This
servesto highlight the rollover surge and Ir..:lkeit more readily apparent.
50 Chapter 5

Figure 5-3
Figure 5-2 Typical Spread Orders to Roll Positions Forward

ABC HEDGE CO.

BUY SELL

50 JUNE XVZ 50 SEPT xYZ

MKT

and
OPEN
INTEREST
DEF SPEC CO.

BUY SELL
~

50 SEPT XVZ 50 JUNE XVZ

MKT

A simple look
Not surprisingly, volume jumps dramatically in an individual con- provides the first ci
tract when it becomes the lead month. Then volume often drops off prior years," which tends
to setting new highs again. This phenomenon can be observed in Figure crop month often b\
5-5. The probable explanation for the volume dip is that spread orders to contracts. Knowled~
roll positions forward were completed. marketing seasonis
To gain further
mitments of Traders"
ined. In the grains,
DISTRIBUTION OF OPEN INTEREST spread activity are d
cultural futures con
Although most technical attention is focused on total open interest, a ough explanation (
look at the distribution of open interest reveals much about the depth Chapter Ten.
and sophistication of a market.
54 Chapter 5

Interest rate futures also lend themselves to a myriad of spread

strategies. For example, a spread in T-bond futures creates an artificial
instrument of duration equal to the time distance between the legs of
spread. The resulting position is a surrogate for the term repro rate for -; r--o"",",
..r--O\N-
the time period in question. ""
0-"1'0\,,",
___N

Strip trading, which involves buying or selling a series of contracts

for protection against adverse interest rate fluctuations, is also popular Q, 0000
OJ -
with hedgers. Table 5-l1ists the open interest of the CBOT 30-day inter- tIJ
est rate futures. The data contains the open interest history from the
contract's inception on October 3, 1988 to March 24, 1989. The distribu- ~
=
...
tion shows that an active back-month trade developed soon after the -
~
-
contract was introduced. c
~

~
A look at open interest in back month contracts, especially in short Q)
cn =
...
term interest rate futures, will reveal if commercial interests are using the o
u
contracts via strip trading. Additional insights into back month open in- > 41
~
terest are found in the Spread Considerations Section of Chapter Eight. "C
=
...=
NN""""

..:
U-
-

"u; ~
Q) (1
--
~
Q)
-
c

c '"
Q) Q, 0000
c. ~
O
-
o
c
o
:;;
=
.c
..:
,Q ~NrI)rI)
"u; 41 ""NrI)O
"' -NN~
c
cn
Q)
--
= = 0'-
- cc -
= N
U-
Q)
m
~ v ""'0\\0-
- U ~""r--N
cn Q -N""",,,
Q)
--
"'
Q) -5
c
c
~0~"'"'N\O"'
O \O~",",r--
> ...Z N"'"'
~
c U

Q 9
M C
O ..OO\0\~

\J N...~r--

UO NNNN

,- ""-~
I t---NN
Ln
0) U U U U
.0 0000
~
..-
CHAPTER 6

T aking the theory and arriving at a market view requires discipline.

Volume parameters must be derived and updated regularly. A proce-
dure of recording open interest changes should be developed. Finally, a
weighing of the evidence leading to a conclusion must occur .

SETTINGVOLUME PARAMETERS

Specific parameters that define "low ," "average:' and "high" volume
must be determined for every chart. In the computer age, it makes sense
to develop a computational method of deriving the required volume pa-
rameters. A mechanical approach will be suggested, but in the end, a
simplistic analysis still seemsthe most viable.
A statistical approach could calculate a moving average of daily vol-
ume for the last 30 trading sessions. Any volume reading beyond a .75
standard deviation on either side of the mean could be classified as low
or high. There is a major drawback to this type of approach. A purely
mathematical model will not know that an important holiday or book-
squaring date is artificially lowering the volume. In addition, the as-
sumption that volume follows a normal bell shaped distribution is

57
58 Chapter 6

suspect. The probability of extremely low volume is less likely than the passed, a more obje
probability of extremely high volume. reached.
Another consideration is that the volume directly relates to the level When an appan
of open interest. If open interest registers a sustained increase or de- the major trend oca
crease, the volume it would support on a daily basis would likely in- estimate of low volu
creaseor decreaseas well. can then be compare
An easier approach to creating volume parameters is to scan back- was in the "low" tel
ward an "appropriate distance" on the chart. Then draw hypothetical only a reaction.
horizontal lines representing the threshold levels of low and high vol- Efforts spent in
ume. The appropriate distance, whether one week or two months, will the process becomes
depend on the specific conditions prevailing on each chart. These condi- els of "low" and "hiQ
tions involve holidays, dramatic open interest changes, options and fu-
tures expiration dates, economic releases, etc. The case studies in this
book showing the derivation of reasonable volume parameters should USING A WORKSH
aid in shaping a new technician's feel of what is reasonable.
In practice, the number of high and low readings observed in the
The next step is to ar
period analyzed should be about equal. There also must be an adequate
general rule for a hec
number of volume readings in the average category. This is to allow for
pIe worksheet, such j
situations where the market is just marking time during a consolidation.
to derive the directio
A ~eneral rule of thumb is:
analyzed, comprisinB
be used where the vo
One-third of the volume readings should fall into each category.

There is no specific determination made about blowoff volume. Any

volume bar that "sticks out like a sore thumb" on the chart is a good A CASE STUDY
candidate for blowoff volume. This, of course, would be a warning signal
of a possible price trend change. The September 1989
ample. The date of ti
to the opening on thE
est figures are availa
UPDATING THE PARAMETERS five trading sessions.
The two volumE
Volume parameters are not static. How often must a new determination portion of the chart i
be made? A review should be made every week. Usually no revision or backward on this paJ
only a slight adjustment will have to be noted. This re-evaluation is different before the e
made easier once the initial parameters are set. in total open interest
A worksheet requiring the analyst to make specific entries to denote
begin with the volum
volume parameters is essential. This is to make sure the technician can-
Horizontal lines
not "cheat." Suppose an apparent "upside breakout" occurs on a price
drawn. Figure 6-5 s]
chart. Volume must then register a noticeable increase to validate the
26,000 and 32,000.TJ
breakout. It is human nature to look at the associated volume and say "It
worksheet (Figure 6-
is hi.1?;henough." By settin.l?;a prior volume hurdle that must be sur-
mate, note the numbE
ning Friday, June 23rl
 Developing A Disciplined Approach 59

passed,a more objective volume confirmation of the breakout will be

reached.
When an apparent price "reaction" in opposition to the direction of
the major trend occurs, the reader should write down his current best
estimateof low volume. The actual turnover when it becomes available
canthen be compared to the predetermined figures. If the actual volume
was in the "low" territory, the price move could correctly be labeled as
only a reaction.
Efforts spent in developing volume parameters will be rewarded-
the process becomes easier. In looking at any new chart, the volume lev-
elsof "low" and "high" become very apparent.

USING A WORKSHEET

Thenext step is to analyze a series of trading sessionswith regard to the

generalrule for a healthy price trend. This is accomplished using a sim-
ple worksheet, such as the one in Figure 6-1. The goal of this analysis is
to derive the direction of the major price trend. Five trading sessions are
analyzed,comprising a full week of trading. Any length time period can
beused where the volume parameters remain unchanged.

A CASE STUDY

The September 1989 D-Mark future in Figure 6-2 will be used as an ex-
ample. The date of the analysis is Thursday morning, July 13,1989 prior
to the opening on the IMM. Wednesday's actual volume and open inter-
est figures are available and posted on the chart. Data for the previous
five trading sessionshas been entered in the worksheet in Figure 6-3.
The two volume parameters must now be set. The enlarged bottom
portion of the chart is in Figure 6-4. The "appropriate distance" to scan
backward on this particular chart is two weeks. The conditions were far
different before the expiration of the June contract. (Note the huge drop
in total open interest with the June 21st posting.) Thus the analysis will
begin with the volume posting on Friday, June 23rd.
Horizontal lines "guesstimating" the volume categories need to be
drawn. Figure 6-5 shows this graphically. The two lines shown are at
26,000and 32,000. These volume parameters are then entered onto the
worksheet (Figure 6-6). As a rough check for how appropriate an esti-
mate, note the number of high, average, and low volume postings begin-
ning Friday, June 23rd. The results are:
 Developing A Disciplined Approach 65

4 readings above 32,000

3 readings from 26-32,000

6 readings below 26,000

This is close enough to meet the criteria of near equal readings in

eachcategory.
Open interest is building. This means that volume is likely to esca-
late as well. The expectation is that subsequent volume postings will in-
creasingly enter the average or high volume categories. The current
parameterslikely will be increased by the time two weeks pass.
The next step is to place each trading session's volume into one of
the three categories (or the fourth -blowoff volume, if applicable). Work-
ing the general rule backwardsdetermines whether the volume and open
interest changes are to be considered bullish or bearish. Given the price
changesfor each session, indicate whether the reading shows a bull mar-
ket or a bear market.

THURSDAY

The first volume figure of 25,232 falls into the "low" category.Prices
closeddown 16 tics that trading session. A low-volume selloff is charac-
terized as a reaction, expected in a healthy uptrending market. This price
down vs low volume reading is deemed to be bullish. The words "low =
bullish" are written by the 25,232 volume posting on the worksheet in
Figure 6-6.
Open interest declined 597 contracts in conjunction with the 16-tic
price selloff. Open interest ideally should increase as prices move in the
direction of the major price trend. Therefore:
Whateverprice changeoccurswhen openinterest declinesis !!Q1the direc-
tion of the major price trend.
Hence the major trend is not down. This price vs open interest read-
ing is deemed to be bullish. "Bullish" is noted next to the -597 open
interestposting on the worksheet in Figure 6-6.

FRIDAY

Thenext trading session (Fri 7/7) saw price up (+46) on high (36,471)
volumeand increasing (+2,901) open interest. This is easy to read. It rep-
66 Chapter 6

resents the definition of an ideal healthy price uptrend. Both interactions Figure 6-6
are bullish.

MONDAY

The third session analyzed (Monday 7/10) is similar to the previous day.
Increasing price, high volume, and a positive change in open interest are
construed as bullish.
High Volume:

Low Volume:
TUESDAY

Tuesday, 7/11, is an interest trading session. Given the big price down
day (-58), did the longs panic? No. Volume did not escalate into the high
category. At 29,750 contracts, turnover falls into the average zone. A Date
technician does not try to force the issue when average volume occurs.
This is a neutral reading. A question mark is placed on the worksheet to Thurs 7/6
mark this as a non-directional reading.
Open interest on Tuesday, 7/11, showed a big increase (+1,558).
Fri 7/7
With a price down day, the general rule states that this is the definition
of an ideal healthy price downtrend. The word "bearish" is written on
the worksheet. MOll 7 110

Tues 7/11
WEDNESDAY
Wed 7/12
Volume on the 22-tic price rally of Wednesday, 7/12, was a disappoint-
ment for the bulls. The longs would have preferred to see a high turn-
over. At only 22,658, this was a low volume rally. Since low volume
rallies are expected in an ideal healthy down market, this is a bearish
signal. The positive change in open interest on the price up day is con-
sidered bullish. This neutralized the bearish volume reading for this
trading session.

7
SUMMARY

The final step is to add up the bullish and bearish readings to arrive at a
"weight of the evidence" verdict about the direction of the major price
68 Chapter 6

trend. At seven bullish signals vs only two bearish signals, the major
price trend is to be considered up. Figure 6-7 "Out

5440IL--
OTHER TECHNICAL CONSIDERATIONSAND OUTCOME 5400
-1~
Two opposing price patterns were apparent to the bar chartists. These 5360
are seen in Figure 6-2. The one-day Island Top was bearish and the
Head & Shoulders Bottom (although unsymmetrical) was bullish. 5320
The outcome of these two forces is seen in Figure 6-7. A pullback to
the underlying support at the neckline occurred. Although additional 5280

bearish price vs volume and open interest readings occurred, the weight
of the evidence still was in favor of the bulls. This led to another price 5240

rally (to a higher high) in late July as the major trend re-asserted itself.
5200
Note the abrupt change in open interest concurrent with the price
high on August 2nd. This is an example of open interest acting as a coin-
5160
cident indicator with price.
5120 HEAD & SHOULD
BOTTOM
Failed to achie\
5080 its minimum
measuring
objective
5040
Left
Shoulder
so 00

90.000

BO.OOO

Total

Open
70000 Interest

60.000

50.000

40DOO

30.000

20000

7 14 21 28 5
April I
 CHAPTER 7

_CI

T his chapter answers the most often asked questions regarding the in-
terpretation of volume and open interest. The majority of the "prob-
lems" are associated with disturbances to the pure theory of price vs
volume or price vs open interest changes.

SCALE CONSTRUCTION

Obviously a technician would like the most responsive volume and open
interest scales practical. Updating a dozen daily charts by hand should
present no problem for the serious trader. Working with more than 12
charts daily would strongly suggest that mechanical methods be used. In
any case,selection of proper scalesis important. Several observations can
be noted:
Do not try/or too much accuracy.The actual figures are not important.
Identifying the volume categoryand observing the changein open interest
is the goal. Trying to place an open interest dot to within 1000 contracts
when the magnitude of the open interest is 300,000 is fruitless. In this
situation, accuracy to within 4,000 contracts is sufficient.
The scalesdo not have to begin at zero. The bottom of the chart does
not need to be cluttered with black vertical lines. Identify a level of obvi-
ously "low" volume and begin the scale at that level. Should a volume

71
 72 Chapter 7

Figure 7-1

405 +~'
t'l~~,
400

t
395

390

385

380

375

370

365

360

170000

160.000

~ Note disconti
in scale

WHEN TO CHANGE MONTHS 60,000

A technician should concentrate his primary price analysis on the most 50DOO

liquid futures month. This is typically the nearby contract, closest to ex-
piration. When does this contract begin to lose liquidity, making it neces- 40,000

sary to change the technical emphasis to the next expiration? The answer
is not standard. In many cases,it can be derived from the contract speci- 30,000

fications. 20.000
Most futures contracts still allow the obligations to be fulfilled by 3 10 17 24 3

actual delivery. However, the majority of market participants, including March

hedgers, do not want or need to participate in this process. As long as
the ability to deliver forces convergence between the futures price and

~
74 Chapter 7

Figure 7-2 Right- and Left-Hand Scales Chicago Board of

The following se
CBOT.

OPENINTEREST VOLUME First Position Da~

SCALE : : : i: : i I i -i i: SCALE
First Notice Day:
1. i ~

::: ~ :
:~!-J
/
-::::
, LEFT ' .., :

~IGHl
/:
" ;

! First Delivery Da~

HAND ;

~CAlJ= The shorts II

tices begins with
very important to
of First Position r:
on First Notice Da

The practicall
be closed out or rolL
0 ..: ..0
As previousl:
sition Day tend tc
CBOT contracts:

Be out of all
month.

Switching/Rollove
cash price, an honest futures quote will result. Prudent trading suggests
that an open long futures position should not be held when receiving The Chicago Boar
delivery is a possibility .Most futures traders are out of their element most liquid contra
when forced to operate in the cash market. into the next mont
Holding a short position in a physical delivery contract when deliv- month is "switchej
ery is possible is not dangerous because the short initiates the delivery the trading pit has
process. However, liquidity declines. Often the spread between the bid the best sight 1ine
and asked widens appreciably. tice on the CBOT,
Some contract characteristics of the two large Chicago futures ex- clerks remain in ti
changes will be examined next. Each trader must do his homework on simply changes.
the contracts he is trading. Knowledge of the contract specs will point to Switching the
the advisability of shifting to the next contract. If volume and ope
 Specialized Problems 75

Chicago Board of Trade

The following sequence governs the physical delivery process on the

CBOT.

First Position Day: Second to last business day preceding

expiration month

First Notice Day: Last business day of month preceding

expiration month

First Delivery Day: First business day of expiration month

The shorts initiate the delivery process. Allocation of delivery no-

tices begins with the oldest-dated long position. First Position Day is
very important to the longs. Holding an open long contract on the close
of First Position Day could result in the trader receiving a delivery notice
on First Notice Day. Actual delivery would occur on First Delivery Day.

The practical ramification of this system is that all speculative longs should
be closed out or rolled forward by the close of business on First Position Day.

As previously discussed, open short positions held beyond First Po-

sition Day tend to suffer from declining liquidity .A general rule for the
CBOTcontracts:
I
Be out of all short positions by the end of the first week of the delivery

month.

Switching/Rollover

The Chicago Board of Trade is well aware of the desire to deal in the
most liquid contracts. This necessitates Ilrolling'l some positions forward
into the next month. To insure that this physically occurs, the most liquid
month is "switched" to the "top stepll of the trading pit. This top level of
the trading pit has the largest area, is most easily accessible,and contains
the best sight lines to the other pits and telephone desks. In actual prac-
tice on the CBOT, the individual pit brokers, scalpers, day traders and
clerks remain in the same physical location. The month they are trading
simply changes.
Switching the pit typically occurs on First Notice Day at the CBOT.
If volume and open interest in T-Bonds, however, are holding up in the
76 Chapter 7

lead contract, the T-Bond pit committee might not switch the pit until a The T-Bill ex
few trading sessionsafter First Notice Day. The smaller contracts such as defined as one bu:
the Municipal Bond futures (even though it is an "index" and does not tract month on w
settle via physical delivery) would switch at the same time as the bigger T -Bill has 13 weeL
T-Bond contract. the last trading dc
A speculative desire to maintain long positions in a physical deliv- provides handy ca
ery month sometimes arises. This stems from a very bullish market often ing days. An exaff
resulting in an inverted price structure (backwardation). The near-by 7-3. Note that the
contract gains in price on the back months. There is an economic func- cide with the CBC
tion being served. A price inversion should draw existing quantities of month prior to the
the commodity out of storage. Playing this game can be dangerous. Eurodollar Tu
When sufficient deliveries occur to break the back of the squeeze, the havior as expiratio
front month often undergoes a collapse in price with respect to the back in the front month
ture. The August .
months. The London Metals Exchange is famous for its many cases of
"backwardation." "Fifty days before
The conclusion to be drawn from this analysis of the CBOT's physi- terest is in the nea
cal delivery contracts is: financial futures]."
This is due to
All technical work and open long speculative positions should be concen- hedge using a "str
trated on the next expiration month contract-beginning with the close two more than one ma
business days prior to the expiration month. proach one month ]
An example a
The March contrac
Chicago Mercantile Exchange position on Mond,
prior to the expirati
Physical deliveries do occur on most of the livestock futures on the CME. Technicians nE
Longs can receive a delivery notice after the market closes on First Notice most active contra<
Day. Therefore: and open interest
When volume in th
All technical price work should move to the next contract beginning with a change of focus
the close one business day prior to the beginning of the expiration month. interest is containe
general:
The currency and T-Bill futures on theIMM present a special case in
the arena of physical delivery contracts. Delivery does not take place Technical price 1
until after the last day of trading. Knowledge of the exact date (and time Euros at the mid-mon
of day) is crucial. The last trading day in foreign currency futures is de-
fined as the Monday prior to the third Wednesday of the delivery
month. Physical delivery then occurs two days later on Wednesday. (A
SIMEX
detailed look at a currency expiration can be found in Chapter Eight.)

In general, holding either long or short positions in currency futures into The Singapore Inte
the first week of the delivery month presents no problems. same rules and cor
analysis of when to
 Specialized Problems 77

The T -Bill expiration is more complicated. The last trading day is

defined as one business day preceding the first business day of the con-
tract month on which a 13-week T-Bill and a previously issued l-year
T-Bill has 13 weeks to maturity .The easiest method of keeping track of
the last trading day is to obtain a listing from the exchange. The CME
provides handy calendars listing both the options and futures last trad-
ing days. An example of one of these expiration cards is found in Figure
7-3. Note that the expiration of the T -Bill options was designed to coin-
cide with the CBOT's interest rate options. T-Bill options expire in the
month prior to the delivery month.
Eurodollar Time Deposit futures exhibit a unique open interest be-
havior as expiration approaches. Open interest in Euros declines rapidly
in the front month further from expiration than any other cash settled fu-
ture. The August 1986 issue of the CME Market Perspectives stated that
"Fifty days before expiration, less than half of total Eurodollar open in-
terest is in the near-by compared to well over 90 percent for [other CME
financial futures]."
This is due to several possible factors. Financial institutions tend to
hedge using a "strip" of Euro futures. There is also a desire to operate
more than one month forward so positions are rolled as the Euros ap-
proach one month prior to expiration.
An example of a rollover in Eurodollars is contained in Table 7-1.
The March contract of the next year was rotated to the most active pit
position on Monday, November lOth. This was more than one month
prior to the expiration of the December contract on December 18th.
Technicians need to focus their attention on the price charts of the
most active contracts. In Euros this means that a glance at the volume
and open interest relationship of the two front months is necessary .
When volume in the second month exceeds volume in the nearby month,
a change of focus is necessary. An additional look at Eurodollar open
interest is contained in the detrending case study in Chapter Eight. In
general:

Technical price work should be concentrated on the next contract month in

Euros at the mid-month ~ to the expiration month.

SIMEX

The Singapore International Monetary Exchange (SIMEX) follows the

same rules and contract specifications as the CME. In this regard, the
analysisof when to monitor the next trading month is similar.
80 Chapter 7

tracts overwhelms the technician trying to discover the nuances. This is Figure 7-4 Wh
especially true on newly introduced contracts. Analysis can be under-
taken, however, on the "mature" futures contracts.
Weekly and monthly charts are called continuation charts. The
nearby future is plotted until less than one full week or month remains
until expiration. The chart is then continued by plotting the next expira-
tion. If a large price spread exists between the lead and back month, a
gap on the chart can result when plotting the next contract. The techni-
cian must live with this. The long term charts are used to monitor the big
picture. Actual entry and exit trading decisions are usually based on a
reading of the daily chart.
OPEN

SPECULATIVE VERSUS HEDGE MARKET

INTEREST ;;
Examine the two graphs in Figure 7-4. Without knowing the name of
what is being traded, a comment concerning the type of market can be
made. Which market is dominated by speculators and which is more VOLUME
heavily used by hedgers?
Graph B is the speculators market. Volume on a daily basis often
exceeds the level of open interest. Day traders playa major role. They
participate in price action during the trading session,but are unwilling to
hold positions overnight.
Graph A is typical of a mature futures contract used by commercial
interests. Hedges are placed and not grossly changed from day to day.
Corn futures would be a prime example.
An interesting difference in trader attitudes is apparent in the inter-
est rate futures in Chicago. This is seen in the two graphs of Figure 7-5.
Large hedge positions in Eurodollar Time Deposit futures make volume S&P market. This
unlikely to surpass open interest levels. But at the long end of the yield "noise."
curve, T-Bond futures daily volume quite often exceeds open interest. Carrying the I
Clearly there is more speculative activity in proportion to the total over- given two charts (I
night positions. Some of the T-Bond turnover is coming from "hedgers" whelmingly opt to
who are "actively managing" the position! lar/Mark chart wo
An important consideration is how much pure speculative activity turned upside dow
is present. The amount of "noise" created by speculators makes placing the inter-bank mar]
protective stop-loss orders more difficult. For example, a 100-point move plied the way curre
in the S&P futures (in either direction) is common every day (no matter
what the major trend may be doing). Price reactions often eat into sup-
port or resistance levels by 100 points. Traders who would normally feel The following
comfortable buying or selling an unchanged opening would wait for a Mercantile Exchang
95-point dip or rally from the previous session's close before entering the are asked to insert t
 Specialized Problems ~1

Figure 7-4 Which Graph Depicts a "Hedge" Market versus

a "Spec" Market?

3RAPHA 3RAPH B

OPEN
INTEREST

vOlUME

5&P market. This is trying to take advantage of the normal speculative

('noise."
Carrying the public idiosyncrasy favoring the long side to extremes,
~iven two charts (one the inverse of the other) the public would over-
whelmingly opt to trade the market that is rising. An inter-bank Dol-
,ar/Mark chart would look like the IMM Deutsche Mark futures chart
:urnedupside down. But the outside speculator is trading in futures, not
'he inter-bank market. The General Rule for a healthy price trend is ap-
Jlied the way currencies are quoted in the futures markets.

The following question has been used in Ken Shaleen's Chicago

\.1ercantileExchange Technical Analysis course since 1976. His students
Ire asked to insert the word up or down to make the statement correct.
 82 Chapter 7

Figure 7-5 Note Relationshipof Volumeto OpenInterest The question

down"! Actual tesl
percent) answer thi
answers are "dowJ
dents are insightfu
EURODOLLARS T -BONDS down" is correct. T
DECEMBER 1989 DECEMBER 1989
INTERNATIONAL MONETARY MARKET CHICAGO BOARD OF TRADE

With the
discontinuity
Figure 7-6
in the scale,
volume does K
IIOt exceed
500
K ! open interest.
750 46P

Total 436!
70C
Open Interest ,
40A 0.1

651)
~-a~
new record ,
372

325
340

27f 308

225 276

244
17."
212
Total
125 Volume
18('

7 14 21284 11 1825 8 152229 7 1421284 11 1825 1 8152229

July August September July August September OPTIONS ON FU

The definitions of V(
changeable with t}
That is where the
chart together with
if not impossible.

Price
Price with open interest increasing indicates the under-
lying trend is healthy and should be expected to continue. The time decay in
tions. Price patterI1
The answer is found on the next page. Additional questions are in tures contract. An
ChaDter 16. advantage of the aI

~
84 Chapter 7

Oven Interest

The options open interest analysis problem is similar to that of cash set-
tled futures, only worse. Total options open interest builds steadily and
then collapses at expiration. Figure 7-7 of open interest in options on
T-Bond futures illustrates the typical shape. Removal of the "trend com-
ponent" of open interest increase is the suggested approach with cash
settled futures contracts. The concept of detrending futures open interest
is found in the Eurodollar case study in Chapter Eight. No attempt has
been made to apply a similar detrending approach to open interest on
options.

Volume

Options volume does not necessarily exhibit a regular escalation and

then drop at expiration. Many options expire worthless and no offsetting
action is needed. Since total options volume is comprised of both put
and call activity , a further complication is introduced. Although it would
be quite easy to plot put and call volume separately, no such attempt has
been made.
Another volume factor is apparent in the graphs of total monthly
Deutsche Mark and British Pound volume in Figure 7-8. In general, vol-
ume on a futures contract increases when options on the contract are
listed.
The specific problem of the futures open interest experiencing a de-
cline coincident with an options expiration is detailed in Chapter Eight.
(/)
Q)
...
=
EVENING TRADE ON THE COBT '0:;
u..
'C
c
o
On April 30, 1987, the Chicago Board of Trade introduced an evening m
.
trading session for Treasury Bond futures. Trading has since been ex- 1-
C
panded to include additional financial instrument futures and options. 0
(/)
Opening of the evening session represents the beginning of the next C
0
.-
official "day." Trading is "suspended" at the conclusion of the evening "'C..
session. A "resumption" of trade occurs the next morning and the close o

takes place in the early afternoon, local Chicago time.

How should a technician handle split-session trading? The answer r-..
I
lies in the availability of volume and open interest information. Having r-..
Q)
specific volume and open interest figures for each of the trading sessions ...
~
01
is the most desirable. Analyzing changes in attitudes and market view- ii:
 o O o
o o o
o o o
o o
~
0 ~
"' "'
N
01
OJ
00 V"
01 ~<
.- -
1"-
gj
'""
M .s.
><
QJ
~
~
0
1"-"5
~-. 0..
o
0
>,
.e
"'
~
~
"'
(\I QJ
-:5
0!
c:
~
63
~
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,"
'!j
'""
QJ
~
~
~ 63
1U' 0..
"'~ o
~
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co
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(/)
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-
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c
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I t
1- "' "E
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(/) QJ CI
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a.
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86 Chapter 7

Figure7-8 points by the ev

mal condition w
The CBOT
The accompanying charts illustrate total monthly volumes for four con- evening trade bt
tracts traded on the Chicago Mercantile Exchange: Deutsche mark futures range for the spJ
and options and British pound futures and options. The graphs demon- above the combi7
strate the coincidence between increased volume in the underlying fu- A price acti
tures and commencement of options trading based on the currency
morning resump
futures contracts. Gap. It results fr,
TOTAL MONTHL y VOLUME be aware of the~
DEUTSCHE MARK FUTURES (BAR) port or resistancE
& DEUTSCHE MARK OPTIONS (LINE)
gap.
7000000

6000000

5000000
EFP TRADES

4000000 Exchange For Pl1

3000000
and open interes
a specific pUrpO
2000000 cash market tran:
1000000
commodity to bE
trade, a cash ma
0 ~ simplest form, ti
1985 1986
futures positions
physical commoc
TOTAL MONTHL y VOLUME tures positions in
BRITISH POUND FUTURES (BAR) The volume
& BRITISH POUND OPTIONS (LINE) cluded in total vc
350000 remain unchange
300000 are as follows:

250000 1) If two p
200000
futures ]
Party A:
150000
Party B:
100000
Result: ,
50000
2) If one si
0 - - - -
1983 1984 1985 1986
(Party B
Party A:
Source: Market Pers.oectives. Chicago Mercantile Exchange, August 1986. is now
 Specialized Problems 87

by the evening session participants would be possible. This opti-

-~.._~.~~~."--' nonexistent in evening CBOT trading in late 1990.
The CBOT Clearing House does provide estimated volume for the
Thus, chartists have to keep the price
trading on the same vertical line/bar, directly
~ ~ u .total open interest.
A price activity gap is possible between the evening range and the
resumption of trade. This type of .£ -
£ ' technical traders must
of these Suspension Gaps. A Suspension Gap will act as sup-
i often acting as a magnet by drawing prices to close the

TRADES

: For Physical (EFP) trades have the potential to cloud volume

open interest interpretation. These types of trades are conducted for
specific purpose, typically to allow buyers and sellers to effect their
market transactions on the basis of a negotiated price, delivery site,
to be delivered, and the timing of the delivery .In an EFP
a cash market position is exchanged for a futures position. In its
form, the buyer of a physical commodity exchanges his long
positions for the physical commodity he needs. The seller of a
, gives up his cash commodity but receives short fu-

...: volume of EFP trades is kept by futures exchanges and in-

in total volume statistics. Open interest can increase, decrease, or
.The three possible EFP situations

1) If two parties enter into a "basis trade" and neither has a prior
futures position:
Party A: Sells physicals -Establishes new long future
Party B: Buys physicals -Establishes new short future
Result: Volume 1 and open interest + 1

2) If one side of the trade already has an open futures position

(Party B is long futures):
Party A: Sells physicals -Receives B's long future and
is now long futures
88 Chapter 7

Party B: Buys physicals -Passes long future to A and change to be soldi

is even in futures cially useful to acti
Result: Volume 1 and open interest unchanged estimated that 30 p
to the IMM, most
3) If both sides have open futures positions, the transfer tenni- placed with a pro.
nates both futures hedges: and open interest f
Party A: Sells physicals -Receives B's long future, covering
existing short, and is now even in futures
Party B: Buys physicals -Receives A's short future, exiting VOLATILITY TRA
from existing long, and is now even in futures
Result: Volume 1 and open interest -1 The same logic is
effect both the opti
viewing whether tI
EFP trades have been increasing as a percentage of total volume in tions price. The t\i
the financial instrument futures. For example, EFP's in T-Bond futures and open interest
amounted to 0.3 percent in 1986; entering 1990 the percentage was esti- open interest figur
mated at 4.0 percent. EFP's in grain and oilseed trading in Chicago aver- ket.
aged 5.5 percent in 1986. This is a representative figure and remains
fairly static at this level.
Currency futures EFP's on the IMM averaged 8-9 percent in the liq-
uid contracts for 1989.S&P 500 EFP's amounted to 1.2 percent of volume;
the livestock futures only 0.25 percent in 1989. With the advent of after
hours automated trading (i.e., GLOBEX), it can be argued that there will
be far less need for EFP trades. This is especially true for EFP's that were
used to create new futures positions.
EFP trades in the more cash oriented exchanges comprise a higher
percentage of volume. Wheat EFP's amount to 15 percent of volume on
the Kansas City Board of Trade. The percentage reached the 25 percent
level on the Minneapolis Grain Exchange in the mid-1980's. The flexibil-
ity afforded by negotiating an EFP trade is also increasing in the oil in-
dustry using the New York Mercantile Exchange's Petroleum futures.

EFP trades are similar to any other futures transaction in the way volume
or open interest is recorded. EFP trades have not proved to be a problem for the
technical trader analyzing total volume and open interest statistics.

MUTUAL OFFSET SYSTEMS

The most successful mechanism for transferring open futures positions to

another exchange exists between the IMM and SIMEX. This inter-ex-
change link allows designated contracts that are bought/ sold on one ex-
 Specialized Problems 89

to be sold/bought on the other and offset. The system is espe-

Lto active international money market dealers. In 1989,it was
.~~L that 30 percent of SIMEX Eurodollar contracts were transferred
the IMM, mostly for the purpose of liquidation. Since any trade is
with a profit motive, it won't disturb the premise that volume
.interest figures can be used to monitor traders' viewpoints.

TRADES

same logic is applied to "volatility trades." An option trader can

..both the options and futures trade in the options pit. The trader is
--v ' the market is over or under stating volatility in the op-
-price. The two transactions are counted individually for volume
open interest purposes. These trades, of course, boost volume and
.interest figures but do not distort technical analysis of either mar-
 CHAPTER 8

T echniCaluse of volume and open interest evolved from the traditional

agricultural futures. This began in the U.S. in 1877 with the inception
of wheat trading in Chicago. With the introduction of new contracts, the
criteria for a healthy price trend should be applied, appreciating the spe-
cific traits of each contract. The conceptual nuances of contracts intro-
duced since 1972 are found in Appendix B -Historical Overview.
This chapter contains macro observations of how open interest acts
in a transition from a bull to a bear market. Then a micro look at contract
specificationswill be undertaken.

MARKETSIN TRANSITION

Sinceopen interest is expected to increase as prices move in the direction

of the major price trend, what happens to open interest as a market re-
versestrend ? If open interest were to exhibit perfect hypothetical charac-
teristics,it would have to rise continually. This does not happen.

Open interest normally declines in the initial stages of a new bear market.

This is especially true in markets that the public likes to trade from
the long side such as the traditional agricultural commodities and metals.
Open interest declining is a result of both longs and shorts exiting from
their positions. But the driving force emanates from the selling pressure
of liquidation by participants with current lon~ positions. Confused

~1
92 Chapter 8

shorts are also closing out positions; they do not realize the trend has The gold Ch
finally turned down-in their favor . est reacts durin~
Open interest often declines to roughly the "steady-state" condition served in a transi
that prevailed before the start of the previous price and open interest
uptrend. After liquidation has brought the open interest down to this
low level then open interest may begin to exhibit the ideal situation by
moving up. At this stage the price downtrend becomes more readily ap- PHYSICAL DEL
parent and the shorts may begin to show their strength by pressing their
winning positions. Would-be longs begin bottom picking and open inter- When physical d
est begins to increase. The result is a healthy bear market. reduced by the a1
time, some dec1i1
Specific contracts
due to the contral
AN ANOMALY?
who is trading it.

Chapter Six suggested using the general rule for a healthy price trend to
identify bullish or bearish price vs open interest changes on a daily basis.
Seeing open interest dip along with prices was deemed a "bullish" read- DELIVERY WHI
ing. It now appears that open interest will decline at the initial stages of
any bear market. Obviously, a conceptual difficulty arises. To clarify this Chicago Board oJ
problem: any time during
and after the last
Price down, open interest down is not an automatic signal to initiate new typically eight fu]
long positions.
grain futures, rot
the delivery proa
A better label to affix to this technical occurrence would be "not fairly predictable,
bearish." the expected cha
Confusion may still exist about the difference in meaning between Delivery Day).
"bullish" and "not bearish." When open interest declines, the direction of Any contract
the price change that trading session is not the direction of the major be fulfilled via de
price trend. Thus, price down, open interest down does not reflect the nitude of the tota
ideal healthy bear market. To twist this reflection around to mean that in the lead contra
the market must therefore be bullish is assuming too much.
To summarize, when prices decline and open interest declines, no
automatic buy signal occurs. This is because the price dip might be the DELIVERY AFTI
start of a major selloff and not simply a correction. At this stage, the
ability to locate underlying support on the price chart becomes crucial. The percentage o
Until the price selloff violates classical support levels, the selloff remains contracts in foreig
onlya "correction." the open interest
The initial discussion may have appeared to suggest that new posi- settlement proces
tions could be taken based upon open interest changes only. Entry into a the contract mont
new position entails a price move that is confirmedby proper volume and arbitrage traders l
open interest changes. A violation of a trendline or support/resistance Trading in t
level on the price chart will normally stop-out a trade. business days prec
 Idiosyncrasies 93

The gold chart (Figure 8-1) is a typical example of how open inter-
est reacts during an important market turn. This phenomenon is ob-
served in a transition from a bull to bear market.

PHYSICAL DELIVERY CHARACTERISTICS

When physical delivery settles a futures contract, total open interest is

reduced by the amount of deliveries against the expiring contract. At this
time, some decline in the plot of total open interest is usually observable.
Specific contracts experience far greater open interest drawdowns. This is
due to the contract specifications, the nature of what is being traded, and
who is trading it.

DELIVERYWHILE NEAR-BY IS STILL TRADING

Chicago Board of Trade deliveries (T-Bonds, grains, etc.) can take place
any time during the delivery month. Deliveries can occur both before
and after the last trading day. On the CBOT, the last day of trading is
typically eight full business days before the end of the contract month. In
grain futures, roughly two percent of all open positions are settled via
the delivery process. The decline observed in open interest is orderly and
fairly predictable. The T-Bond case study in Chapter Nine will examine
the expected changes in open interest on important days (such as First
Delivery Day).
Any contracts open in the lead month after the last trading day must
be fulfilled via delivery .Thus the technician has a good idea of the mag-
nitude of the total open interest decline that must be posted after trading
in the lead contract ends.

DELIVERYAFTER TRADING IN NEAR-BY CEASES

The percentage of deliveries is in the 30-40 percent range of total open

contracts in foreign exchange trading on the IMM. The graphic change in
the open interest plot oIl a forex futures chart is dramatic due to the
settlement process occurring on a single day-the third Wednesday of
the contract month. The large percentage of deliveries stems from dealer
arbitrage traders utilizing the physical delivery settlement mechanism.
Trading in the expiring currency futures on the IMM stops two
business days precedingthe delivery day. The last trading day is typically
 Idiosyncrasies 95

the Monday of the third week of the contract month. Thus the magni-
tude of the open interest drop, due to the expiration that will occur on
Wednesday, is known when the statistics for Monday's trade are re-
leased.

CURRENCYFUTURES EXAMPLE

When total open interest declines substantially because of heavy deliver-

ies into the expiring contract, a technician must temporarily look further
into the open interest changes to gain an understanding of what traders
are thinking. .A prime example is the IMM foreign currency expirations
in September 1989. The delivery day was Wednesday, September 20,
1989.The changes in open interest for that trading session are found in
Table 8-1.

Table 8-1 OpenInterest at the Conclusionof Delivery Day

Wednesday,September20, 1989
IMM ForeignCurrencyFutures

D-Mark Swiss Franc Japanese Yen British Pound

Sept'89 -30,904 -14,429 -30,115 -9,555

Dec '89 -758 -89 -2,190 -784
Mar '90 +111 -14 +80 +67
June '90 +92 O 0 0
Total -31,459 -14,532 -32,225 -10,272

Trading in the September contracts ceased on Monday, September

18th. The magnitude of the open interest drop in the expiring September
contracts was known on Tuesday morning, September 19th, after the re-
leaseof volume and open interest statistics for Monday.
The large drops in open interest in the expired September contract
masked what was really taking place. What is important to the technician
is that open interest declined in the mostactive December contracts.
The price changes on Wednesday, September 20th were as follows:
D-Mark SwissFranc JapaneseYen British Pound
Dec'89 +34 +34 +31 +118
contract
96 Chapter 8

The analytical conclusion was that the price rally was net short cov- the Eurodollar Ti
ering, a signal of a weak rally. In addition, small price gaps (between The first stock in
Tuesday's high and Wednesday's low) were posted on three of the four on February 24, 1
high-low-close bar charts. In a cash se
The gaps on the IMM charts were properly classified as "pattern longs. Therefore,
gaps." This meant the gaps were found within a trading range or conges- ration approache
tion area and would quickly be filled. Declining open interest added shorts either.
credibility to this technical interpretation. Open interest changes were Both sides c
available at 2:45 AM Chicago time on Thursday morning September 21st. of trading. The E
This means that spot forex dealers in Europe had ample time to position futures contract t
themselves with long Dollar views before the resumption of dealing in set. This forces t]
North America. both sides were t
When futures trading began on Thursday morning in the U .5., interest would bE
quotes were lower. The lower openings on the IMM were a reflection to roll, open inte
that the previous day's rallies were suspect. Nimble day traders in the open interest cur
U .5. futures markets did have room to initiate shorts even on the lower the technician wl
openings. The gaps, even lower than the openings, were the targets. This
information is illustrated in Table 8-2.
The graphic portrayal of the Wednesday and Thursday price activ-
GENERAL CON
ity is shown in Figures 8-2 through 8-9.
SETTLED FUTU

Table 8-2 Price Changes Thursday, September 21, 1989 The total open iJ
IMM Foreign Currency Futures general configur,
then drops preci
dency occurs to
D-Mark Swiss Franc Japanese
Yen British Pound nounced on a c
analysis is requiI
-16 -11 -5 -28
Open
-20 -20 No Gap -86
Gap
Low -25 -28 -42 -64
Close -13 -15 -32 -24 DETRENDING
Comment Gap Gap
No trade based on Gap not filled;
Filled Filled a gap; but OI did it was closed A technician ml
indicate a the next trad- open interest in.
selloff was likely ing session.
regression analy1
fig the last few
sary .A trendlinE
This is done in F
cal bar charting
CASH SETTLEMENT rather represent~
A simple Pj
The Chicago Mercantile Exchange introduced the first futures contract count up to the
settled in "cash" rather than by physical delivery. This occurred when creased during t
 Idiosyncrasies 97

the Eurodollar Time Deposit future began trading on December 9, 1981.

The first stock index future soon followed with the Value Line contract
on February 24, 1982 on the Kansas City Board of Trade.
In a cash settlement future, there is no threat of delivery for the
longs. Therefore, no urgent need exists to roll positions forward as expi-
ration approaches. Obviously, there is no delivery mechanism for the
shorts either .
Both sides can hold their open positions until and into the last day
of trading. The exchange then simply marks the price of the expiring
futures contract to the underlying cash market and all positions are off-
set. This forces the convergence of the futures with the cash market. If
both sides were to roll forward, in equal numbers, the plot of total open
interest would be' unaffected. In actual practice, without the inducement
to roll, open interest in the lead contract plunges to zero and the total
open interest curve undergoes a severe drop. This creates a problem for
the technician who is trying to analyze open interest changes.

GENERALCONFIGURATION OF OPEN INTEREST IN A CASH

SETTLEDFUTURE

The total open interest plot of all cash settled futures reflects the same
general configuration. Total open interest increases rather steadily and
then drops precipitously as the lead month expires. Although this ten-
dency occurs to some extent on all futures charts, it is much more pro-
nounced on a cash settled contract. Therefore, an additional level of
analysis is required for this type of contract.

DETRENDINGOPEN INTEREST

A technician must try to isolate the normal "trend component" of the

open interest increase. This does not require the use of high powered
regression analysis. A simple "eyeball" approach is sufficient by examin-
ing the last few expiration cycles. No more than four should be neces-
sary.A trend line of best-fit is then placed through the open interest line.
This is done in Figure 8-10. Note that this is not a trendline in the classi-
cal bar charting sense. The line is not constructed tangent to lows but
rather represents the general slope or gradient of the open interest line.
A simple procedure is to move sideways ten trading sessions.Then
count up to the line of best fit, obtaining the number of contracts in-
creasedduring the ten-session period. Dividing the results by ten yields
106 Chapter 8

the normal trend component of open interest increase for each trading Figure 8-10
session.

EURODOLLAR EXAMPLE

The IMM Eurodollar future is one of the most straight forward contracts
to analyze. Four quarterly expirations are examined. These are seen in
Open
Figure 8-10. The "eyeballed" slope of the open interest trendlines for the Interest Volume

four quarters of 1988 are summarized in Table 8-3.

420.000
Note that no consideration is given to the price trend (up, down, or
sideways). The period under analysis (the year 1988) did, however, ex- 380000- 180.000

hibit all three price trend conditions.

The result of this example, on average, is total open interest in- 340000- 140000

creased by 2,700 per trading session in the IMM Eurodollar futures, no 300.000 -1 nnnnn
matter what prices did! Armed with this statistic, a technician has a
benchmark with which to analyze open interest changes in later time
frames. .
An increase in total IMM Eurodollar open interest of 1,000 contracts
would actually represent a sub-trend increase! For determining the
health and direction of the major price trend, the open interest change
would be considered a decline of 1,700 contracts. The direction of the
price change in that particular trading session would not be considered
the direction of the major price trend. Open
Interest Volume I
For more thorough analysts, Appendix D -Mathematically Detrend-
ing Open Interest -provides a " check" of the eyeballed line of best-fit for 540,000
the first quarter of 1988. The slope of the line as calculated mathemati-
500.000 -200.000
cally was 2,015 contracts per trading session. This is close enough to the
2,700 contract figure derived by simply looking at the plot of total Euro- 460,000- 160,000

dollar ODeninterest.
420,000 -120,000
1-)1

80,000 IJII
APPLICATION TO A CURRENT CONTRACT 40,000 I

1 8
March '89 Euros

Prices on the March 1989 IMM Euro chart were in a healthy price down-
trend; see Figure 8-11. A relatively rare Head & Shoulders Continuation
Top forecasted a downside move to 90.14. That forecast objective was
achieved.
 Idiosyncrasies 107

Figure 8-10 De-trending Open Interest in a Cash Settlement Future

Open
Interest Volume

420.000 .

380.000- 180.000'

340,000- 140,000

300.000 -100.000

60,000

20.000
8 15 22 28 5 12 19 26 4 11 18 25 B 15 22 29 6 1320 27 3 10 1724
January February March April May June

Open
Interest Volume

540.000

500.000 -200.000

460.000- 160.000

420,000 -120,000

80.000

40.000

8 1522 29 5 12 19 26 2 9 16 23 30 7 14 21 28 4 11 18 25 2 9 16 23 30

July August September October November December

108 Chapter 8

Eurodollars: Slopes of Open Interest Trendlines Figure 8-11

Table 8-3

(From Figure 8-10)

9090 ~
lst quarter 1988 1,800 per trading session
2nd quarter 1988 2,800 per trading session 90.80

3rd quarter 1988 3,400 per trading session

4th quarter 1988 2,800 per trading session 90.70
..
10,800 + 4 = 2,700 contracts
9060

*. See Appendix D for a mathematical determination.

9050

9040

A disciplined trading strategy dictated removing 1/4 to 1/2 of all

existing shorts. Any Head & Shoulders measuring objective is only a 90.30

minimum. Prices can continue to decline much farther than the mini-
mum target. The obvious question is: When should a trader cover the 9020

remaining shorts? One answer is contained in the analysis of open inter-

est changes. The "smart money" had been the shorts. When the shorts
determined that the quotes had dropped enough, they began taking prof-
its. This is reflected in a sub-trend increase (or actual decrease) in total
open interest.
On the price down day, Friday, February 17, 1989, open interest de-
clined 558 contracts. This was not only a sub-trend increase, but also an
actual decline. This statistic was released by the CME Clearing House
and available to technicians at 1:46AM Saturday, February 18th. The in- 580.000

formation was ready for use by interest rate traders on SIMEX or the
540,000 ~
London International Financial Futures Exchange (LIFFE) before the re-
sumption of trading in the U .S.
Open interest declined the next trading session as well. Then price
and open interest showed a healthy bear market was resuming. Figure
8-12 shows how Euro quotes continued to fall and the increase in open
interest resumed. .
In this -example, an analyst would have received a premature signal
to cover shorts. But the discipline of following this approach, using open
interest changes as a guide, does payoff in the long run.
An aggressive trader wanting to reinstate positions would see that
the resumption of the price downtrend generated healthy, positive open
interest changes. Because the rollover of positions from the March con-
tract into June was beginning, new shorts would have been placed in the
TuneEuros.
 Idiosyncrasies 111

A note concerning re-establishing a position is in order. Many non-

disciplined traders find it difficult to open new shorts at a price level
lower than where previous shorts were covered. The same is true about
not wanting to chase a bull market. If the technical signs point to a con-
tinuation of the major price trend, new positions must be initiated even if
prior positions proved to be prematurely closed out.

OPTIONS EXPIRATION

Futures open interest will typically experience a drop in the nearby con-
tract when the option on it expires. Often, this decline in open interest is
enoughto cause the total open interest line to drop.
Extreme caution should be used to not read too much into the inter-
action of the price change vs the total open interest change of that trad-
ing session.It is wise to look below the surface of total open interest and
examinethe changes in the back months. This is the same technique sug-
gestedfor analyzing the situation when the nearby futures expire.
Table 8-4 contains the changes in open interest, both total and lead
month, for the December 1989 expiration of the popular options contracts
that trade in the large Chicago markets.
To gauge the possible decline of the futures open interest, it may be
instructive to see how many in-the-money options were exercised. The
hedgeratio (delta) could be large enough to affect the futures open inter-
est appreciably if delta neutral options strategies were being used. Fu-
tures positions created from options exercised would be offset versus
existing open futures positions; futures open interest would decline.
Table 8-4 shows that open interest in the December '89 futures de-
clined at the expiration of its options series in all but the D-Mark con-
tract. The D-Mark situation was abnormal. At this time, D-Mark open
interest was surging to new record levels. This was strong enough to
suppressthe normal tendency of the lead futures open interest to decline
at option expiration.
In the December '89 T-Bond options, 61,875 in-the-money options
were exercised on November 18, 1989. The total T-Bond futures open
interest declined 12,757contracts. Contrast this to the December '89 corn
futures. Big increases in the back month open interest during the same
option expiration were large enough to cause total open interest to re-
main unchanged.
Total futures open interest increased in live cattle and live hog fu-
tures when the December '89 options expired on November 24th. It is
unusual that no in-the-money puts were exercised. This stems from the
 Idiosyncrasies 113

No specific relationship concerning the magnitude of the in-the-

money options vs futures open interest declines at options expiration is
beingproposed. The bottom line:

A technician must be aware of the options expiration dates. Be prepared to

look at open interest changes in more detail on these dates.

Refer to Appendix G for selected examples of Chicago Board of

Trade data sheets for the December 1989 options expiration on Friday,
November 17, 1989. Also shown are foreign currency Daily Information
Bulletins from the CME's December '89 options expiration on December
8, 1989.

SEASONALITY

When assessing open interest changes, especially in the agricultural fu-

tures, the possibility of a seasonal influence must be examined. Varia-
tions in volume are more important in day to day comparisons and no
seasonaladjustment is necessary.
The Commodity Research Bureau (75 Wall Street, New York, New
York 10005) periodically updates a study of the seasonal variations of
some of the more active U.S. futures. Figure 8-13 exhibits the seasonal
trend in corn volume and open interest. The graph is constructed with a
percentagescale. The absolute level of open interest is most often differ-
ent from year to year but the percentage changes during any year do
exhibit a regular pattern. In fact, comparison of this study for the 10
years ending in 1988 produces a high correlation to the same study for
the 10 years of 1955-1964.The only difference is the two relative lows in
open interest currently expected in mid-May and late June as opposed to
a single low at the end of July back in 1955-1964.With the emergence of
bigger crops and earlier grain and oilseed harvests in South America, the
slight movement of the expected seasonal open interest low can be ex-
plained. Additional studies are located in Appendix F.
The Commodity Research Bureau Chart Service (CRB) makes this
task easier by including a graphic history of open interest for the previ-
ous 6 years. The historic open interest plot is displayed on the chart of
the near-by future together with the current open interest.
Refer to the pork belly chart in Figure 8-14. Note the price uptrend
into mid-August. Is this a healthy price uptrend and is it expected to
continue? The standard answer would be no. Open interest is declining.
What does the open interest in this particular commodity normally do at
 Idiosyncrasies 115

this time of the year? The dotted line represents the average open inter-
est for the years 1975-1980. Open interest normally declines between
mid-July and mid-August. How does this change the analysis? Since the
current decline in open interest is at a much steeper rate than would
normally be expected seasonally, the same conclusion is reached. The
price uptrend is unhealthy and it would be expected to reverse soon.
Financial instrument futures (currencies, interest rates, stock index
futures) do not exhibit enough seasonality to alter the analytical ap-
proach. There are times of the year when cash market trading or inter-
bank dealing will slow. Mid-December to the end of the calendar year is
a good example. But these times of book-squaring are very evident. A
detailed analysis of historic open interest curves is not necessary.
The method used by the Commodity Research Bureau to construct
the seasonal open interest line is simple: the total open interest figures at
the beginning and middle of each month of the previous six years are
added and the result divided by six. The plotted results tend to smooth
out the open interest drops that occur when the lead contract expires.
The circled areas of the graphs in Figures 8-15 and 8-16 do not represent
seasonalinfluences; this is a smoothed expiration effect. The shallow de-
clines in the historic open interest curve are the result effect of the near-
by contract's expiration.

OPENINTEREST AS A COINCIDENT INDICATOR

In bull markets, open interest often acts as an indicator with price. Open
interest peaks coincide with price peaks. Price is the driving influence.
When longs are getting stopped-out on a selloff, the financial press often
mislabels the price decline as "profit taking.lI
Figures 8-17 through 8-19 contain examples of open interest as a
coincident indicator in livestock, currency , and grain markets. The ten-
dency of open interest to coincide with turns in the foreign exchange
markets will be explored in more detail in Chapter Nine -Specific Mar-
ket Behavior.

SPREADCONSIDERATIONS

Spread trading is a popular strategy in the futures markets. Much of the

spreading in agricultural and livestock futures is based on the life cycle
of the commodity. Financial instrument spreads rely on an economic
judgment about the relationship of the two contracts. Does heavy spread
116 Chapter 8

Figure 8-14 Weak Price Uptrend: Downside Reaction likely Figure 8-15

c
- LB
PORK BELLIES MARCH 1982 CME

75

-:A

/ 70
PREVIOUS
/ 6-YR AVERAGE
OPEN INTEREST
0.1.

65
THS.
BUS 1

.~~~
~
25

60 0
9 23 7 21 4 18

DOTTED LINE REPRESENTS THE ocr NOV

SEASONAL TENDENCY IN OPEN INTEREf.T
j,.. 55
0.1
THS.

GTAS. CURRENTOPENINTERESTOPENINTEREST /
-"""'-~ (1975-1980AVG.) , VOl
20
THS.
CTRS
~._.:-~;.;;;~~:~ME--~ ---~ .~~..~-',
',--
~ ,~
f . 7. 10
10

trading hamper
No. The analytic
0
0
22 5 19 3 17 31 14 28 11 25 9 23 6 20 4 18 15 vidual contract n
MAY JUNE JULY AUG SEPT. OCT. NOV. DEC. JAN. The spreadi
A spread trade if
made. The trade]
two variables. A
change. The ted
positions. Even i
or forward mark
that normal arb
function of futur4
The more p
Execution takes 1
 Idiosyncrasies 119

HOGS (LIVE) JUL Y 1980 CME

e
LB.
III
46
I~~
.1 44

1\1

...l
~I~'
II
II'\
I \ }r I~,jl/~

;f
I

II~~J.
42

II \ '\ 40

".
'!
38
.NOTE COINCIDENT NATURE OF
PRICE & OPEN INTEREST 36

1979 1980 ,
\ / TOTAL OPE
VOLUM
TEREST & I
All Gontracts) r
,.
'l'jll,~1 34

30
32
~ ~ VOl.
THS.
20 --1 CTRS.
CURRENT OPEN INTEREST ~
'20
VOLUME OPEN INTEREST .#'

10
1~~~rll.jJl~JLIIIJ..Ii1"IUIJI~I~I.lill::~:4Ii:j~~IJI

O
18 1 152913271024 721 5 19 2 16301428418 1 152914281125 9 23 620
MAY JUNE JULY AUG. SEPT OCT NOV. DEC JAN. FEB MAR APR MAY JUNE

STORABLEVERSUS PERISHABLE COMMODITIES

The simple definition of a "storable" futures contract is one in which a

delivery resulting from a long futures position can be held for an ex-
tended period of time (e.g., three months) and then be redelivered via a
short position in a more distant contract. Spreads using storable com-
modities lend themselves to carrying charge calculations. The "full carry"
canbe computed. Full carry is the maximum differential that a more dis-
tant future should trade above a near-by future.
Spreads involving storable commodities tend to be more stable than
spreads involving "perishable" commodities. Live hog futures on the
CME are a typical example used to describe a perishable commodity con-
tract. Live hogs received via a long position in July will not meet the
 Idiosyncrasies 121

.delivery into a short August live hog future a

._0 60In this regard, U.S. Treasury Bond futures would be consid-
.storable, whereas U.S. T-Bill futures would be considered perish-

CARRY TRANSACTIONS

,/ themselves to a "cash & carry" analysis.

cash market inventory that is easily deliverable into an existing

e
BU.
280

270

260

VOl.
THS.
BUS
240

400

200

0
9 23 7 21 4 18 I 15 29 13 271024 8 22 1226 9 23 9 23 6 20 4 18 I 15 2913
JUNE JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB MAR. APR. MAY JUNE JULY

.A tiny "window" exists where a delivery resulting in T-Bonds with less than 15 years and 3
months to First Call Date would not be eligible for delivery 3 months hence.
122 Chapter 8

short position allows an implied interest rate return to be calculated. Figure 8-20
Comparing this return to other short-term interest rates, such as Eurodol-
lar yields, may reveal more favorable returns. If true, the open interest in
this futures market would be swelled by this factor. This problem would
only arise in a storable commodity such as gold that was trading very
close to full carry .In grain futures, even in times of surplus, the spreads
rarely move beyond 80 percent of full carry.

TAX SPREADS
Prior to 1982 technicians had to be aware that some spread trading oc-
curred solely to obtain preferential tax treatment. These spreads were ex-
ecuted mainly in storable commodities, particularly metals. The logic
was that metals should tend to trade near full carry. Many would-be tax
spreaders received an unwelcome education in the effects of increasing
prices, increasing interest rates, a yield curve inversion, and increasing
physical demand in the silver bull market of 1979!
The important point to realize is that historical analysis of any stor-
able futures contract before 1982 must be conducted with the knowledge
that tax spreading may have been a factor. Beginning in 1982, futures
spreads were marked-to-market, meaning that all realized and unrealized
gains and losses are taken into account for U.S. tax purposes.
The following two observations should aid in the historic analysis
of any storable commodity futures charts of the late 1970's and early
1980's:
TYPICAL
The month of May in the United States represented a critical
INTER
month with respect to tax planning. A holding period of 6+ CONFIGUI
months qualified a long position for preferential tax treatment. WHE
May was the last chance for traders to place positions that had TAX SPRI
the possibility of "long term" (6+ months on long positions) WAS POI
capital gains (taxed at a lower rate) in the current calendar year.
Open interest often increased
January was another important calendar month. This is
when the bulk of the tax spreads were unwound. When tax
spreading was prevalent, total open interest often experienced a
drastic decline in the first few days of the new calendar year .

The gold charts of 1980 in Figures 8-20 and 8-21 exhibit the distinct
fall and rise in open interest due to tax spreading.
The actual CBOT volume and open interest sheet in Table 8-5
shows the likelihood that spreads (probably Butterfly Spreads for non-
U.S. based tax purposes) were removed on January 3,1984.
 category of futures markets possessesunique volume and open
characteristics. These idiosyncrasies are due to both individ-
specifications as well as what is being traded. This chapter
The matrix ~-in Table 9-1 at the end of~ this chapter summarizes

SPECIFICATIONS

I Open interest in the nearestto expire futures contract would normally be

expectedto decline:

1) when options on the futures expire

2) when receiving delivery is first possible
3) on the last day of trading
4) on the last delivery day

In various futures contracts, some or all of the above conditions may

occur on the same day. For example, options on the Eurodollar futures
expire on the last day of trading of the futures contract. An analysis of

127
128 Chapter 9

open interest changes on any futures contract must include a consider- Figure 9-1 "Th
ation of the four important benchmark dates listed above. The CBOT's
Treasury Bond futures will be examined in detail to demonstrate the the-
oretically expected open interest behavior; then a comparison will be
madp to what actuallv occurrpd.

T-Bonds ~

The important dates unique to T-Bond futures are:

1) Options Expiration: Noon of the Friday preceding Ist Notice

Day by at least 5 business days
2) First Position Day: Two business days preceding delivery
month (Longs could receive notice of de-
livery prior to opening on Ist Notice Day)
3) First Notice Day: Last business day of month preceding de-
livery month iii
Q)
"-
4) First Delivery Day: First business day of delivery month Q)
"E
5) Last Trading Day: 8th full business day prior to end of deliv- c
ery month ~
0
6) Last Delivery Day: Last business day of month
Time

Hypothesizing that open interest would be expected to decline on

these dates, a theoretical shape of a total open interest curve has been .Assuming positive carry,

constructed in Figure 9-1. This hypothetical open interest curve was cre-
ated without regard to what price changes may have occurred. The "the-
ory" being tested is that the influence due to the contract specificationswill 1) Open iJ
overwhelmthe openinterest changesdue to marketconditions. only 3 c
The next step is to examine actual open interest curves to determine the Fril
if reality conforms to the hypothetical curve postulated in Figure 9-1. ately fo
Twenty-four consecutive T-Bond expirations beginning in 1984 were ex-
2) Open i
amined. The last two years in the study are shown in Figure 9-2. The
This sl1
five important dates are indicated by arrows (the First Notice Day was
the ral1
not analyzed).
An "actual" total open interest curve has been created "byobserva- nearby
occur.
tion" of the 24 actual curves. This plot is shown in Figure 9-3. Note the
similarities and differences when the actual is compared to the hypothet- 3) Open i
ical: ations.
to-expi
 136 Chapter 9

Figure 9-7

u.s.
$
SWISS FRANC SEPT 1980 IMM
720
NOTE THE SHARP DECLINES
~ IN OPEN INTEREST COINCIDENT
1-
.700
.l WITH MANY OF THE PRICE
L REVfRSALS AT RELATI\II:: HIGHS
I
.680
~1 G) ~~
-r I .,
~ I~..itt'f .
I' Ir\ ~L,:t._; , , r~
II, l'11q .660

.L I r '.'~
Open Interest can be a I ~
.640

warning signal, especially

0.1. in currency futures .620
rHs. ..
GrAs. 1979 1980
16
~ .600
CV CURRENT OPEN INTEREST
Jr/
12 -(,-. N
.580
VOl.
~ THS.
y~
~TRS.
" ., II
TOTALvr_,. "",",;"-,-,,
I VOLUME (All Contracts)
0
21 5 19 2 16 30 14 28 4 18 115 29 '428 " 25 9 23 6 20 4 '8 ,. '5 29 '2

SEPT. OCT. NOV. DEC. JAN. FEB. MAR. APR. MAY JUNE JULY AUG. SEPT.

other excellent example can be found on the Sept '89 D-Mark chart in
Figure 6-7. Note that the phenomenon was observable in 1980 and is still
operating in 1990. This idiosyncracy allows open interest to be used as a
corroborative tool in conjunction with other forms of technical analysis
such as chart interpretation. Thus open interest changes can highlight the
fact that perceptions of foreign exchange dealers are changing.
.
138 Chapter 9

SUMMARY

Examining the contract specifications of the major groups of futures con-

tracts results in the summary matrix of expected open interest activity
found in Table 9-1.

CHAPTER

Table 9-1 Summary Matrix of Open Interest Idiosyncrasies

Option Delivery Other

Characteristic Type Considerations

T-Bonds Options expire in month Physical delivery; Ist 1. On Last Delivery Day
prior to futures expira- Position Day is two (OloJj if positive carry)
tion (01 :::r> business days prior to
expiration month 2. 01 likely to increase
(Watch for 01 '"'::'J') in a bear market.

3. At year end (01 ~ ) I ~ the u.s. ~~

Important illS]
Eurodollars Options expire on last Cash settled, but Severe tin 01 at fu- month. Every tr,
trading day for futures rollovers begin at mid- tures/options expira-
(01 I) month prior to expira- tion-Must "de-trend" market where ti
tion month (Watch 01 curve would give the tJ
volume & 01 in near-by movements of ec
vs. deferred to know
when to start charting does not exist. E
deferred) can be used, and
Exchange c
Currencies Options expire 2nd Fri- Physical delivery; 3rd 01 reversal often found foreign brokers
day prior to 3rd Wednesday (01,+ as at price reversals
Wednesday of contract arbitrage unwound) Futures Trading
month (01 "'-"=7) their books that
limit for the IMJ
Grain/Livestock & Options expire in month Physical delivery Seasonal01 factor must
be considered
tracts. Other rep(
Any Agricultural prior to futures expira- (01"""::r>
Commodity tion (01 '""::!1'> Positions of
are commercial ,
Stock Index Options expire on same Cash settled (01 ..., ) Can chart prices until
any reportable p
day as futures (01 ..Jt ) last trading day
(01 J, )
porting commer(
other large trad,
Metals Options expire in month Physical delivery Unusual to find OI in- "Large speculato
prior to futures expira- (01~) creasing in a bear mar- The non-rel
tion (01, ) ket
positions from t
CHAPTER

I n the u.s. futures markets, the Commitments of Traders Report yields

important insights as to the internal makeup of the markets each
month. Every trader has thought: "Wouldn't it be amazing to view a
market where the positions of all the participants were known?" This
would give the trader the perspective of looking into a goldfish bowl; the
movements of each player would be readily observable. This, of course,
does not exist. But, this chapter will explain what the report is, how it
can be used, and examine some practical applications.
Exchange clearing members, futures commissions merchants, and
foreign brokers are required to file daily reports with the Commodity
Futures Trading Commission (CFTC) listing any trader's positions on
their books that exceeds the minimum reporting level. The reporting
limit for the IMM Eurodollar futures, for example, is 400 or more con-
tracts. Other reporting levels are listed in Appendix F.
Positions of the reportable traders are classified as to whether they
are commercial or non-commercial. The term commercial is applied to
any reportable position used for hedging. For analysis purposes, this re-
porting commercial category will be referred to as "Large Hedgers." The
other large trader category (the non-commercials) will be labeled the
"Large Speculators."
The non-reporting category is derived by subtracting the reported
positions from the total level of open interest. These "Small Traders"

139
 Commitments of Traders Report 143

Table 10-3

Commitments 01Traders-LargeHedgers.Speculatorsand SmallTraders

OpenInterest PositionsShownIn P8rC8nt(Rounded)As 01SePtember29. 1989

Large Hedgers LarQe Speculators Small Traders

Long Short Net b. Long Short Net b. Long Short Net b.

Cattle(LV) , 20 39 <;::iV -16 21 11 GQ) 14 54 46 CV 0
Cattle(FE) 16 18 -2 -8 21 ~ 13 12 56 68 -12 -5
Cocoa 63 71 -8 0 12 14 -2 -2 24 14 10 3
Coffe 51 80 -29 -1 15 6 9 -8 32 12 20 9
Copper 41 43 -2 23 10 9 1 -15 47 46 1 -9
Corn 47 39 8 0 14 8 6 0 34 48 -14 0
Cotton 59 61 -2 19 9 11 -2 -13 27 22 5 -4
Crudeoil (NY) 55 62 -7 -7 7 6 1 4 33 27 6 3
Gold(Comex) 66 56 10 -19 4 11 -7 9 21 24 3 10
Heatingoil #2 40 73 -33 -9 24 1 23 9 36 26 10 0
Hogs 13 21 @ 0 34 9 @ 12 45 62 @ -11
Unleaded Gas 49 71 -22 -23 19 * 18 17 27 23 4 5
Lumber 42 44 -2 -8 21 7 14 9 30 42 -12 -2
orangeJuice 59 45 14 -4 6 24 -18 -1 31 26 5 6
Platinum 39 60 -21 -25 19 15 4 18 38 21 17 7
PorkBellies 5 16 -11 0 39 31 8 15 47 45 2 -16
Silver(Comex) 23 69 -46 -17 20 9 11 11 52 17 35 5
Soybeans 38 33 5 -2 9 14 -5 -5 43 43 0 7
Soybean Meal 56 50 6 1 5 8 -3 2 34 36 -2 -2
Soybean oil 47 50 -3 -7 6 6 0 0 40 37 3 7
Sugar"11" 35 94 -59 -20 33 * 32 13 32 6 26 7
Wheat(CHI) 41 27 14 -8 14 16 -2 3 36 48 -12 6
Wheat(K.C.) 44 61 -17 -6 10 8 2 1 44 29 15 5
Eurodollar 62 61 1 1 3 2 1 -1 33 35 -2 1
MuniBonds 48 71 -23 4 28 17 11 -7 22 11 11 2
T-Bills(90 Day) 29 60 -31 -6 43 16 27 19 27 23 4 -13
T-Bonds 47 50 -3 0 14 9 5 0 36 38 -2 -1
T-Notes 75 70 5 6 6 6 0 -6 19 24 -5 -2
NTSEComosite 18 13 5 14 34 42 -8 -4 35 32 3 -11
MMI-Maxi 57 38 19 14 22 27 -5 3 22 35 -13 -15
S&P500 70 60 10 6 8 17 -9 -1 22 23 -1 -4
BritishPound 39 62 -23 -76 22 7 15 32 39 31 8 44
DeutschMark 26 76 -50 -71 34 5 29 44 39 19 20 26
Japanese Yen 49 48 1 -42 12 15 -3 20 35 33 2 23
SwissFranc 27 38 -11 -32 22 22 0 9 49 38 11 23
NOTE:Appliesonly to C.O.T.Table
6 Changein % Net from PreviousMonth(PLUS-increasedlong or decreasedshort.
MINUS-increasedshort or decreasedlong) .Less than .05%
NOTE:Positionsdo not equal 100%becauseintermarketstatistics are not included.
Source:CommodityResearchBureau
CirculationDept.
P.O.Box 92144
Chicago,IL 60675-2144
Fax (312) 454-0239
144 Chapter 10

ensuing price activity .Move to the right on the chart, day by day, seeing Figure 10-1
who was helped or hurt by the price movement. Note the daily change
in total open interest to see how much shifting of positions was likely.
Understanding each of the three main categories of traders, a technician
can make a guess as to what each group's likely reaction would be. This
process yields a good estimate of the present positioning.

APPLICATION

Note the distinct differences in direction that open interest moved on the
December '89 live cattle and live hog charts in Figures 10-1 and 10-2. !iI'
Live cattle futures registered a net declineof 14,555contracts in the two-
month period ending September 29th, 1989. During the same time, live
hogs were undergoing a net increaseof 6,909 contracts.
Figures 10-1 and 10-2 also contain the smoothed line of average 0.1.
open interest in the previous six years. Open interest in live cattle would THS.
CTRS \
normally be declining slightly during this time frame. But the current ~
70
decline is much more severe than what would be seasonally expected.
The live hog situation is even more curious. The current open interest
20~
increase is markedly different from the normal expected decline. 23 6 20 3 1,

The September Commitments Report can be used to determine JAN FE8

which category of trader was increasing or reducing holdings during

September, and their bullish or bearish orientation. The next step in the
analysis is to compare the current situation to the historic net long or
short position of each group at the end of September. This is done using
the graphs in Figures 10-3 and 10-4. These graphs are the historic per-
centagesplit of open interest for each group.
The more the current postings deviatefrom the historic norm, the more 66,848 contracts c
strongly this categoryof traderfeelsabout the direction of prices. cent of the total
(long and short) ,
Prior testing by the CommodityResearchBureau has detennined that
the "Large Hedgers and Large Speculators had the best forecasting re- ments Report. Al
cords, and the Small Traders, the worst by far." In addition, "the Large that amounted t<
Hedgers were consistently superior to the Large Speculators." Armed side of Live CattL
with this knowledge, a trader can compare his views with that of the The CRB vet
"smart money." the {rounded) pe
gory is excluded.
is derived by sui
Live Cattle Large Specu1ato~
cent net long Liv
From the Commitments Report in Table 10-1, the non-commercial re- were 20 percent
porting traders (Large Speculators) were long 13,801 contracts of the
146 Chapter 10

Figure 10-2 Figure 10-3

CTS.
LB

46
>=-"'
45

44

43

42 JAN FEB MAR

0.1.
THS. 40
CTRS VOl.
THS.
20 CTRS
10

0
23 6 20 3 17 3 17 31 14 28 12 26 9 23 7 21 4 18 1 15 29 13 27
JAN FEB MAR APR MAY JUN JUL AUG SEP tOCT
Small Traders stO(
DATE OF
REPORT net long.
The change II
reports. The chan!
CRB (Table 10-3)
example, the Larg
and decreasing sh
reflected in the +1,
ulators in Table 11
net long positions
 Commitmentsof TradersReport 147

Figure 10-3 Seasonally Normal Positions

Long

Small Traders stood at 54 percent -46 percent = +8 percent = 8 percent

net long.
The change in positions from the previous month is shown in both
reports. The change in the number of contracts is seen in Table 10-1. The
CRB (Table 10-3) details the percentageshift in the "delta" column. For
example, the Large Speculators were adding to longs (+3,963 contracts)
and decreasing shorts (-5,662 contracts) during September. This shift is
reflected in the +14 percent figure in the delta column for the Large spec-
ulators in Table 10-3. This means the Large Speculators increased their
net long positions by 14 percent (from -4 percent to +10 percent).

.
148 Chanter 10

Figure 10-4 Seasonally Normal Positions Table 10-4

LONG
0

SHORT
Now ans~
-2 sent a materia]
bullish or bean
-4 Past wor1
deviations of ]
-6 Also, deviatior
usual situation
-8
The concll
JAN FEe MAR APR MAY JUNE JULY AUG SEPT OCT NOV DEC 4 are:

1)

2)

INTERMEDIATE ANALYSIS 3)

Using the net positions and the changes in open interest from the previ-
ous month yields these observations: Only the ~
or more from n
1) Large Speculators:Have made a complete shift from net short to By using the "h
net long. tion would be
2) LargeHedgers:Adding to shorts; reducing longs; still net short. Large Hedgers
Traders. The PI
3) Small Traders:Decreasing both longs and shorts (confused); still was 74.62; this
net long. able for analyst
of 76.25 on No,
Next, using the seasonally normal live cattle graph in Figure 10-3,
month reachinQ
the month-end normal percentage long or short position for each cate-
gory is obtained. The results are summarized in Table 10-4.
 Commitmentsof TradersReport 149

-
Table 10-4 live Cattle-September 29, 1989 Worksheet

Current Situation Trader Category Historic Normal

+10% Large Speculators + 8%

-19% Large Hedgers -21%

+ 8% Small Traders +13%

Now answer the question: Do any of the current situations repre-

sent a material deviation from the norm? If so, this reflects that group's
bullish or bearish bias.
Past work by the Commodity ResearchBureau has determined that
deviations of less than 5 percent from normal should be disregarded.
Also, deviations of greater than 40 percent from normal reflect an un-
usual situation and also should be disregarded.
The conclusions to be drawn from the cattle worksheet in Table 10-
4 are:

1) The Large Speculators are slightly more bullish than normal: 10

percent now versus 8 percent usually.
2) The Large Hedgers are slightly less bearish (short hedged) than
normal: -19 percent now versus -21 percent usually.
3) The Small Traders are definitely not as bullish: 8 percent now
versus 13 percent usually.

Only the Small Trader category represents a deviation of 5 percent

or more from normal, the difference between + 13 percent and +8 percent.
By using the "track records" of the three categories of trades, a long posi-
tion would be favored. The desired position is one that sides with the
Large Hedgers and Speculators, in this particular case, against the Small
Traders. The price of the December '89 live cattle future on October 12th
was 74.62; this was the price when the Commitments Report was avail-
able for analysts. Quotes continued higher, setting a life of contract high
of 76.25 on November 24th and continued even higher in the expiration
month reaching 77.42 on December 14th.
 E~
c~ 0 O-~OON ~~(") 0 (,,)~ON~
~~
"' "' ",,-oN~ I I ~ I'-.U")~
.-.N N
-1-
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c ~ \CfF,t-.O~ I N N ~ I ~
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-Q,
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.-= ~ UQ.,
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ct I
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-
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C Q:::;; E~
~ This is shown i
E OO~Lt) (X)(X)"' ~r')~N
N NO\-o
C
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~~
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~"'
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1'-~ 0\ Lt)
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The daily pri<
- ~~ ""c '!1. Lt)('JI'-I",' ",' I'-.' g::::!:!Lt)
I ~' I ~' -' ",'
~
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'=~
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0
~ ~~ 6~ uptrend on the ch,
~
5~
~E
A market sho
~ ~
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.5 ;:
a former price top
C -oooooU") -"'""' °""t-..
~
.-E
~.9
-
-.0
NNN """'t-..
,,",K,,",
~~ffi[;Q~ conscious. Traden
cn t:::,
$~~~~
~,~ ;;::,
""!. ""!. N, 'X1. "!.
C
0
~ E.~ ~ ";I' ::::' '1" ~' ~' ",'~ ~' r')r')NCX>~ "on the L&.LU~.~
~
~
~
~ are motivated
cn cn
0-
c..C
establish new
"'
-~ ~ ~
~ E ns .. ~ Perhaps
-~
~
~-
- ..>-
>-0
~
>. ZJ
quotes would
ccn C lr)'...
~
IrJ
c:
=
QJ substanti" 1
.5 :E
C:'= g) "' ~
.~ .~ ;z '.{J E
~ ~
..c "' ~ ;> "'
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and the (
QJ ;s; .. .6
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'.{J ;j
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= .-.,
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port (or ~
~2; 8
Q) 'O..5.c","' .. 5 "' -.c"'(/) in this ~..L
U) g) ns u .. "Qi8. ~~
..c ns ns ~ .. (jiQJ 0 ~~~ "!j ~QJ 1UQ,
"E .~ ..Q) ..>- (/) :-E ..~ ~~ ;0
~""'
A.IU
QJA.
The
~..",..>->->-o
.-E e S 8 .."... lr) ,...
>...~
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U
>- O U
UIU
~ ...~Q)~
~ ~ U)° Q)-
~u
(ji~ QJQJd,
c
- ". ~ cU -..'uIU shown in
I "' ~.~ C:~~bO
~ ~ ~ ~ ..0 .$ =~ 'w QJ
., =- ...~ O
o
,-
~
V) ti=;'
> ;3 § .~~~~~.s
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~ O
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bO ., QJ
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_0",p, E-- mc:QJQJQJ2fJ :f:f-- .-0 ...~ E
Q) cOns;3P;3;3;3 ..QJ;j~;j.. ~
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(L o The magnitu<
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thp amount of dea
~
 CHAPTER

T he classic chart definition of underlying support is a "former top."

This is shown in Figure 11-1.
The daily price high of the former top begins the support level. Sell-
offs often eat into the support. If damage is kept to a minimum, the price
uptrend on the chart remains intact.
A market should encounter support as quotes sell off to the area of
a former price top because traders remember this price level. This is sub-
conscious. Traders are not specifically looking at a chart. If traders are
I'on the market" they remember trading at a particular price level and
are motivated to deal in this price area again. The would-be bulls buy to
establish new longs. The shorts buy to cut their losses.
Perhaps only one lot traded at the daily high. This implies that
quotes would have to sink farther before finding price levels at which a
substantial number of contracts cha~d hands. The Market ProfileTM
and the CBOT's Liquidity Data Bank aid in determining where sup-
port (or resistance) should be the strongest. This will be examined later
in this chapter.
The classic definition of resistance is a "former bottom." This is
shown in Figure 11-2.
Resistance is always overhead. A price rally will encounter selling
pressure (resistance) as it approaches the former bottom price.
The magnitude of the resistance should be directly proportional to
the amount of dealing done at a particular price level. Quotes may have

153
 Chapter 11

Figure 11-1 Definition of Support Figure 11-2

PRICE
;( \
?
'l
r FORMER
-r,",n
~
"" 'l
~
///
"'--/
<:~r. / ~ 0;:::
or
/
/
/
/
/
/

/
/

\
y
/
,"
~
/
_./

UNDERLYING
I
I \ ~(

/ SUPPORT L<

to eat into overhead resistance until a sufficient amount of former trad- profile for the SI
ing is encountered. Looking at the distribution of price vs volume for the Bond futures is £
trading session where support or resistance is expected is instructive. 10 minutes of tra(
The daily T-1
tember 15 was (
price selloff wouJ
MARKET PROFilETM
was the daily hig
A look at tl
A trading session breakdown of price, by predetermined time periods, curred in the "H'
creates a diagram. This is The Market ProfileTM. A different letter (or
23. Looking at tl
symbol) represents each time bracket. The Chicago Board of Trade began
volume occurred
collecting price information by one-half hour time brackets to produce a
97-05). Volume j
better "audit trail." A revised bracketing system was introduced in Janu-
tained in the Liqu
ary, 1990, shortening the time bracket to 15 minutes. An example of the
 \I

Supportand Resistance 155

11-2 Definition of Resistance

PRICE
OVERHEAD
I RESISTANCE

"/-: ~
-9r '\
" '\
'\\
"

for the September 15, 1989 "day" session of the U.S. Treasury
in Table 11-1. The "Z" bracket represents the first
-..7:30AM local time.
The daily T-Bond chart in Figure 11-3 shows why the proffie of Sep-
tember 15 was of interest to technicians. Underlying support on any
price selloff would be expected at 97-28 on the December T-Bonds. This
was the daily high on September 15th.
A look at the proffie in Table 11-1 shows that "single prints" oc-
curred in the "H" time bracket from the daily high at 97-28 through 97-
23. Looking at the price proffie only, it can be inferred that not much
volume occurred until the fat part of the distribution (between 97-20 to
97-05). Volume interpretation is enhanced with the information con-
tained in the Liquidity Data Bank1M.
156 Chapter 11

Table 11-1 Market Profile December 1989 T-8onds, 9/15/89 Table 11-2 liQI

UQUIDITY DATA BANK VOLUME DETAIL REPORT FOR DAY SESSION 89/09/18
Copyright Chicago Board of Trade 1984. ALL RIGHrS RESERVED. 09;45;02
UQUIDITY DATA BAN
FOR 89/09/15 US BONDS DEC 89 UPDATED 89/09/15 22:45:25
Copyright Chicago Boar
NOTE Volume figures shown are actual number of contracts multiplied by 2.
FOR 89/09/15 US 00
NOTE Volume fiw
HALF HOUR
TRADEPRICE TOTALVOL % LOCAL COMMERCIALS BRACKET TIMES
CATEGORY PI
96 23/32 3200 0.3 41.4 27.5 E
OPEN 97
96 24/32 9354 0.9 57.2 7.0 E
TO 97
96 25/32 6938 0.7 59.9 12.2 E
CLOSE 97
96 26/32 8960 0.8 62.4 13.2 E
TO 97
96 27/32 7418 0.7 53.1 20.4 E
HIGH 97 :
96 28/32 9938 0.9 59.9 12.8 EFK
QUADRANT 97 :
96 29/32 19274 1.8 59.6 14.3 EFK 1 TO 97 .
96 30/32 15628 1.5 54.6 13.1 AEFK
QUADRANT 97
96 31/32 15026 1.4 54.1 11.5 AEFK
2 TO 97
97 26256 2.5 53.7 12.9 AEFK
QUADRANT 97
97 1/32 20778 2.0 55.4 16.8 AEFK
3 TO 97
97 2/32 31256 3.0 56.8 13.7 AEFK
QUADRANT 96 :
97 3/32 30008 2.8 54.6 17.3 ABEFGK 4 TO 96 ,
97 4/32 18410 1.7 54.5 14.2 ABEFGK
LOW 96
97 5/32 24632 2.3 52.6 14.1 ABCDEFGK
70% OF 96
97 6/32 38048 3.6 54.7 13.1 $ABCDEFGKL
TOTVOL 97
97 7/32 53008 5.0 55.1 14.9 $ABCDGKL
TOT VOLUME US 00
97 8/32 56910 5.4 58.7 11.6 Z$ABCDGKL
97 9/32 57584 5.4 59.8 12.2 Z$ABCDGHKL
97 10/32 62150 5.9 54.2 13.3 Z$ABCDGHKL
97 11/32 35980 3.4 59.9 12.7 Z$ACGHKL
97 12/32 33926 3.2 57.1 12.1 $AGHKL
97 13/32 31404 3.0 60.2 11.7 $AGInJKL
97 14/32 45838 4.3 55.6 14.0 $AGHIJKL Liquidity Data
97 15/32 73142 6.9 55.1 11.5 $AGInJKLM
97 16/32 71450 6.7 55.1 13.1 $AGHIJKLM The CBOT provi(
97 17/32 46780 4.4 55.3 12.4 $AGHIJKL
during a trading
97 18/32 44666 4.2 53.2 18.6 $AH1JK
97 19/32 40818 3.9 54.6 12.6 $HIJK LDB volume sun
97 20/32 43408 4.1 48.6 15.1 $HIJK commercial cleat
97 21/32 15240 1.4 56.0 12.1 $H1JK Table 11-2. It sh
97 22/32 19454 1.8 54.5 8.0 $H
was in the "valu
97 23/33 12506 1.2 51.2 13.9 H
97 24/32 10664 1.0 55.7 5.1 H considerably str(
97 25/32 4920 0.5 58.3 9.1 H come of the sub:
97 26/32 9016 0.9 48.5 18.6 H Figure 11-4. Th.
97 27/32 4868 0.5 39.6 20.4 H area) .Observe t]
97 28/32 62 0.0 53.2 0.0 H
13th concluded v
Note: The CBOT'smethodof organizingthe data is such that the daily low is locatedat the top of the page.This The LDB p
conventiontakessometime getting usedto. within a trading
provide support
CHAPTER

T his question should be posed in discussing technical analysis with

foreign exchange dealers: What was the turnover in spot Dollar-Mark
dealing yesterday? Because inter-bank dealing is an "over the counter"
market, an exact answer is not available. But turnover (volume) figures
are important inputs to a technical approach. There are additional ques-
tions: Were new positions being opened? Was it liquidation? Was the
price move short covering? They also cannot be answered sufficiently.
A viable futures market, one that has achieved a "critical mass,"
produces exact high-low-close price figures as well as volume and open
interest statistics. But futures trading represents only a small percentage
of world currency trading.
This chapter will explain the theoretical interpretation of the data
and will illustrate, via an actual example, how a market view is techni-
cally established. The premise:

A currency futures pit is a microcosm, diminutive but analogous to the

larger inter-bank system.

Thus clearing house statistics can be used as a surrogate in the ab-

senceof inter-bank data.

161
164 Chapter 12

Wednesday 23 Nov -19:58 GMT B)

C)
The spot D-Mark was quoted at 1.7180in U.S. inter-bank dealing at 19:58
GMT on Wednesday, November 23,1988. The March 1989 IMM D-Mark
future was in the process of closing at .5894.This was two points (.0002)
higher than the previous day's settlement price. In addition, the futures 2) Volume'
settle was as close to the middle of the session's trading range as possi- A) Anc
ble. This Mid-Range Close is detailed in Figure 12-1. B) The
Technicians often regard a Mid-Range Close as a minor trend
change indicator. In this case, the minor price trend going into
Wednesday's IMM trade was up (weaker Dollar). Therefore, it would not
be unusual to expect a slight selloff on the IMM the next trading session. 3) Volume

A) An(
hea
Wednesday, 23 Nov 1988- 22:04 GMT B) An.

C) The
Australian forex dealers did little to move the Dollar-Mark relationship.
Spot D-M was quoted at 1.7165.This was to be expected as no new tech-
nical or fundamental input was available. The Mid-Range Close in the Actual total,
U.S., however, should have alerted technicians as to a possible change in to buy Dollars.
the minor trend.

OPEN INTERES"
Thursday, 24 Nov 1988- 7:45 GMT -
Volume and Open Interest Available Similarly, forex (
change and then:
Although Thursday, November 24th was the Thanksgiving holiday in
the U.S. (exchanges closed), the Chicago Mercantile Exchange released
1) A decfu
the volume and open interest statistics as usual. The CME statistics de-
partment had the information on the tape at 1:45AM Chicago time (7:45 A) Be
GMT). Thus the vital data was available at 2:45PMlocal Singapore time. on

B) Be

C)
VOLUME ANALYSIS

A reasonable definition of total D-Mark futures volume parameters at the An

2) incr,
time was: high volume = above 34,000; low volume = below 24,000.
A) Be
Forex dealers could obtain the D-Mark volume and then:
B) Be

1) Volume of less than 24,000would be considered "low" C) Th

A) And would imply that the previous trading session's price

rally was "unhealthy" ;
 Asian and European Foreign Exchange Dealers 165

B) And is bearish for D-Mark futures;

C) Therefore, buy Dollars.

OR
Volume between 24,000 -34,000 would be considered average
2)
A) And is a neutral indicator;
B) Therefore, no inter-bank action is suggested.

OR

3) Volume above 34,000would be considered "high"

A) And the price rally in the D-Mark futures would be
healthy;
B) And is bullish for D-Mark futures;
C) Therefore, maintain a bearish view on the Dollar .

Actual total volume was 22,767contracts. This was a technical signal

to buy Dollars.

OPEN INTEREST ANALYSIS

Similarly, forex dealers could obtain the llv1M D-Mark open interest
change and then:

1)
A decline in open interest would
A) Be short covering on a price push into new high ground
on the chart;
B) Be bearish for D-Mark futures;
C) Therefore, buy Dollars.

OR

2) An increase in open interest would

A) Be a sign of a healthy price trend;
B) Be bullish for D-Mark futures;
C) Therefore, maintain a bearish view on the Dollar.
166 Chapter 12

The actual total open interest change was a decrease of 2,204 con- IMM TRADING
tracts. This was a technical signal to buy Dollars.
Of note was the fact that open interest on the IMM Swiss Franc,
JapaneseYen and British Pound futures also declined. This was in con- Friday 25 Nov 1
junction with price upmoves on the IMM futures. Thus the previous Dol-
lar bears, in general, were undergoing a change of attitude and were The March D-M.
unwilling to hold short Dollar positions. (.0013) from Wec
Most U.S. based futures traders assumed they had no choice but to lar strengthened
wait for the resumption of trading in the U.S. on Friday before shorting Mark futures raU
the D-Mark futures. SIMEX was open and trading the D-Mark futures at of trading. When
the time the Chicago volume and open interest data was released! tics (.0006) but l
A major question addressed in this case study is: Did Asian or Eu- dealing, the Doll.
ropean forex dealers respond to the blatant warning signals of a price
trend change in Dollar-Marks?
ADDITIONAL A

DEALER RESPONSE What did volum

tempt to make ru
ume was only 1~
Thursday 24 Nov -16:57 GMT for the price raI
contracts and w,
There was very little reaction in the Asian time zone. In Europe, the Dol- ume considerati<
lar declined slightly to 1.7140 D-M in Zurich at 16:57 GMT Thursday. overall consensu
This presented an excellent opportunity for astute technicians to accumu- influence remain
late long Dollar positions. By the time of the normal close of currency est in conjunctioI
futures trading in Chicago (had the exchange been open on Thursday), volume and ope
the Dollar was quoted at 1.7130in Sydney (21:23 GMT). The Dollar was Asian forex marl<
weaker still in Hong Kong at 1.7100D-M (3:09 GMT Friday 25 Nov).

FOLLOW-UP
INTERVENTION

Sometime prior to the opening of the futures market in Chicago on Fri- Sunday 24 Nov
day, November 25th, the Bank of Japan bought Dollars. At 13:12 GMT (8
minutes prior to the IMM's open), the Dollar was quoted at 1.7210 in A violent move
Copenhagen. GMT), the U.S. c
 Asian and EuropeanForeign ExchangeDealers 167

IMM TRADING

Friday 25 Nov 1988 -13:20 GMT

The March D-Mark futures opened at .5881. This was a drop of 13 tics
(.0013)from Wednesday's close. In the first 10 minutes of trade, the Dol-
lar strengthened to 1.7248in Frankfurt. Then a real battle developed. D-
Mark futures rallied up to the daily high of .5907 in the next 30 minutes
of trading. When the dust finally settled, the March future had gained six
tics (.0006) but was unable to post a new life of contract high. In spot
dealing, the Dollar was back down to 1.7165in New York (20:20GMT).

ADDITIONAL ANALYSIS

What did volume and open interest have to say about the D-Mark's at-
tempt to make new price highs on the IMM? Friday's total D-Mark vol-
ume was only 14,064 contracts, definitely low. This was a bearish signal
for the price rally in the D-Mark futures. Open interest increased 647
contracts and was bullishly construed. This neutralized the bearish vol-
ume consideration. Often volume and open interest do conflict, but an
overall consensus usually emerges. In this case, the dominant technical
influence remained Wednesday's low volume and declining open inter-
est in conjunction with a price rally into the new high ground. (Note that
volume and open interest statistics for Friday were available when the
Asian forex markets began dealing on Monday, November 28.)

FOllOW-UP

Sunday 24 Nov 1988 -23:31 GMT

A violent move took place in the Dollar. From 1.7133 in Tokyo (23:31
GMT), the U.S. currency strengthened to 1.7290 in Singapore (2:17 GMT
168 Chapter 12

Monday). It is interesting to note that at the same time, the T-Bond fu- Figure 12-2
tures were rallying in price (Sunday evening trading) at the Chicago
Board of Trade.
By 13:14 GMT Monday, November 28th (six minutes prior to the 5920

IMM's opening), the Dollar was quoted at 1.7322in London. This caused
.5880
a gap-opening to the downside in the D-Mark futures in Chicago. The
March contract closed 60 points (.0060) lower. Volume did expand to
.5840
24,445,but was considered only "average." Open interest increased 2,365
contracts. This was a classic sign of a healthy bear market.
5800
A price rally in D-Mark futures later in the week closed the gap on
the chart, but quotes did not make new contract highs. In fact, a classical Outer
5760
Head & Shoulders Top formation was the resulting pattern on the IMM Left
Shoulder
D-Mark chart. Figure 12-2 graphically summarizes the outcome.
.5720

5680
CONCLUSION
5640
This insight into the use of volume and open interest statistics should
provide the Asian and European forex dealers incentive to use their time 5600
zone advantage in shaping a technical market view. As in any approach
to trading, discipline is a key ingredient. It takes discipline to monitor 5560
the statistics on a daily basis, but it pays off!
5520

5480
~

.5400

60000

50,000

40.000
-Jv"1

30.000

20.000

10.000
14 21 ,

October
 CHAPTER

T his chapter will investigate specific technical situations in which vol-

ume and/ or open interest analysis is particularly useful.

ANALYZING EQUITY MARKET PRICE MOVES

Since open interest is nonexistent in the equity market, stock index fu-
tures can be used to judge the quality of a price move. Note the head-
lines from The Wall StreetJournal in Figure 13-1. U.S. stock prices moved
into new high ground, as did the stock index futures. But the change in
open interest in the S&P futures told a different story for that trading
session.
Figure 13-2 shows that total S&P open interest declined 3,962 con-
tracts on the 190-point rally. "Investors anxious not to miss another
rally" were far from evident. The rally was actually net short covering.
Volume on the S&P futures of 42,914 could only be categorized as
average. The combination of declining open interest and lackluster vol-
ume would make technicians very nervous about following the rally.

S&P Follow-Up

The S&P futures opened 60 points lower the next trading session. A run
at the previous day's life of contract high resulted in a new high by the
minimum allowable price fluctuation (a .05 increase). The close, however,
was not lower so a Key Reversal Day was not created. A Key Reversal is

171
172 Chapter 13

Figure 13-1 13-2

I
364
THE WALL STREET JOURNAL THURSDAY. OrToRRR 5. 19R9

362

Stocks Set
360

New Reco rd
358

At 2771.09
356

Bonds Flat as Dealers

354
Await New Figures;
Dollar Trades Mixed 352

--- WEDNESDA V's

MARKETS 350
By ThIt-(;I.AS R- SEASE
S(aff R"po,'", ofTIl' WAUSTRf:f:TJUURNAL
Investors anxious not to miss another 348
rally boosted stock prices to a new high,
The Dow Jones Industrial Average
climbed 16.53. to 2771.09. in moderately ac-
tive trading. setting a second-consecutive 346
record. Currency traders bid the dollar
higher against the yen, but the U,S. cur-
rency was off against the mark. Long-term
344
bond pric('s bareiy budged as traders
, awaited key economic data scheduled for
I re!ease tomorrow.
Stock-market analysts said the surprise 342
rally that sent stock pric('s to new highs
Tuesday jolted mon('y managers irito ac-
tion. Fearful they may be left behind if a 340
big new rally is g('tting under way, portfo-
lio managers jumped into the market,
sending the industrial average up more
than 22 points by early afternoon. Most of 140,000
those gains evaporated in a brief mid.af-
ternoon sell-off, but a late rally involving
computer assisted blly programs restored
much of th(' lost ground in the <'losing half 130.000
hour of trading-
Traders took a mixed vi('w of ye~t('r-
day.s action, Trading volume, while contin- 120,000
uing at bI'!t"r iev('ls thal1 prevailed
through rnuch.of September. still doesn't
sigllal a bull market, More disturbing, onty
831 issu('s on tIle NeW York Stock Ex- 50,000
change post('d gain~, whil(' 6)6 issues f('ll,
Analysts look fllr more thaJI1.000 advanc-
ing issues to indicate hroad sllp\J')rt for a
40,000
rally,
But on tll" brlglit ~id(', It'chm)logy
stocks, which hav(' lleen lag!(ing the ov('r-
all mark('t, pt'rked up Int('rnattonal Bust. 30,000
n('ss Machln('s, do!(ged in recent days by
expt'ctations of poor thirct-quarter r('sults,
I!;linf'd 21,. tu lOR'"
20.000
 Case Studies 177

Figure 13-5 Key Reversal Day

NEXT
TRADING
SESSION

I KEY
-~REVERSAL
DAY

Important to the understanding of the Key Reversal phenomenon

are several additional criteria. Presuming a Key Reversal is forming,
"leading off' by taking a position early in the day can be extremely haz-
ardous. Seldom does a Key Reversal make itself evident early in the trad-
ing session.More often, the price move to a higher or lower close occurs
in the last 20 minutes of trading. Evidence of a Key Reversal early in the
day is more likely to result in price making a violent move to anew
contract low or high before the late price move in the opposite direction.
Price gyrations, often expanding the range for the day several times
in both directions, will generate high volume. Thus, a Key Reversal that
occurs on "average" or "low" volume should not be trusted. Access to
knowledgable sources on the trading floor for an estimate of volume ac-
tivity during the day's trading is ideal.
The series of gold charts, beginning with Figure 13-6, show how the
, open interest helped in gauging the likelihood of the Key Re-

-
178 Chapter 13

versal Low performing as expected. Gold had been in a downtrend. The Figure 13-6
day before the Key Reversal of Thursday, February 25th gold plunged
10.20$/oz and satisfied the minimum downside measuring objective of a ,-..
515
bearish Rising Wedge pattern. Total open interest increased by 5,618 con-
tracts on the price decline; this was an unusually bearish signal.
Gold is a commodity that the public likes to trade from the long
side. The open interest increase means that the outside speculator was
500
probably buying the price break.
A Key Reversal Low developed on Thursday, February 25th. If the \
495
Key Reversal was successful in purging the gold market of weak longs, \
490
open interest would decline.
Figure 13-7 shows the trading session immediately following the \
485
Key Reversal Day. Friday was an Inside Range Day. This posting on a \
;Ian
bar chart is normally classified as a minor trend change indicator. In this
case, it simply perpetuates the measuring implication of the Key Rever-
sal.
It was important that plenty of time was available for the technician 470 W ~nl

to check the volume and open interest of the Key Reversal on the prior 465
trading session. Volume was not of blowoff proportion (only 55,964 con-
tracts). Open interest increased by 4,504 contracts and showed no signs
of liquidation.
A Key Reversal Low should be an indication that the longs are
"throwing in the towel" and the shorts are "taking profits." The technical
situation would be correct for a price rally. This was not true in the gold
situation where the shorts were pressing their winning positions and
speculators were trying to pick a bottom. The longs were cannon-fodder
providing the fuel to sustain the price down move.
Gold gap-opened to the downside on Monday, February 29th. This
is shown by the opening IIdot" to the left of the price plot in Figure 13-8.
The opening price of 427.00 was 4.10 lower than Friday's close and 3.20
160,000
below Friday's low.
Obviously the Key Reversal Low day on Thursday failed. But the 150.000
technicianknew that the internal characteristicof openinterest was not correct.
140,000
Monitoring open interest changes often allows the technical trader to
side-step a whipsaw move in prices. 60,000
Another Key Reversal Low formed by the end of trade on Monday.
50.000
Did the downside gap-open cause long liquidation? The change in open
interest will tell. 40,000
Figure 13-9 shows that open interest declined 1,911 contracts. Vol-
30.000
ume was 53,128 (still not ideal). Following the long liquidation, quotes
rallied slightly on Tuesday. This satisfied the minimum objective of this 20000

second (and more technically proper) Key Reversal Low.

182 Chapter 13

Figure 13-9 EARLY WARNIN

GOLD APRIL 1988 COMEX
The September 19
on LIFFE (Figure 1
460
early warning sigI1
the year, total ope
~ As quotes moved
455
late January. It W
"'
was dealing in this
450 A distinct def
-E- Breakaway
tion was first seen
Gap 447.10
445
Open interest did
(the smart money]
led to the price cor
,
440 The upward
r
r
r
strong surge in of
,

/
,
I As of close I abrupt change in
435
I Wed, Mar 2 I May 1st. Quotes j
points. In the face
430 931 contracts. This
Monday Open interest declined
Key Reversal -; 1,911 on Monday's K-R.
open interest as pI
Ii Following this long 425
ket ready to chang
liquidation, quotes were
""' able to rally slightly on
decline ensued, liQ
Tuesday (and Wednesday)
to satisfy the K-R objective. 420

ASSESSING THE

A highly regarded
volume must expa
I Monday K-R nical analysts mus
Volume
chart-followers set
market participant
validate a breakou
real market movin:
over necessaryto (
As discussed
on an upside brec
trading. They are ~
sell a market. The'
market.
15 22 29 5 12 19 26 11 18 25 8 The nonprofe!
January February March April on the way down,
 Case Studies 183

EARLy WARNING SIGNAL

The September 1987 three-month Sterling Time Deposit contract, traded

on LIFFE (Figure 13-10), is a classic example of open interest acting as an
early warning signal. During the price uptrend in the first two months of
the year, total open interest was acting as a coincident bullish indicator.
As quotes moved higher so did open interest. Note the price decline of
late January. It was accompanied by declining open interest. Whoever
was dealing in this contract "wanted" to be bullish.
A distinct departure from the coincident price/ open interest interac-
tion was first seen in early March. Price moved into new high ground.
Open interest did not.. This open interest decline was stating the bulls
(the smart money) were no longer enamored with the price rally. This
led to the price correction from mid-March to mid-May.
The upward move in price at mid-April was accompanied by a
strong surge in open interest. Once again the bulls were in control. An
abrupt change in the internal characteristics of the rally took place on
May 1st. Quotes in the Sterling Time Deposit future rose seven basis
points. In the face of this good news for the bulls, open interest declined
931contracts. This was the start of a series of five consecutive declines in
open interest as price moved higher. The early warning signal of a mar-
ket ready to change direction was stronger than ever. A substantial price
decline ensued, liquidating the bulls who did not heed the signal.

ASSESSINGTHE VAliDITY OF UPSIDE BREAKOUTS

A highly regarded principle of classical bar chart interpretation is that

volume must expand on a price breakout, especially to the upside. Tech-
nical analysts must be able to ascertain that the breakout was not simply
chart-followers setting off a price pattern. By themselves, this group of
market participants would be unlikely to generate sufficient volume to
validate a breakout. The addition of good fundamental participation (the
real market moving force) would produce the noticeable increase in turn-
over necessaryto confirm the breakout.
As discussed in Chapter Four, the reason volume is more important
on an upside breakout is due to the general public's attitude toward
trading. They are always looking for reasons to buy a market rather than
sell a market. They are eager to participate when they perceive arising
market.
The nonprofessional trader is usually stopped-out of a long position
on the way down, rather than entering a new short. Often, this forced
 Case Studies 185

exit does not occur on the initial downside breakout. Several trading ses-
sions later, it becomes painfully apparent that the trader is "long and
wrong." Then long positions are sold out and volume soars.
The December '89 T-Bond chart in Figure 13-11 is a good example
of using volume to validate the breakout of a Symmetrical Triangle price
pattern. The upper boundary line of the Triangle was at a price level of
99-20 on November 1st. The December Bonds settled at 99-22 +11. This
was an apparent upside breakout. The (predetermined) threshhold level
of total high volume was 300,000at the time. When the actual figure of
262,671was released, it became clear that an upside breakout on only
average volume had occurred. Open interest did increase by 7,381 con-
tracts (a bullish sign). As explained in Chapter Four, the volume inter-
pretation should carry more weight in assessingupside breakouts.
When average volume accompanies a breakout, it does not neces-
sarily mean that the price pattern will fail to act as expected. It does
mean that a pullback (retracement) to the breakout is highly likely.
Figure 13-12 shows the outcome. Quotes closed five tics higher in
the trading session following the "upside breakout." Volume (197,319)
declined even further, falling into the low volume category, below
244,000.The technical situation was very weak. This led to the 19-tic
drop on November 3rd, destroying the Triangle by falling below the
lower boundary line.
Figure 13-12 shows the original Triangle boundary lines being re-
drawn using new reversals at points 3 and 4. Another apparent upside
breakout took place on November 8th on a close of 99-26. Again volume
was only average (266,049).Quotes dropped 13 tics the following session
and the new Triangle formation was eventually destroyed on Friday, No-
vember 17th. To summarize:

Looking at price patterns without the confirmation of volume can lead to

costly surprises.

WAS IT REAllY SHORT COVERING?

A comment from the Wall Street Journal on Tuesday, February 21, 1989
provides an excellent opportunity to explore several major misconcep-
tions:
In soybeans, last Friday's powerful closing rally ended the week
on a positive technical note; one analyst attributed it to massive
short-covering, or buying to offset short, or selling, positions, by
professional traders and commodity funds.

.
188 Chapter 13

First, is short covering "a positive technical note?" No. This is sim- This SCena
ply poor buying. A price uptrend cannot sustain itself if the rally is due press. Headlinef
to buying by the shorts. ticular price raIl
Second, how did the analyst (or reporter) know the price rally was
short covering? The prior positions of the major buyers must first be
known. If the major buyers were previously short, then the observer
would be certain that the rally was really short covering. It is difficult, if
not impossible, to ascertain the prior status of the purchasers. Any state-
ment concerning short covering made before open interest changes are
released is only conjecture.
Third, how is it possible to determine what the commodity fund
managers are doing? It may be possible to examine a representative
moving average model (such as the CRB "Computer Trend Analyzer," 75
Wall Street, New York, NY 10005) to determine if the trend following
fund managers were short. A normal technique used by these fund man-
agers is a buy-stop-close-only order to cover shorts in a rising market.
In the Soybean example, the fund managers were indeed short.
Their buy-stop-close-only orders in the March '89 Soybeans were resting
at the 7.81 level. But the Friday (rally) close was only 7.46. This was not
high enough to activate the buy-stop-close-only orders. The buying was
not from the contingent of fund managers who receive signals from
models of this type.

How is any observer to know that a price rally in a futures contract was
net short covering? Open interest will decline.

Preliminary volume and open interest from the CBOT Statistics De-
partment for Friday, February 17th was available Tuesday, February 21st.
Monday, February 20th, was the "President's Day" holiday. The point is
that the reporter was not privy to the change in open interest when his
comment was written; it was a guess.
One hour prior to the 9:30 AM opening of Soybean trading on Tues-
day, the CBOT "Midis Touch System" (code 2220#) yielded the following
statistics for Soybeans for Friday: volume 65,321 contracts and open in-
terest 117,140contracts. The change in open interest was an increase of
1,297 contracts. Thus, the price rally was not net short covering. An en-
tirely different (bullish) view was the result.
To summarize the critique of this simple newspaper statement:
1) A short covering rally may "look" powerful, but it really isn't.
2) Short covering cannot be identified with certainty until open
interest changes are available.
3) Fund managers were not responsible for the price rally.
 Case Studies 189

This scenario is played out time and time again in the financial
press. Headlines proclaim that short covering was responsible for a par-
ticular price rally. Caution is warranted.
CHAPTER

E ach exchange uses a clearing corporation that is responsible to the

buyer and seller as a third party guarantor. It provides the volume
and open interest data. Actually, the timely distribution of statistics var-
ies widely by exchange. The easeof obtaining the figures also varies con-
siderably. Waiting until the figures are published in a newspaper is too
late. Optimally, the traders should obtain the statistics as soon as possi-
ble. Table 14-1 contains information from a U.S. edition of The Wall Street
Journal.Note tllat actual volume and open interest results are always one
day behind the price data given.

ESTIMATED VOLUME

SomeU .5. exchanges make an attempt to estimate volume during a trad-

ing session.At the Chicago Mercantile Exchange this is a mechanical esti-
mate. The estimate is not derived from actual order tickets. It is derived
from IItic volume.1I When the price changes by one minimum price fluc-
tuation, the tic volume is increased by one.
The CME extends the tic volume by a specific multiplier depending
on whether the contract is a lead month or further back. This produces a
volume estimate. This process does not consider the actual number of
contracts that changed hands. Comparison of the estimate versus the ac-
tual volume total has shown that the reported figure can be "off' by one

191
192 Chapter 14

Table 14-1 Volume and Open Interest from a Newspaper volume category
volume and high
sion. The mechal
the actual to char
gories (i.e., from 1
The Chicago
Thursdav, October 18, 1990
volume estimates
floor reporters. TJ
Open Interest Reflects Previous Trading Dav.
as the initial estll
technician regard
to shift the volw
Open High Low Settle Chanoe
LIfetime Open
High Low Interest
estimate, during ,
cally asking a pit
-GRAINS AND olLsEeDs-
tities traded, will
CORN (CBT) 5,- bu.; cenh per bu.
Dec 229'/2 2293;. 2273;. 228 -3/. 286'/2 221'/2 110,820
M~l 2381/2 238'/2 236V2 237 -3;. 302'/2 23Q3;. ~,591
May 2~ 2~1/2 242'/. 242'/2 -1'/. ~'/2 2371/2 18,632
July 2. 248'/. 2~ 2~'/. -1'/. D'/. 2411/2 19,9S6 Recorded Messagf
SePt 2~3;. 2~3;. 24S 24S -1'/. 287V2 240'/. 2,578
Dec 249 249 2~V2 2463/. -13;. 275 242'/2 9,4S4 "Midis Touch" afi
Est vol 3O,(KK); vol Wed 24,131; open Int 208,115. -360.
OATS (CBT) 5,- bu.; cents per bu.
Dec 1241/. 1241/. 122 123 -'/. 194'/. 110 10,493
M~l 134 134 1321/2 1331/2 201 1201/2 2,904 Many u .5. futuref
May 141 141 139'/2 140'/2 ...18334 129 962
July 147 147 14S'/2 1~ 1643/. 13S'/2 46S taining volume a
Est vol 1,(KK); vol Wed 1,34S; open Int 14,839, + 157.
SOYBEANS (CBT) 5,- bu.; cenh per bu.
changes have a'
Nov
Ja91
6151/2 6161/2 610
63"/2 63"/2 62S
610'/. -41/.
6251/. -4
682
692
S64'/2 51,894
S87 26,044
technical and fun
Mar
May
643 643'/2 6381/. 6438'/2 -33/.
6S3'/2 654 649 649 -33/.
703
711
~ 18,170
6141/2 10,974
department of thl
July 6621/2 663 657'/2 6573/. -3 718 62S 9.OS3 worth the minima
Aug 655 6S6 6521/2 652'/2 -2'/2 695 628 895
SePt 632 633'/2 627 627 -1 670 623 1,024 The Chicago
Nov 621 621 617'h 61734 -13/. 674 6121/2 6,681
Est vol 36,(KK); vol Wed 40,603; open Int 124,740, +3,279. Touch." This acrc
SOYBEAN MEAL (CBT) 1. tons; $ per ton.
Oct 181.00 181.00 178.70 179.20 -1.00 200.00 168.00 S6O tern. The Chicago
Dec 18S.SO18S.SO183.30 183.70 -1.10 205.SO 170.SO 35,88S
Ja91 187.~ 187.~ 185.60 186.00 -1.10204.00 171.SO 12,267
are aimed at makj
Mar 190.SO 190.70 189.20 189.40 -.90 212.00 174.SO 8,496
May 192.00 192.00 190.40 190.60 -.80 208.00 175.80 4,881
July 193.SO 193.SO 191.80 191.~ -1.20 209.00 177.SO 3,782
Aug 193.00 193.00 192.00 192.00 -.SO 199.00 176.SO 1,397
Sept 191.00 191.00 187.~ 187.~ -1.40 193.SO 175.SO 1,364
Oct 18S.00 18S.00 184.00 184.20 -.~ 190.00 182.00 514
Dec 185.00 18S.00 184.00 184.70 + .20 189.~ 182.00 559
Est vol 18,(KK); vol Wed 16,015; open Int 69,7OS, + 1,155.
SOYBEAN OIL (C.T) 60,- Ibs.; cents per Ib.
Oct 22.3S 22.38 22.04 22.~ -.10 25.S6 19.65 523 How to acce
Dec 22.62 22.72 22.33 22.3S -.17 2S.55 19.75 37,151
Ja91 22.92 22.96 22.61 22.66 -.14 2S.55 19.81 18,910
the CBOT's "Midi
Mar 23.30 23.41 23.10 23.10- .11 2S.61 19.8S 11,717
May 23.68 23.72 23.43 23.47 -.04 25.65 20.2S 5,517
phone number (3
July 23.82 23.92 23.65 23.66 -.04 25.70 20.90 3,S36
Aug 23.75 23.~ 23.60 23.67 + .12 2S.SO 23.4S 804 modity Exchange
SePt 23.SO 23.60 23.4S 23.57 + .17 2S.10 23.30 600 It is importaJ
Oct 23.10 23.15 23.00 23.07- .13 24.90 23.00 341
Dec 23.15 23.15 22.~ 23.00 + .15 24.75 22.~ ~8 early 1990's, the (
Est vol 19,(KK); vol Wed 20,029; open Int 79,S47, +819. ~
release of statistic
opens the next tr
change in open II
 Howto Obtainthe Data 193

volume category. This could mean the difference between an average

volume and high volume or an average versus low volume trading ses-
sion. The mechanical volume estimate is seldom different enough from
the actual to change the classification of the figure by two volume cate-
gories (i.e., from low to high or vice versa).
The Chicago Board of Trade and the New York exchanges rely on
volume estimates gathered from traders, pit committee members, and
floor reporters. This is the figure that appears in the Wall Street Journal
as the initial estimated volume. Extreme care must be exercised by the
technician regarding these initial estimates. They too can be "off' enough
to shift the volume one category in either direction. A better turnover
estimate, during an "open outcry" trading session, is obtained by physi-
cally asking a pit broker for his opinion. Floor brokers, hearing the quan-
tities traded, will possessa more accurate "guesstimate."

Recorded Message Systems

"
"Midis Touch" and "MercLine'

Many u .5. futures exchanges provide a recorded telephone messagecon-

taining volume and open interest statistics. The two large Chicago ex-
changes have available a myriad of additional information, both
technical and fundamental. A telephone call to the statistics/marketing
department of the various exchanges (to ask what is available} is well
worth the minimal cost.
The Chicago Board of Trade has a system that is called the "Midis
Touch." This acronym stands for Market Information Data Inquiry Sys-
tern. The Chicago Mercantile Exchange has the "MercLine" System. Both
are aimed at making the acquisition of data as easy as possible.

CBOT l'Midis Touch'l 312-939-CBOT

CME "MercLine" 312-930-8282

How to accessT-Bond volume and open interest information from

the CBOT's "Midis Touch" System is found in Table 14-2. The same tele-
phone number (312-939-2268)can be used to accessMid-America com-
modity Exchange information.
It is important to determine when the data is made available. In the
early 1990's, the Chicago Mercantile Exchange is far ahead in the timely
release of statistics. Final figures are always available before the market
opens the next trading session. The "MercLine," in addition, gives the
change in open interest as well as the absolute number. It is especially
 Chapter 14

Table 14-2 Chicago Board of Trade Telephone Update on Saturday. In :

"Midis Touch" 312-939-2268 trade sessions bec
urday out-trade s
the previous Fridc
Example: T-Bond Futures, July 28,1987 The MercLin
Recorded turing in 1990. H(
Code:
Response: hours a day. Hou
2200# Floor trader's estimate of volume 210,000 volume statistics 1
(Available 2:30PMCST)
This is the figure that appears in The Wall StreetJournal
as the estimate figure.
New Yark, Kansa:

5:00PMcleared volume 289,825

{Available 7:00AMnext day) Other U.S. future:
This is a sequential tape. It begins with the estimated vol- portant exchange
ume for the evening session and then a 5:00PMcleared vol-
ume for T-Bonds. Final volume and open interest for
message is availal
COOT options are also available at this time. of access codes. J
actual volume an
Preliminary volume and open interest
trading session) a
Volume
(Available 8:30AMnext day) end of trading. Tt
287,649
Open Interest" numbers.
294,237

Actual volume and open interest Volume

{Available 12:00noon next day; delayed if CBOT Clearing 287,444
FOREIGN EXCHj
House experiences problems in processing the data) Open InteresfO
290,507 Interestingly, the
.To determineif this open interestfigure representsan increasesor decrease,the previoustradingsession'sopen interestmust changes are more
be known This is because tra

helpful to the technical analyst to have the direction and net change in London
open interest calculated and included in the recorded message.
The CBOT's system does not calculate the open interest change. On the London !J
With the push toward electronic trading, reprogramming the Midis mated volume is
Touch to produce this change is a low priority. Thus a manual computa- close of the last (
tion remains necessary. same day. The exl
The usual time availability of the CME's futures volume and open cent of actual vo1l
interest statistics was 2:26AM Central Standard Time in 1989. The earliest hours electronic h
release was 12:30AM; the latest 5:00AM. CME options data, always re- the screen.
leased later, was out at~7 AM, on average, in 1989. U nfortunatel~
A note regarding the~ME's MercLine statistics is in order. When a imately 5:00PM th4
Saturday "out-trade session~'occurs, the data is not available until later puterized system
12:00 noon the ne"
 How to Obtainthe Data 195

on Saturday. In 1989 there were 32 regularly scheduled Saturday out-

trade sessionsbecause of option expirations. In addition, two special sat-
urday out-trade sessions were dictated by hectic volume conditions on
the previous Friday.
The MercLine recorded messagesystem underwent a major restruc-
turing in 1990.Hourly updates of price and volume are now available 24
hours a day. Hourly Globex volume will be accessibleas well as hourly
volume statistics for the regular open outcry trading session.

New York, Kansas City, and Minneapolis Exchanges

Other U.S. futures exchanges have telephone numbers for obtaining im-
portant exchange information, including volume and open interest. If the
messageis available in recorded form, the exchange provides a directory
of access codes. Normally the recorded message is updated when the
actual volume and open interest figures are released (for the previous
trading session) and then updated again with estimated volume at the
end of trading. Table 14-3 provides a listing of the pertinent telephone
numbers.

FOREIGNEXCHANGES

Interestingly, the volume estimates from most non-U.S. futures ex-

changes are more accurate and released earlier than U.S. counterparts.
This is becausetrade matching is conducted during trading hours.

London

On the London International Financial Futures Exchange (LIFFE), esti-

mated volume is usually available by 4:40PM,twenty minutes after the
close of the last contract. Actual volume is available by 5:15PM on the
same day. The exchange states that estimated volume is within .03 per-
cent of actual volume, even on a busy day. Volume generated by after
hours electronic trading is added tQ the day's turnover and available on
the screen. "..,
Unfortunately, open interest statis\ics are not available until approx-
imately 5:00PMthe next trading day. 'Ijhe planned conversion to a com-
puterized system will allow LIFFE ;0 release these figures earlier (by
12:00noon the next session).
196 Chapter 14

Table 14-3 Additional Exchange Telephone Numbers 2) There iJ

3) Trade~
costlyo
Coffee, Sugar and Cocoa Exchange:
212-938-2847 Actual opel1
the evening of tl1
Commodity Exchange:
212-938-9020Info Line the data by 11:0(
Volume 9:00AMEST the CME betweE
Open Interest 12:00NOONEST then transferred
7:00AM Chicago t
New York Cotton Exchange: was being consid
212-432-2821Cotton & Orange Juice
212-432-7274Options
212-839-9083FINEX
New York Futures Exchange:
212-938-4946(Not recorded)
New York Mercantile Exchange:
212-938-0064Fastfacts
212-938-2875Marketing Department
Kansas City Board of Trade:
816-753-1101
Minneapolis Grain Exchange:
612-338-6212(Not recorded}
612-340-9438(Prices only}

Singapore

Trades on SIMEX are matched every hour during the trading session. As
of late 1989, the energy contract was the last future to close, settling at
6:00PMlocal time. Estimated volume is available by 6:30PM.This is a very
accurate figure because a match has been attempted for every trade. All
cleared trades are counted.
Comparison of the estimated turnover on SIMEX with the later re-
lease of actual cleared volume at approximately 11:00PMis particularly
good on the Nikkei contract. Probable reasons for this are:

1) The Nikkei future is the first SIMEX contract to close at 2:15PM;

 How to Obtainthe Data 197

2) There is no mutual offset system or EFP trades;

3) Traders are particularly careful, desiring to avoid potential
costly out-trades.

Actual open interest figures for SIMEX contracts are ready late in
the evening of that trading day. Quote vendors generally have accessto
the data by 11:00PM.SIMEX volume and open interest data is faxed to
the CME between 8:00AM and 9:00AM the following morning. This is
then transferred to the CME's MercLine System and easily available by
7:00AMChicago time. As of early 1990,a recorded announcement system
was being considered by SIMEX.
CHAPTER

I nter-bank dealing is a "24-hour" market. At any time, a dealer some-

where in the world is ready to make a market. As of mid-1990, a fu-
tures technician attempting to track a 24-hour market had only the
3-month Eurodollar Time Deposit future trading as a viable contract on
the exchanges in the three major world time zones-Asian, European,
and North American. Eurodollar trading hours overlap between SIMEX
(Singapore) and LIFFE (London) and between LIFFE and the IMM (Chi-
cago). Only the 3 3/4 hours between Chicago's close and Singapore's
open are not covered.

EURODOLLAREXAMPLE

The technician's approach to monitor 24-hour dealing is to keep separate

futures trading charts of all three time zones. This is shown (Dec 1989
Euros) in Figure 15-1. An examination of the three charts results in these
observations:

1) The open interest curves exhibit markedly different shaped

structures. Which chart is the most important? The "home mar-

199
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 LookingAheadToward24-HourFuturesTrading 201

ket" (the IMM) would be expected to provide the most relevant

volume and open interest analysis. The technician should still
look for nuances in volume and open interest changes on the
SIMEX and LIFFE charts. For example, the highest price day
(August 1st) produced blowoff volume (25,768 contracts) and
declining open interest (-422 contracts) on the LIFFE chart. On
SIMEX, Eurodollar open interest peaked coincident with the
price peak.
2) Open interest on LIFFE and SIMEX was of the same relative
magnitude; but volume was much higher on SIMEX. The prob-
able reason for this difference is the mutual offset system. It
facilitates dealing on SIMEX, therefore generating volume.
3) The slope of the price trendlines drawn from the price highs is
different on each chart; but the direction of the major price
trend is the same. The dominant price patterns are similar.
Note the dashed horizontal trendline representing the neckline
of aHead & Shoulders Top on each graph.
4) Many gaps exist between daily price postings on the SIMEX
Eurodollar chart. The rea~on is that no overlap in the trading
hours between SIMEX and the IMM exists. Most price-moving
U .S. economic data is released during the U .S. trading hours (in
the morning overlap in dealing in Chicago and London).
5) Small changes (500 contracts or less) in open interest are diffi-
cult to see on the LIFFE chart. The scale used in Figure 15-1
was created for an easy comparison to the SIMEX chart. In ac-
tual practice, a more responsive scale could be devised. In ad-
dition, a discontinuity between the volume and open interest
scales, similar to the IMM chart, would be included in the
LIFFE chart construction.

ElECTRONIC TRADING

By using electronic trading after "regular trading hours," substantial

progress is being made toward "around the clock" futures and options
trading. Even with the 6:00PMto 6:00AM(Chicago time) Clobex electronic
trading system, a 33/4 hour gap in the 24-hour day exists. A short-term
trader monitoring futures markets would ideally have accessto price in-
formation hourly as shown in Figure 15-2. With the advent of screen
trading, real-time volume will be an important addition to price-only
charts.
 looking AheadToward24-HourFuturesTrading 203

When 24-hour electronic futures trading is a reality, the technician

will accessand plot information based on the time frame covered by the
volume and open interest statistics. Separate price activity should be
plotted to coincide with each distinct volume and open interest segment
available. The first opportunity to try this concept was when an evening
open outcry trading session was established on the CBOT in 1987. Ide-
ally, two price plots should be constructed, each with volume and open
interest data. Because no open interest figures are released for the eve-
ning trade, there is no choice but to combine the sessions (plotting price
on a single line).
The CME's "MercLine" information system plans to provide statis-
tics for: 1) regular trading hours, 2) Globex trading, and 3) combined
regular trading hours and Globex. The technician should monitor the
two separate trading sessions. Data available from newspapers is likely
to be the combined 24-hour data. By using the data from this source,
only a single chart can be created.
CHAPTER

EXERCISEONE: SETTING VOLUME PARAMETERS

Use the December '89 T-Bond chart in Figure 16-1 to determine suitable
levels of high, average and low volume. The graphic "answer" is found
in Figure 16-2.

II Answer'l
Setting Volume Parameters

Becausetotal open interest has fallen so dramatically in August, do not

go back further than August 29th to draw (imaginary) horizontal lines.
Figure 16-2 shows the values of 204,000- and 276,000+. Counting
the postings in each category beginning with the 346,985 figure on Au-
gust 29th yields the following breakdown:

1 blowoff posting (566,695)

5 postings above 276,000
7 postings from 204,000 -276,000
7 postings below 204,000

This is close enough to the rule of thumb that an equal number of

postings fall into each of the three main categories.

205
 Practical Exercises 209

ANSWERS TO VOLUME AND OPEN INTEREST EXERCISE

1) Price DOWN with volume UP and open interest UP

represents a healthy price downtrend.

2) Price UP with volume DOWN and open interest DOWN

meansthe uptrend is doubful.

3) Open interest DOWN with price UP is a weak situation

(short covering) and a downside reaction would be expected.

4) v olume DOWN with price DOWN is a weak situation and

an upside reaction would be expected.

5) Price UP with volume and open interest UP is the most

bullish situation.

6) Extreme high volume (of blowoff proportion) indicates that the

current price UP/DOWN trend is likely to encounter a reac-
tion to the DOWN /UP side.
 Glossary 213

forex Foreign exchange.

full carry In a storable commodity , full carry is the theoretical maxi-

mum differential that a more distant contract should trade above a near-
by contract.

GLOBEX Global Exchange. The after regular open outcry trading de-
veloped by the Chicago Mercantile Exchange.

GNMA Government National Mortgage Association. GNMA futures

were the first interest rate futures contract. They began trading on the
CBOT on October 20, 1975. The GNMA future was a difficult contract to
analyze because the underlying instrument (a pool of mortgages) in-
volved a monthly repayment of principal and interest and did not have
an exact maturity. The GNMA contract was revised many times; as of
early 1990it had been replaced with the Mortgage Backed contract.

gap No overlap in price on a chart from one trading session to the

next. Gaps occur most frequently on a chart encompassing one time zone
only. A gap would only be found on a 24-hour spot forex chart over a
weekend or major worldwide holiday.

Pattern Gap Occurs within a congestion area or trading range; quickly

closed.

Last Traverse Pattern Gap Occurs on the "last traverse" across a con-
gestion area prior to a breakout; does not have to be filled.

Breakaway Gap Occurs at the beginning of a new price move; associ-

ated with the penetration of a trendline; does not have to be closed. The
higher the volume on the t. 1ding session that created the gap, the less
likely the gap will be closed.

Measuring Gap Found during a rapid, straight-line price move; repre-

sentsthe mid-point of a dynamic price trend.

Suspension Gap Created when no overlap in price occurs between the

evening CBOT T-Bond session when trading is suspendedand the re-
sumption of trade the following morning. The Suspension Gap must
then be classified as one of the four main types of gaps.
APPENDIX B

S ince the organization of the Chicago Board of Trade in 1848, techni-

cal traders have been studying the interaction of price, volume and
open interest. Many of the interpretative "rules" used by today's techni-
cians were derived from observation of grain futures, wheat in particu-
lar. Little change in the technical analysis of agricultural commodity
futures with their physical delivery characteristics was needed unti11972.

May 1972

"The Great Grain Robbery:' the Russian wheat buying, propelled futures
into the financial spotlight. More important financial futures were cre-
ated. The Chicago Mercantile Exchange, with its new International Mon-
etary Market Division, launched foreign exchange futures in May of
1972.This required the first methodology modification in analyzing open
interest. This was due to a departure in contract specification from the
traditional. Physical delivery still existed; but it took place after the last
trading day I not while the nearby contract was still trading.

October 1975

The next revision in the traditional approach to open interest analysis

took place with the advent of interest rate futures. The Government Na-
tional Mortgage Association (GNMA) contract began trading on the
CBOT in October of 1975.The actual commodity being traded was inter-

217
218 Appendix B

est rates. But the contract was invoiced and traded in terms of price. A tions and Financ
departure from typical open interest action was first noticeable during trading and clear
the big U.S. Treasury Bond price rally of early 1986; open interest de- Of importar
clined steadily during the major price uptrend. tual volume and
the agonizing wa

December 1981

April 1987
Cash settled futures required another modification. This began with the
Eurodollar Time Deposit contract on the IMM in December of 1981.This An evening sess
was the first "cash settled" futures contract. With no onerous delivery 1987. Handling (
mechanism to avoid, the "rollover" process from one contract to the next
Clearing Corporc
created a distinct shape to the total open interest curve. is released; no o
the single postinl
"day." Total volt
October 1982
session.
Options on futures began in October of 1982. This produced another
"distortion" in the typical behavior of volume and open interest. Knowl-
1990 and Beyond
edge of both futures and options contract specifications became neces-
sary.In particular, the options expiration date emerged as an important
The regulatory d4
factor in developing an expectation of futures open interest changes. has spawned a it
large Chicago e~
the technological
Sevtember 1984
is different, the d
philosophically u
Mutual offset of futures contracts between the Chicago Mercantile Ex-
change and the Singapore International Monetary Exchange first took
place on September 7, 1984.With one transaction, open interest was cre-
What To Do Nex
ated on two exchanges.
Fungible contracts between other exchanges have also emerged, but The creation of r
none of~ links has come close to the success of the CME-SIMEX welcomed. It is hi
relatiohship. \ provide a trader
exchange may int

Tanuay¥ 1985

The earliest establishment of a purely electronic futures exchange is im-

possible to state with certainty. The true definition would include both
automated trading and a clearing system. An attempt was made by the
International Futures Exchange (Bermuda) Limited (INTEX), but a liquid
market never developed. The New Zealand Futures Exchange (NZFE)
began automated trading in January 1985. In May of 1988, the Swiss Op-
 Historical Overview 219

tions and Financial Futures Exchange (SOFFEX)opened with automated

trading and clearing.
Of importance to the technician is the ability to obtain "on-line" ac-
tual volume and open interest data. No longer must an analyst endure
the agonizing wait before obtaining the important statistical inputs.

April 1987

An evening session in T-Bond trading on the CBOT was started April 30,
1987.Handling of volume and open interest was resolved by the CBOT
Clearing Corporation. Only estimated volume from the evening session
is released; no open interest statistics are made available. This requires
the single posting of price for the two trading sessions that comprise the
"day." Total volume and total open interest is plotted for the combined
session.

1990 and Beyond

The regulatory desire for a perfect audit trail as well as a 24-hour market
has spawned a furious drive toward greater electronic trading. The two
large Chicago exchanges escalated their efforts in early 1989. Although
the technological approach to after-hours trading on the CBOT and CME
is different, the derivative statistics of volume and open interest remain
philosophically unchanged.

What To Do Next

The creation of ~tract types and their quirks are inevitable and
welcomed. It isioped thi's look at the evolution of technical analysis will
provide a trader with the momentum to tackle any contract a futures
exchangemay introduce.
APPENDIX c

T he premise that futures represent the market as a whole needs to be

examined in a more conceptual manner. What ties the two markets
together is the "basis." Basis is the difference between cash and futures
prices, specifically:
Basis = Cash -Futures

In this case, basis is the dependent variable. The basis is determined

by subtracting a futures price from a cash price. This is a simple mathe-
matical formula. As such, the equation also can be written:

Cash = Futures + Basis

~ OR
/
Futures = Cash -Basis

The conceptual question posed is: Which is the dependent variable?

Which market, cash or futures, represents the dominant price setting
mechanism? There is no simple answer. It lies in the maturity and so-
phistication of the users of both markets.
In the grain and oilseed trade, futures are the cutting edge of price
determination. The world grain trade is comfortable with the term basis.
Basis tables and charts have a long historical precedence. Basis is an in-
dependent variable. As a result, grain is priced at a specific differential
{basis} with respect to a futures contract. Futures statistics can and

221
222 Appendix c

should be relied upon to represent a true picture of the market forces at

work. The true functional representation in the grain trade is:

Cash = Futures + Basis

In the livestock sector, the "terminal market" has held the tradition
of establishing cash market quotes. The basis is not as stable as the grain APPENDIX
trade. Often it seems the cash price for live cattle in Omaha, Nebraska
and the price of the live cattle futures on the CME were derived indepen-
dently. Basis simply equals the mathematical difference between the two
markets. Here cash and futures quotes are two independent variables
and basis is the result. Functionally, this means:

Basis = Cash -Futures

This does not mean that analysis of a futures contract cannot be

used in the analysis of livestock prices. It does mean that the basis is not
as stable as in the older grain trade. At expiration, basis convergence will
bring futures and cash into line. The technician does have to be aware of
how much "noise" exists between the cash and futures.

A s detailed in (
a cash settled
FINANCIAL FUTURES
The actual change
The financial instrument futures are a recent {and continuing) innova- ponent.
tion. Thus, the battle between the cash market dealers and futures mar- In Figure 8-
ket traders is still observable. When a futures market initially begins drawing a "best-f1
trading, it disrupts the "old boy" dealer network. To many dealers, the mination of this tI
futures market represents a group of nonprofessionals. In some financial sion to calculate tJ
communities, the dealers are so powerful they are able to squash fledg- be expressed in co
ling futures contracts. Witness the poor success of the currency futures The followin~
contracts on the London International Financial Futures Exchange and in the regression ana
sion 2.0 or later), .
Singapore on SIMEX. It. took the IMM in Chicago years to establish a
critical mass in its foreign exchange futures. dollar open intere:
As more arbitrage between cash and futures takes place, basis from the model C
trades become common. Some critics would say that these trades distort 8-10.
the analysis of futures volume and open interest. What actually occurs is In a blank pi
akin to Adam Smith's "invisible hand." Arbitrageurs, by trying to profit column for the pe
from pricing inaccuracies, actually produce a more viable futures market. close to contract e
This creates environments where the financial community can substitute rather erratic befo
futures for cash, shift risk, or speculate. Whatever the motive, the inter-
nal characteristics of "the market" can be monitored in futures volume
and open interest.
APPENDIX D

A s detailed in Chapter Eight, the trending increase of open interest in

a cash settled future can be used to evaluate open interest changes.
The actual changes are either greater or less than the normal trend com-
ponent.
In Figure 8-10, the trend component was determined by merely
drawing a "best-fit" line through the open interest. A more exact deter-
mination of this trend is ascertained using standard least squares regres-
sion to calculate the slope of this best-fit line. The slope or gradient will
be expressed in contracts per trading session.
The following method outlines how this would be performed using
the regression analysis that is part of the LOTUS software package (ver-
sion 2.0 or later). The results are located in Table 0-1. Total IMM Euro-
dollar open interest for the first quarter of 1988 is examined. The output
from the model can then be compared to the "eyeballed" line in Figure
8-10.
In a blank part of a worksheet, enter the total open interest in a
column for the period of time under consideration. Periods of time very
close to contract expiration should be avoided since the open interest is
rather erratic before dropping sharply. The period analyzed in the fol-

223
224 Appendix D

Table 0-1 lowing example

columns such as
X-Range Y-Range
An additior
Total Total column will be t
Date Volume Open Interest shown to the let!
04-Jan-88 294,065 used for the "X-
2 05-Jan-88 301,065 not to increase i
3 06-Jan-88 299,960
4 07-Jan-88 302,321 fit" line to be ca
5 08-Jan-88 308,915 The "Y -range" f
6 11-Jan-88 308,536
7 12-Jan-88 311,363
umn.
8 13-Jan-88 310,933 To set thesE
9 14-Jan-88 310,776 command menu
10 15-Jan-88 318,321
11 18-Jan-88 318,686
commands. An I
12 19-Jan-88 319,070 be at least nine
13 20-Jan-88 323,707
menu. The regre
14 21-Jan-88 325,272
15 22-Jan-88 328,952 put will look ill
16 25-Jan-88 327,252 on the operation
17 26-Jan-88 327,956
18 27-Jan-88 333,545 consult the LOT
19 28-Jan-88 336,772 The value 4
20 29-Jan-88 339,608 This value is 2,C
21 01-Feb-88 339,306
22 02-Feb-88 348,088 2,015 contracts.
23 03-Feb-88 351,154 The 2015 fi
24 04-Feb-88 348,406
25 05-Feb-88 350,623 trendline with c
26 08-Feb-88 351,303 Figure 8-10.
27 09-Feb-88 354,312 Open inter
28 10-Feb-88 357,702
29 11-Feb-88 356,126 nent would be I
30 12-Feb-88 369,713 considered sub~
31 16-Feb-88 362,232
32 17-Feb-88 360,281 represents is sh<
33 18-Feb-88 365,794
34 19-Feb-88 362,339
35 22-Feb-88 362,984
36 23-Feb-88 366,232
37 24-Feb-88 365,144
38 25-Feb-88 366,261
39 26-Feb-88 368,176
Output Range

Constant 2.9697E+05
Std Err of y Est 4075
R Squared 0.97
No. of Observations 39.00
DeQreesof Freedom 37.00

x Coefficient(5) 2015
Std Err of Coef. 57.98

Slope of the least squares regression line in contracts per trading

session.
 Mathematically Detrending Open Interest 225

lowing example is from January 4,1988 through February 26,1988. Other

columns such as date and total volume also can be entered.
An additional column of sequential numbers is also required. This
column will be the "X-range" for the regression analysis. This column is
shown to the left of the date in the example. The date column cannot be
used for the "X-range" since weekends and holidays cause this column
not to increase in a single step-wise fashion. For the slope of this "best-
fit" line to be calculated correctly this "X-range" must increase linearly.
The "Y -range" for the regression analysis will be the open interest col-
umn.
To set these ranges, choose "Data Regression" from the main Lotus
command menu and choose the setting of the "X-range" and "Y-range"
commands. An output range must now be specified. This range should
be at least nine columns wide. Finally, enter "Go" from the regression
menu. The regression output will appear in the assigned range. This out-
put will look like the output range in Table 0-1. For more information
on the operation of the LOTUS regression analysis, the technician should
consult the LOTUS manual.
The value of concern from the regression data is the X coefficient.
This value is 2,015. It represents an average contract per day increase of
2,015contracts.
The 2015 figure is in close enough agreement with the "eyeballed"
trendline with a slope of 2700 contracts per trading session shown in
Figure 8-10.
Open interest increases greater than the determined trend compo-
nent would be considered above average, while values below would be
considered substandard. A graphical picture of what this "best-fit" line
represents is shown in Figure D-l.
 Agricultural futures,
crop years of, 51
open interest (01) and, 138
use of, 91
Audit trail, definition of, 154
Basis trade, use of, 87-88
Bear market,
blowoff volume and, 14
ideal situation for, 5-6
open interest (OI) and, 91-92
versus open interest interaction, 29
versus volume interaction, 8
Blowoff volume,
bear market and, 14
definition of, 9-10
diagram of, 18
examples of, 12-13
versus high volume, 14-15
Breakout volume, diagram of, 17
British Pound, open interest (OI) changes
at December 1989 options expira-
tion, 112
Bull market,
blowoff volume and, 9-10,12-13
healthy bull market, 26
ideal healthy bull market, 38
low volume and, 65
Silver Bull Market of 1979,122
unhealthy bull market, 27
versus open interest interaction, 25
versus volume interaction, 5
volume and, 4
Butterfly spreads, for non U.S. based tax
purposes, 122
Cash,
cash & carry transactions, 120-121
cash market, 1-2
cash settlement, 96-97
configuration of open interest in cash
settled future. 97
Cattle,
live cattle charts, 144,148-149
open interest (01) changes at December
1989options expiration, 111-113
Caveat,
definition of, 9
signs for traders, 28-31
Charts,
continuation charts, 80
live cattle/hog charts, 144,148-150
plotting on weekly / monthly charts, 79-
80
point & figure chart, 16-17,20
Chicago Board of Trade (COOT),
30-day interest rate futures of, 54-55
collection of price information, 154
deliveries of, 93
evening trade on, 86-87
holiday trading and, 42
physical delivery process on, 75-76
283
 284 Index

point & figure chart of, 20 Convention, volume figures and, 20 Exchange Teclu
split-session trading of Clearing House, Corn, CME,81-:
87 commercial interests/ corn futures, 80 Expiration,
volume/open interest (01) of, 122-124 open interest (OD changes at December options expi'
Chicago Mercantile Exchange (CME), 1989options expiration, 111-113 shape of seq'
Eurodollar expiration card and, 78 seasonal trends of open interest ofT-Bonds, ,
Exchange Technical Analysis Course, (OD/volume,114 Eyeball,
81-83 Crop, eyeball appr
futures settled in cash, 96-97 agricultural futures and, 51 eyeballed sIc
hog futures on, 119-120 old/new crop, 151 106
holiday trading and, 42 Currencies,
physical delivery process on, 76-77 of IMM currency futures, 132-137 Federal ReservE
rollover surge of, 49 IMM foreign currency futures, 95-96
and,42
Chicago Mercantile Exchange (CME) Clear- open interest (Ol) and, 138 Former bottom,
ing House, 108 Former top, def
Comex gold futures, D-Mark. SeeDollar-Mark Futures,
chart of, 72-73 CME futures
Delivery,
Seealso Gold after trading in near-by ceases,93-95 configuratiol
volume/ open interest (OI) of, 39 of futures, 75-76 settled
Commercial, definition of, 139 physical delivery characteristics of fu- corn futures,
Commitmentsof TradersReport,34 tures, 93 currency fuh
Commodity ResearchBureau (CRB) while near-by is still trading, 93 foreign exchc
and,145-147 Detrending, of open interest, 97-106 futures mark
contents of, 151-152 Deutsche mark futures (DM), trading activ- IMM curren<
large non-commercial spreaders in, 151 ity of, 2-3 IMM Eurod(J
spread activity occurence, 118 Distance, appropriate distance, 58-59 London Intel
for U.S. futures markets, 51 Dollar-Mark, Exchar
updating of, 140-144 dealing of, 1-2 in nearest to
use of, 139-152 futures chart for, 31 127-13:
Commodities, storable commodities ver- IMM foreign exchange futures and, 135- options on, 8
sus perishable commodities, 119-120 136 physical deli'
Commodity Exchange of New York open interest (01) changes at December T-Bond futuI
(COMEX) gold futures contract, use 1989options expiration, 111-112 trading of, 21
of,34 volume parameters of futures, 59-65 Treasury Bor
Commodity Futures Trading Commission Downtrend, when to Char
(CFTC), reports to, 139-140 healthy price downtrend, 10,30 Futures. Seealso
Commodity ResearchBureau (CRB), ideal healthy downtrend, 5-6 Futures trading,
application of Commitments Report, ideal healthy price downtrend, 27-31 electronic tra
140
24-hour tradi
Futures Chart Service of, 140
Electronic trading, 201-203
seasonal variation studies of U.S. fu-
Equities, concept of, 34-35 Gaps,
tures,113-115
Estimated volume, 191-193 pattern gaps,
testing by, 144-149
Euro futures, use of, 77 types of, 87
version of Commitments Report, 145-
147 Eurodollars, Gold,
IMM Eurodollar rollover, 79 price rally of,
Continuation charts, use of, 80
open interest (01) and, 138 as storable C<
Contract, open interest (01) of, 77-78
behavior of open interest (OI) for an in- transition fro
slopes of open interest (01) trendlines, 94
dividual contract month, 47-48
108 Grain,
delivery and, 93
Exchange For Physical (EFP) trades, use open interest
in nearest to expire futures contract,
127-132 of,87-88 spreads of gr,

Value Line contract, 97


Exchange Technical Analysis Course, of
CME,81-83
Expiration,
options expiration, 111-113
shape of sequential expirations, 51
ofT-Bonds,128
Eyeball,
eyeball approach, 97
eyeballed slope of open interest (01),
106
Federal Reserve Bank, holiday trading
and, 42
Former bottom, definition of, 153
Former top, definition of, 153
Futures,
CME futures settled in cash, 96-97
configuration of open interest in cash
settled future, 97
corn futures, 80
currency futures, 95-96
foreign exchange futures, 135-137
futures market, 1-2
IMM currency futures, 132-137
IMM Eurodollar futures, 106,139
London International Financial Futures
Exchange (LIFFE), 108
in nearest to expire futures contract,
127-132
options on, 83-86
physical delivery characteristics of, 93
T-Bond futures, 54
trading of, 21
Treasury Bond futures, 86-87
when to change months, 72-77
Futures. Seealsospecifictypesby name
Futures trading,
electronic trading trends, 201-203
24-hour trading, 199-201
Gaps,
pattern gaps, 96
types of, 87
Gold,
price rally of, 39-41
as storable commodity, 121
transition from bull to bear market, 93-
94
Grain,
open interest (01) and, 138
spreads of grain futures, 121
Index 285
volume on Minneapolis Grain Exhange,
88
Grains, deliveries of, 93
Head & Shoulders, measuring objective of,
106-108
Hedge market, versus speculative market,
80-83
Hedgers, large hedgers, 139-140,144-147
Hogs,
hog futures on CME, 119-120
live hog charts, 144, 150
open interest (01) changes at December
1989options expiration, 111-113
Holiday trading, volume and, 42-45
Interest,
open interest (01),1-2,21-35
Seealsospecific types by name
short interest, 34-35
International Money Market (IMM),
analyzing of Eurodollar future, 106
currency futures of, 132-137
currency/T-Bill futures on, 75-76
eurodollar expirations of, 49-52
Eurodollar futures, 106-111
eurodollar futures of, 44
foreign currency futures of, 95-96
foreign exchange futures of, 135-137
foreign exchange trading of, 93-95
IMM Eurodollar rollover, 79
reporting limit for Eurodollar futures,
139
trading activity of, 2
Japaneseyen, open interest (01) changes
at December 1989options expira-
tion, 112
Jiler, William L., 140
Kansas City Board of Trade,
Value Line contract and, 97
Wheat EFP's volume on, 88
Large hedgers,
definition of, 139-140
intermediate analysis of, 148-151
testing by Commodity ResearchBu-
reau,144-147
Large speculators,
definition of, 139-140
286 Index

intermediate analysis of, 148-151 configuration of in cash settled future, relationship t

testing by Commodity ResearchBu- 97 selloff of, 4
reau,144-147 curves for CBOT Treasury Bond fu- sideways pri<
Liquidation, tures,129-131 types of, 1-2
definition of, 32 definition of, 1-2, 83 versus open i
open interest (01) and, 92 detrending of, 97-106 versus volum
Liquidity Data Bank (LDB), contents of, distribution of, 50-54 weak price uI
157-159 equation for, 21 likely, 1
Livestock, open interest (01) and, 138 eurodollars slopes of open interest (01) Primary Dealer I
London International Financial Futures Ex- trendlines, 108 of,151-152
change (LIFFE), 108 importance of, 38-45 Profit taking, deJ
influence of seasonality on changes of,
Market, 113-115 Rationale, defini
don't buy a quiet market after a rise, 11 in nearest to expire futures contract, Resistance, defil1
don't sell a quiet market after a fall, 7 127-132 Resumption, of t
specific market behavior, 127-138 open interest (01) changes at December Rolling, from on
speculative versus hedge market, 80-83 1989 options expiration, 111-112 next, 48-49
in transition, 91-92 price steady/ open interest (01) Rollover,
types of, 1-2,4-9 down/up,32-34 definition of,
Market Perspectives,49,77 significance of, 23-24 definition of I
Market Profile, contents of, 154-156 smoothed historical open interest (01), diagram of ro
Market Reports Division of the Federal Re- 117 IMM Eurodol
serve Bank of New York, report by, summary matrix of open interest (01)
151-152 idiosyncrasies, 138 Scales,
"MercLine," 193-195 versus price, 65-67 definition of s
Metals, volume and, 37-38, 60-62, 67, 72, 77, 79- right/left han
open interest (OI) and, 138 82
Seasonality,
as storable commodity, 121-125 Options expiration, of contracts, 111-113 influence on c
"Midas Touch," 193-195 Outcome, graph of, 69 113-115
Minneapolis Grain Exhange, volume on, seasonally noJ
88 Parameters, Selling pressure,
Municipal Bond futures, switching of, 76 updating of, 58-59 Selloff,
Mutual offset systems, use of, 89 volume parameters, 57-65 of price, 4
Pattern gaps, definition of, 96 price selloff, 9
Noise, of speculators, 80-81 Perishable commodities, versus storable Settlement, cash :
Non-commercial, definition of, 139 commodities,119-120 Shaleen, Ken, 81-
Petroleum futures, of New York Mercan- Short covering ra
Offset, mutual offset systems, 89 tile Exchange, 88 Short interest, co
Oil, New York Mercantile Exchange and, Plywood chart, coincident price/open in- Sideways price a,
88 terest changes in, 25 and,31-34
Old crop, definition of, 51 Point & figure chart, use of, 16-17,20 Silver bull marke
Open interest (01), Price, SIMEX,196-197
at conclusion of delivery day, 95 definition of, 83 Singapore, SIME
bear market and, 91-92 general rule for healthy price, 81-83 Singapore Intern;
behavior for an individual contract healthy price downtrend, 30 change (SI~
month, 47-48 ideal healthy price downtrend, 27-31 trading and, 7
of CBOT 30-day interest rate futures, 54- ideal healthy price uptrend, 24-27 Single prints, def
55 price selloff, 92 Small traders,
of CBOT, 122-124 price steady / open interest (01) down, definition of, 1
changes of, 21-23 32-34 intermediate a
as coincident indicator, 115 price steady/open interest (01) up, 32- testing by Cor
34 reau, 14

relationship to open interest (01),91-93
selloff of, 4
sideways price activity, 31-34
types of, 1-2
versus open interest (01),65-67
versus volume, 8-9
weak price uptrend/downside reaction
likely,116
Primary Dealer Positions Report, contents
of,151-152
Profit taking, definition of, 115
Rationale, definition of, 1-2
Resistance,definition of, 153, 155
Resumption, of trade, 87
Rolling, from one expiration month to the
next, 48-49
Rollover,
definition of, 75-76
definition of rollover surge, 49-50
diagram of rollover surge, 53
IMM Eurodollar rollover, 79
Scales,
definition of scale construction, 71-72
right/left hand scales,74
Seasonality,
influence on open interest (OI) changes,
113-115
seasonally normal positions, 147-148
Selling pressure, definition of, 153
Selloff,
of price, 4
price selloff, 92
Settlement, cash settlement, 96-97
Shaleen, Ken, 81-83
Short covering rally, definition of, 38-41
Short interest, concept of, 34-35
Sideways price activity, open interest (OI)
and,31-34
Silver bull market, of 1979, 122
SIMEX, 196-197
Singapore, SIMEX trading, 196-197
Singapore International Monetary Ex-
change (SIMEX), 108
trading and, 77-79
Single prints, definition of, 155
Small traders,
definition of, 139-140
intermediate analysis of, 148-151
testing by Commodity ResearchBu-
reau,144-147
Index 287
Soybean meal, open interest (01} changes
at December 1989 options expira-
tion, 112
Speculative market, versus hedge market,
80-83
Speculators,
large speculators, 139-140,144-147
noise of, 80-81
Split-session trading, problem of, 87
Spot market, definition of, 1-2
Spreads,
Butterfly spreads, 122
of new / old crops, 51
spread analysis, 151
spread orders to roll positions forward,
50
spread trading, 115-119
spreads being removed, 125
in T -Bond futures, 54
tax spreads, 121-125
Steady state, condition of, 92
Stock index, open interest (01} and, 138
Storable commodities,
cash & carry analysis of, 120-121
versus perishable commodities, 119-120
Strip, of Euro futures, 77
Strip trading, definition of, 54
Support, definition of, 153-154
Suspension, of trade, 87
Suspension Gap, definition of, 87
Switching, definition of, 75-76
T-Bill futures,
expiration of, 77
as perishable commodities, 120
price surge of, 12
T -Bond futures,
blowoff volume signal and, 14
deliveries of, 93
evening trade on, 86-87
Exchange For Physical (EFP) trades in,
88
important dates unique to, 128-132
open interest (01) and, 138
open interest (01) changes at December
1989options expiration, 111-112
as storable commodities, 120
volume/ open interest (01) and, 75
year-end phenomenon, 132-133
Tax spreads, of storable commodities, 121-
125
288 Index

Tic volume, open interest (01) and, 37-38, 77, 79-82

definition of, 16 price versus, 8-9
three days of 30-minute bars with, 19 significance of, 3-4
Trade, table for, 13
basis trade, 87-88 tic volume, 16,19
Exchange For Physical (EFP) trades, 87- upside breakout and, 42
88 volume parameters, 57-59
Kansas City Board of Trade, 88
resumption of, 87 Wheat,
small traders, 139-140,144-147 EFP's volume on, 88
suspension of, 87 open interest (01) changes at December
volatility trades, 89 1989options expiration, 112
Trading, Worksheet, use of, 59-62, 67
delivery after trading in near-by ceases,
93-95 Year-end phenomenon, of T -Bond futures,
delivery while near-by is still trading,
132-133
93
holiday trading, 42-45
Kenneth H. ~
location of trading session, 14-15 the futures ir
Singapore International Monetary Ex- offered by CI
change (SIMEX) and, 77-79
split-session trading, 87
spread trading, 115-119
strip trading, 54 .
switching of pit, 75-76
trading pit, 75-76
Treasury Bond. SeeT-Bond futures .

Upside breakout, volume and, 42

Uptrend,
healthy price uptrend, 6
Please direct
ideal healthy price uptrend, 24-27
ideal healthy uptrend, 4-5 CHARTW ATI
Urgency, volume as, 3-4

Value Line contract, Kansas City Board of

Trade and, 97
Volatility trades, use of, 89
Volume,
blowoff volume, 9,18
breakout volume, 17
of COOT, 122-124
convention and, 20
definition of, 1-2,83-84
equation for, 3
high volume versus blowoff volume, 14-
15
high/ average/low volume, 63-64
holiday trading and, 42-45
importance of, 38-45
open interest (01) analysis and, 60-62,
67,72
Kenneth H. Shaleen is President of CHARTW A TCH, a research firm to
the futures industry that he founded in 1984. Among the many services
offered by CHARTW A TCH are:

. A weekly technical research report CHARTWATCH

. Daily telephone market updates covering financial instrument
futures
. Technical analysis videotapes
. Technical analysis course presentations

Please direct all inquiries concerning any of the services offered by

CHARTW A TCH to:

CHARTWATCH
Fulton House 1700
345 North Canal Street
Chicago, IL 60606 USA
Telephone: 312-454-1130
Fax: 312-454-1134
 Shaleen then applies this disciplined
approach to specific markets, including:

.T-bonds
.Eurodollars
.Metals
.Currencies
.Grains
.And Others.

Filled with clear and insightful exam-

ples, state-of-the-art charts and figures
and extensive tabular material and ap-
pendices, Volumeand Open Interest is not
only a "must read," but a "must have"
for every trader, speculator, arbitrageur,
portfolio manager, investment advisor or
analyst who wants to be on the cutting
edge of futures trading!

About the Author

Kenneth H. Shaleen is President of

CHARTW A TCH, a research firm for the
futures industry, and conducts technical
analysis courses for the Chicago Mercan-
tile Exchange, among others, that he
presents worldwide. Prior to founding
CHARTWATCH in 1984, Mr. Shaleen
was a Management ScienceAnalyst with
the Northern Trust Company in Chicago.
He also supplied analysis for twelve
years as Director of Research for two
Chicago Board of Trade clearinghouses.
Mr. Shaleen is a charter member of the
Commodity Options Market at the Chi-
cago Board of Trade. He holds a B.S. in
Civil Engineering from the University of
Colorado and an M.B.A. in Finance from
Northwestern University.
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