THE BIG PICTURE

Volume:
The ultimate guide to sentiment
Not knowing “real” volume in the spot forex market is a challenge for currency traders.
Tick volume and futures “commitment of traders” data can help you gauge market sentiment.

BY BARBARA ROCKEFELLER

V olume data and analysis is commonplace in

the equity market — several popular techni-
cal indicators depend on the easy availabili-
ty of volume — but in the spot forex market,
volume numbers are a proprietary secret of the banks and
brokers executing the trades.
The business is, literally, private. When a fund or multi-
national corporation has a big trade to do, such as $2 billion
in a day (or over two or three days), they tell their banks not
to move the market as they execute the orders. So, even
rallying, you want to see volume rising, too. When prices
are going up but volume is falling, you may question
whether the move has legs.
Stock traders have access to volume data in real-time
throughout the trading day. In the futures market, true vol-
ume data typically isn’t available until a day later — e.g.,
you get Friday’s currency futures trading volume on
Monday. Before then, what you see is something called
“tick volume,” which is not the actual number of contracts
traded, and can be misleading.

Even when you see a big price move, you never know whether it had
“real money” behind it, meaning it was an authentic commercial transaction
such as a foreign acquisition or a new stock or bond position, or if it was
a speculative move by a hedge fund.
when you see a big price move, you never know whether it A “tick” is the smallest price fluctuation that can be trad-
had “real money” behind it, meaning it was an authentic ed — e.g., 0.0001 for the euro futures. When the euro
commercial transaction such as a foreign acquisition or a changes from 1.1850 to 1.1851, it has moved one tick. Tick
new stock or bond position, or if it was a speculative move volume reflects the number of ticks the market has moved
by a hedge fund. over a given time interval — say, every five-minute bar.
Volume confirms or denies price action. When a stock is The price can move one tick regardless of whether there

18 January 2006 • CURRENCY TRADER

was one or 100 contracts behind the move. (You can check ment from the price reaction to various news releases and
“time and sales” to verify trade size, but that is a laborious economic developments: When dollar-favorable news
process.) As a result, when you chart tick volume, you get comes out but the dollar fails to rise, is the tone turning
the appearance of correspondence or correlation — i.e., a against the dollar or it is just a “sell on the news” phenom-
price peak is usually accompanied by a peak in tick volume. enon? Analyzing the news can be complicated and it’s
Although it’s not true volume data, it can still be useful. always time-consuming. What we are really seeking is a
For example, on Nov. 23, 2005 (the day before grip on the supply-demand dynamics — and volume, in
Thanksgiving), the Euro spiked over 50 points — nearly conjunction with price data, is the single best indicator of
half its average daily range — with no accompanying boost supply and demand.
in tick volume during those hours (Figure 1). You could As noted, tick data is not true volume data, although it
have used this information to imagine the price move was a can be useful. The real volume data is reflected in the
blow-out top lacking the support of many buyers, and Commitment of Traders Report from the
therefore was something to be avoided on the long side or Commodity Futures Trading Commission (located at
even exploited on the short side. www.cftc.gov/cftc/cftccotreports.htm), which totals all the
Notice the tick volume
in the bottom window has FIGURE 1 — TICK VOLUME
not been updated for the
An up move complemented by declining tick volume is followed the next day by a down
next bar (the Friday after
move and low close.
Thanksgiving) — that
information would come
the following Monday,
although a live data serv-
ice (like eSignal) displays
tick volume all day. The
circled price bar is the
day before Thanksgiving.
Four of the five previous
bars had higher highs,
and they all had higher
lows, connected by the up
trendline.
Now look in the bottom
window. The first and sec-
ond days of the new up
move had rising volume,
but after that, volume fell
or at least failed to match
that of the highest volume
day. On the fateful
Wednesday, volume was
actually significantly
lower — despite the euro Source: Reuters’ DataLink
having made a new price
high. Even though it was
a (short) day ahead of a virtual four-day holiday in the U.S., open trade positions among different classes of traders
a divergence between price and volume can be a dandy (commonly referred to as “open interest”). Like all govern-
indicator in its own right. Sure enough, on the Friday after ment data, you need patience to grind though the defini-
Thanksgiving, the euro failed to make a new high and tions and get a handle on what the data means. (You also
closed at its low. The close also violated the minor support have to wade through soybeans and rough rice to get to
line, although at the time it was not clear if this was signifi- Swiss francs and Japanese yen.) Frankly, the COT data is so
cant. poorly organized and so hard to understand that most
traders give up after a first effort.
The COT report: The open interest story However, Larry Williams recently wrote a new book
Forex traders spend a lot of time deducing market senti- continued on p. 20

CURRENCY TRADER • January 2006 19

 THE BIG PICTURE continued

FIGURE 2 — COT ANALYSIS

In the COT data windows, the blue line represents commercial traders, the green line is non-commercial traders, and the red
line represents small traders. Circle A shows the non-commercials (green) switch from slightly long yen to very long yen, two
weeks ahead of a big move up. In circle B, non-commercials switch from a moderate 60 percent long position to a big short
position (over 80 percent).

Data source: CFTC, Reuters’ DataLink; Chart: Metastock (COT program by tsagroup.com)

titled Trade Stocks & Commodities with the Insiders: Secrets of
the COT Report (Wiley, 2005), which may re-ignite interest in
the report. Also newly available is COT data in a usable
form from Trading Systems Analysis Group
(www.tsagroup.com). You can download the data to Excel
or MetaStock and generate eye-catching charts.
Before venturing into the COT report, you absolutely
must understand one seemingly obvious, but frequently
overlooked, aspect of futures trading: For every buyer, there
is a seller. In other words, brokers might “make a market,”
which means to step in with their own trading capital if the
market gets so one-sided that liquidity dries up, but on the
whole, each trade is created out of fresh cloth when a seller
agrees to an offer to buy from a new party. And it shouldn’t
be a surprise to know that often the sellers line up together
in one category and the buyers line up in a different catego-
ry. Thus you have one class of traders all on the long side
and another class all on the short side.
What are these categories? The CFTC in its infinite wis-
dom has the futures brokerages report their customers as
being either “commercials,” meaning they supposedly have
an underlying commercial purpose in taking the futures
trade, or “non-commercials,” which means “speculators” to
the rest of the world. The non-commercials are sub-divided
into large speculators and small speculators, the latter
group being you and me.

20 January 2006 • CURRENCY TRADER


Because the customers themselves are responsible for
choosing their category and they have a self-interest in
being considered “commercials” because of the lower mar-
gin requirements for that category, it goes without saying
that some commercials are really speculators, which makes
these categories less than tidy and accurate.
In addition to the categorization issue, the main draw-
back to the COT report is its delayed delivery. The report is
issued every Friday afternoon for the week that ended the
Tuesday before. Since market sentiment can easily change
directions in three days, is the report really helpful in mak-
ing trading decisions? The qualified answer is, “Yes, some-
times,” but remember that often we are at such a total loss
that any clue to market behavior is welcome.
This is not to say the COT report is a last-ditch factor to
turn to when all else is failing, but rather a tool with limita-
tions. Once you acknowledge those, you still have a tool.
During the euro’s corrective up move in September, for
example, the proportion of long open interest by the non-
commercial category reached a record high level. When
everyone in a category who was going to buy has already
bought, you can take three guesses as to where the price
heads next. The simple act of exiting the positions, which
means selling to cover previous purchases, drives the price
down.
So does the standard quarterly rollover when the current
contract matures and the next contract in the cycle takes its
place, such as when December rolls to March. These effects
can be clearly seen on COT charts and dismissed for what
they are — not a change in sentiment, but a mechanical re-
jiggering of positions.
The COT report doesn’t always deliver a tradable insight,
but when it does, it pays to take heed. For example, in
Figure 2, the COT data for the Japanese yen is displayed in
graphic form using the TSA Group’s software. The top three
windows show the COT data and the bottom window is
price data. In the COT data windows, the blue line repre-
sents commercial traders, the green line is non-commercial
traders, and the red line represents small traders.
The top window shows the three groups’ net positions by
number of contracts. On the right hand side of the chart, the
high blue line means commercials are net long, while the
low green line shows the non-commercials are net short,
and the red line shows small traders slightly short. Note
that if you add all the longs and all the shorts, you get zero,
reflecting that for every buyer, there is a seller.
This takes some getting used to, but it’s worth it to
become accustomed to the display characteristics. TSA
Group points out, for example, that when you have a big
divergence such as this one, price is generally trending
strongly. When the number of contracts is smaller and the
CURRENCY TRADER • January 2006
Related reading
“Larry Williams looks inside futures”
Active Trader, January 2006.
Larry Williams discusses his book on the COT report and
his techniques for using COT data in futures and stocks.
“Floyd Upperman: Digging into COT data”
Active Trader, February 2006.
A CTA shares his insights on interpreting the COT report
and the methods he outlines in his upcoming book.
divergence is smaller, the market is moving sideways. You
can verify this observation yourself by eye.
The second window in Figure 2 contains a proprietary
strength index that shows the percentage of each category
that holds the net position of the entire category, and thus
the strength of the conviction of the group. Obviously it
means one thing if 90 percent of a category is long or short
and another thing if only 35 percent are long or short. On
the right side of the chart, showing the latest data, the blue
commercials are about 60 percent long while the green non-
commercials are about 80 percent short. In a nutshell, this
means the non-commercials feel more strongly about being
short than the commercials feel about being long.
As for predictive value, the first area circled (A) is the
first week of February 2005, when the Group of Seven (G7)
was holding a meeting. The non-commercials switched
positions to a large long yen position — two weeks ahead of
a major upside breakout (see the area in the price portion of
the chart marked by a triangle). In circle B — also around
the time of the February 2005 G7 meeting — they did the
opposite and shorted the yen. A glance at the price chart
shows the non-commercials were correct in positioning
themselves on both occasions.
In fact, in currencies, it generally pays to follow the
speculative crowd rather than to follow the commercials,
despite age-old commodity trading lore of always follow-
ing the commercials.
The third window shows total open interest. This is
where you can detect the closing of positions marking the
quarterly maturity of the futures contracts, although this
chart uses continuous contract data, which minimizes that
effect.
Using volume and open interest in either tick volume
form or through the COT report can enhance your trading,
and it is about to become a far more important factor in the
months to come.
For information on the author see p. 6.
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