I have been working on a new script that is built around the underlying symbol as an approach to getting an early look at what is going to happen to the futures. In this case it deals with the 4 main indexes, that of the S&P (SPX), Dow (DJI), Nasdaq(NDX) and the Russell(RUT). So far it is looking great and early testing shows it to be an amazing way of reading what is coming. But more on that later.
Pretty much everyone you turn to, that has but a modicum of trading experience, will tell you that volume is important and you should pay attention to volume.
Some statements you have probably heard are;
Volume is the fuel that powers price movement.
Volume is required for an active trading environment
And you should always have volume going your way.
But what do these statements mean and how do they impact your trading?
Well we should explain what volume actually is. Essentially, volume is the number of shares traded. And exactly what does that number tell us? Actually, standing on it own, not much.
If you have a volume indicator at the bottom of your chart you can tell when there is a lot of volume and you can also tell when it up volume or down volume but not the disparity of the two only how the bar moved. There are other indicators that you can plot on your charts. In TOS, the indicator for the SNP showing the difference between advancing issues and declining issues is $VOLNDD . That is not volume. Volume is $VOLSPD. That is the difference between upside volume and downside volume. Go ahead try it. You might find it confusing, that is not uncommon.
On the market we know what the seller is asking for by the “ask” price and we also know what the buyers are willing to pay with the “bid” price. (If I am boring you with this basic stuff, please allow me this digression for those who do not understand this concept) What drives this market is fear, greed, emotion and, in the astute trader, knowledge.
The astute trader is working with tools and knowledge that help him understand where the market is going and is not affected with the other three drivers being fear, greed and emotion. And that is what allows the astute trader to run the stops of the other traders. So, even if I explain all about what is volume, if we discount those three drivers we miss the picture. At this point I will call these psychological drivers and will delve into these at some later date, just understand that they exist. For the moment we are going to discuss how an auction, which is what the market is, is affected by volume knowing those three psychological drivers are in play.
The market is driven by supply and demand. What? Does that surprise you that it is a basic financial concept? It is true, as buyers rush in to take a position in the market it overwhelms what the sellers asking price and it rises as more sellers are enticed as they ask even higher prices. The desire to hold a position creates the volume that drives the price up. In order words the demand is greater than the number of traders who are rushing in to sell (supply). However, when that does happen and the traders are wanting out of a position, either to take profit or stop losses. The first surge of selling action creates an environment for other sellers to protect their positions and this volume of non-demand to ow. But now a demand to get out creates a new demand and the principal is the same in reverse. Now as the number of buyers diminish at a given price, the sellers lower the price to make it more attractive. This creates a volume surge until a level is found of a balance between the bid and ask. But this condition is not static it is just a pause for the market to take a breath and then it starts a new cycle. This is why Tested Wisdom incorporates cycles in our studies.
But is this really volume doing this. It is apparent when I wrote about the “number traders rushing in to sell” I was not saying volume but rather trades or Ticks which is what a tick chart is base on. Many people advocate tick charts for that reason but changing the chart does not affect how price is going to react. The ticks themselves are hugely important however. If we were going to use volume alone it could be created by a very few big trades or it could be created by a huge number of smaller trades and the volume would be exactly the same. Some might say that volume is an accounting of what happened and had nothing to do with the promoting the event. In any case, it is a lagging indicator.
Through the years I have spent a great deal of time testing the impact of alone on price and frankly it could be a great indicator one day and not so great another day. It did not appear to me to be a good indicator of what price was likely to do. The Trin is an indicator that is used by some traders but even it has weakness because of the disparity in how volume is created. Here is the formula:
TRIN = (The number of advancing stocks / The number of declining stocks) / (The composite volume of advancing stocks / The composite volume of declining stocks) Remember those two indicators I mentioned above, well those are the active elements Mr. Arms used in building the Trin. So yes, it would have that same flaw associated with volume. It should suffice to say, I would not use it.
There is an indicator that will tell you what other traders are doing and it is called the Tick Index. It measures the difference of the up ticks and down ticks and reports that number as a plus or minus indicating the disparity between the two. If it reports that it is -241 then you know there were 241 more trades bearish than bullish. If you watch that indicator you will often see how it precedes the price movement to follow. It is most effective in fast moving markets like the futures where a trade might be a very short duration one. But this is not volume. You see can the differences in these indicators by typing in the symbols. If you use three unlinked charts side by side you can see how the U/D volume, Trin and U/D Ticks compare. Here are the symbols for the SNP which you would trade with the /ES. This must be done during regular market hours as the data does not stream after regular market close.
U/D Volume $VOLSPD
U/D TICKS $TIKSP
I mentioned to you in the opening paragraph that I was testing a new script to avoid the pitfalls of trying to use volume. I am not saying throw volume away, I am saying, is “understand what it does not tell you”. Frankly, I am blown away by early testing of my new script. I am scoring much larger gains in much shorter times with this new approach. I have also incorporated, into the scripting, a risk management tool that computes your order entry based on your risk tolerance and the win to loss ratio you desire. That alone has saved me from making too early an exit and stopped those losing trades far before I would have on my own. It is back to that psychology I mentioned earlier. This new study addresses a lot of things that have not been addressed before by anyone. It is very easy to use and understand and an easy learning curve. I look at all the stuff the other guys are selling. Most of it is the same old approach with new clothing. None of them address what the TWFuturesTrader does.
The whole idea of this posting was to give you a wake up call to what you think you know. It is not uncommon for me to discover that what I thought I knew, as it was conventional wisdom, does not perform as anticipated. In this business of trading the one thing we do not want to do is to take anything at face value. Look at it closely and draw your own conclusions, after all it is your money. The is seldom a day go by that I do not learn something new.
Sometime is foreseeable future I will be releasing this new system. But not until it has experienced the test of all market conditions. Just because I have been tearing it up in this volatile market is no guarantee it will perform reasonable well in a flat market given the restraints of a flat market. So until later.
SEE YOU ON THE OTHER SIDE.