Saeed Ebrahimijam Spring 2012- 2013

1. DoğuAkdenizÜniversitesi Faculty of Business and Economics Department of Banking and Finance Fundamentals of Technical Analysis and Algorithmic TradingChapter 10: Volume and Open Interest SaeedEbrahimijam Spring 2012- 2013 FINA417

2. Contents • Blowoffs & Selling Climaxes • On-Balance Volume • Volume reversal Fundamentals of Technical Analysis and Algorithmic Trading

3. two dimensions of market analysis, namely, time and price. • Most technicians examine a third dimension, which is volume. • In addition, commodity traders analyze open interest numbers for supply and demand considerations. Fundamentals of Technical Analysis and Algorithmic Trading

4. Volume tells you: • How much trading is taking place in the market? • How excited are people about the current price? • Do they see this as great opportunity to buy or to sell? • Are they selling fast, to get out now, or are they taking a more leisurely approach to the market these days? • This information is carried in the volume of the trading, and it’s an important adjunct to the information you see in the prices. • Volume tells you whether there’s enough support to maintain price trends, or if price trends are likely to change soon. Fundamentals of Technical Analysis and Algorithmic Trading

5. BASIC RULES OF VOLUME • Volume and Market price. Fundamentals of Technical Analysis and Algorithmic Trading

6. Volume is viewed as a measure of market strength or weakness. • If volume is increasing while prices are moving either up or down, it is likely that prices will continue their current trend. • A decline in volume is considered to signal that steam is running out in the direction of the current trend and that a consolidation or reversal could be forthcoming. Fundamentals of Technical Analysis and Algorithmic Trading

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8. BLOWOFFS AND SELLING CLIMAXES • Dramatic market action that is common at market tops and bottoms is known as blowoffs and selling climaxes. Fundamentals of Technical Analysis and Algorithmic Trading

9. BLOWOFFS • Blowoffs occur at market tops. - They usually occur after prices have moved higher over an extended period of time. At the end of the up move, prices rally sharply and are accompanied by a large increase in volume. • Typically, all those who were going to buy at this level have done so. Profit taking occurs, and prices reverse, often suddenly, to the downside. Fundamentals of Technical Analysis and Algorithmic Trading

10. Selling climaxes • Selling climaxes are simply the opposite of blowoffs. • They occur at market bottoms - After prices have been declining for an extended period of time. One final wave of selling drives prices sharply lower on significantly increased volume. • Bargain hunters then jump in buying and thus reversing the trend and sending prices higher. Fundamentals of Technical Analysis and Algorithmic Trading

13. ON-BALANCE VOLUME • On-balance volume is a technique of volume analysis that has been popularized by Joseph E. Granville, author of A New Strategy of Daily Stock Market Timing for Maximum Profit (Prentice Hall, Englewood Cliffs, NJ, 1976). Fundamentals of Technical Analysis and Algorithmic Trading

14. On-balance volume is calculated in two steps: • First, each day’s total volume is deemed as being positive or negative depending on whether prices closed higher or lower for the day. • If prices close higher, the total volume is positive; • if prices close lower, the total volume is negative. • Second, each day’s positive or negative value is summed in a running cumulative total. Fundamentals of Technical Analysis and Algorithmic Trading

15. On-balance volume (OBV) • On-balance volume (OBV) is a technical analysis indicator intended to relate price and volume in the stock market. OBV is based on a cumulative total volume. • OBV is generally used to confirm price moves. The idea is that volume is higher on days where the price move is in the dominant direction, for example in a strong uptrend more volume on up days than down days. Fundamentals of Technical Analysis and Algorithmic Trading

16. In OBV • The actual value of on-balance volume is not important. Its direction relative to market price provides clues to buying and selling pressure. (See Figure 10-1 for an example.) Fundamentals of Technical Analysis and Algorithmic Trading

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19. VOLUME REVERSAL • Another method of volume analysis is the Volume Reversal technique, which was implemented and refined by Mark Leibovit. • It is based on the concept that volume precedes price, and therefore changes in the trend of prices often can be signaled by the expansion and contraction of volume. • The Volume Reversal technique can be used to project stock, commodity, or index futures prices. Fundamentals of Technical Analysis and Algorithmic Trading

20. In order to understand the Volume Reversal technique, you first must understand the following definitions: Rally day: A day when the intraday high is higher than the previous day’s high and when the intraday low is the same or higher than the previous day’s low. Reaction day: A day when the intraday low is lower than the previous day’s low and when the intraday high is the same or lower than the previous day’s high. Inside day: A day when the intraday high is the same or lower than the previous day’s high and when the intraday low is the same or higher than the previous day’s low. Outside day: A day when the intraday high is higher than the previous day’s high and when the intraday low is lower than the previous day’s low. Fundamentals of Technical Analysis and Algorithmic Trading

21. A Volume Reversal occurs • when a change from a rally day to a reaction day, or vice versa, is accompanied by an increase in volume. • Thus, if volume increases and the criteria for a reaction day are met, it is considered a negative Volume Reversal, and it’s time to sell. • If volume increases and the criteria for a rally day are met, it is considered a positive Volume Reversal, and it’s time to buy. • Inside and outside days are ignored in the Volume Reversal technique. Fundamentals of Technical Analysis and Algorithmic Trading

22. Day 2 was a rally day (higher high and higher low) followed by an outside day (higher high and lower low) on Day 3. • On Day 4, a reaction day (lower high and lower low) occurred accompanied by an increase in volume signaling a negative Volume Reversal and time to sell. Fundamentals of Technical Analysis and Algorithmic Trading

23. Day 2 was a reaction day (lower high and lower low) immediately followed on Day 3 by a rally day (higher high and higher low) accompanied by greater volume. • One final point: The closing price is not used in the Volume Reversal technique. • A positive Volume Reversal signaled that it was time to buy. Fundamentals of Technical Analysis and Algorithmic Trading

24. OPEN INTEREST • Open interest is the number of contracts that are trading for a particular commodity. • it gives traders useful information about demand. • The basic rules for open interest are similar to those for volume. They are as follows: Fundamentals of Technical Analysis and Algorithmic Trading

25. In the stock market, open interest is the number of buy orders submitted before the market opens. • If the open interest is high, that means that people are ready to add shares to their positions or initiate new positions, and that in turn means that the stock is likely to go up in price on the demand. • Note : In the options and futures markets, open interest is the number of contracts at the end of every day that have not been exercised, closed out, or allowed to expire. Fundamentals of Technical Analysis and Algorithmic Trading

28. Expanding open interest in an uptrend represents aggressive new buying and is bullish. • On the other hand, expanding open interest in a downtrend represents aggressive new short selling and is bearish. • Declining open interest in an uptrend represents short covering, not new buying, and is bearish. • However, declining open interest in a downtrend suggests the liquidation of losing long positions and is bullish. Fundamentals of Technical Analysis and Algorithmic Trading

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30. Money flow index (MFI) • Money flow index (MFI) is an oscillator calculated over an N-day period. • Money flowing “into” or “out of” a stock Sometimes finance commentators speak of money "flowing into" a stock, but that expression only refers to the enthusiasm of buyers (obviously there's never any net money in or out, because for every buyer there's a seller of the same amount). • MFI is ranging from 0 to 100. value 50 is neutral. value higher than 50 Represents money inflow to the stock (A value of 80 is generally considered overbought), value lower than 50 Represents money outflow from the stock (a value of 20 oversold) . Fundamentals of Technical Analysis and Algorithmic Trading

32. Put/call ratio • Put/call ratio (PCR) is a technical indicator demonstrating investors' sentiment. • The ratio represents a proportion between all the put options and all the call options purchased on any given day. • The put/call ratio can be calculated for any individual stock, as well as for any index, or can be aggregated. • The ratio may be calculated using the numbers of puts and calls or on a dollar-weighted basis. • Generally, a lower reading (~0.6) of the ratio reflects a bullish sentiment among investors as they buy more calls, anticipating an uptrend. Conversely, a higher reading (~1.02) of the ratio indicates a bearish sentiment in the market. Fundamentals of Technical Analysis and Algorithmic Trading