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Using Volume and Open Interest with Support and Resistance - 11-16-2003

Question:

I understand that you monitor volume and open interest to give you clues to what might happen next, but how does that work?

Answer:

I’ve actually written a special report that deals specifically with the subject of volume and open interest and how they can help forecast price movement. It is available to subscribers at the website (http://www.tradershelpingtraders.net). Just follow the “login” link at the top of the page from where you will be able to download the report.

Briefly however, by following Volume and Open Interest, relative to current prices, traders can get a better idea as to the strength of a current trend or the strength of a market breakout from a formation. Following Volume and Open Interest is not rocket science and as indicators they are fairly straightforward and usually reliable. Both Volume and Open Interest are usually used as secondary indicators, and are best used to confirm trading decisions as opposed to initiating them.

Volume represents the total amount of trading, or how many contracts, have changed hands in a given day. A quick look at the volume bars will show which days trading had heavy trading and on which days trading was light. The volume figure can be used to determine the strength of the current trend. If volume is high, or increasing, then the pressure behind the trend is high, and the current trend is likely to continue (up or down). If volume is falling, then the pressure behind the trend is weakening and a reversal maybe around the corner.

Open Interest measures the number of outstanding contracts at the end of each day. Actually, Open Interest only records half of the outstanding contracts, since for each buyer there must also be a seller, but this does not affect how we use open interest. Open Interest can also be interpreted as the flow of money entering and exiting a market. If Open Interest is increasing then this is a sign that there is new buying taking place, and traders are expecting the current trend to continue. Conversely if Open Interest is declining it shows that traders are taking their money out of the market, or liquidating, and the current trend will likely end soon. Similarly, if Open Interest levels off after prices advance, it is a sign that no new buying is taking place and the current uptrend is losing steam.

When interpreting volume and open interest keep in mind that:

* When prices, volume and open interest are rising, prices will continue to rise; * When prices are rising, but volume and open interest are falling, this is a sign that the current uptrend is weakening; * When prices are falling, but volume and open interest are rising, then the market is weak and the current downtrend will continue; * And finally, when prices, volume and open interest are all declining, then the current downtrend is losing steam and we could be looking at a bottom as the market momentum slows.

-Erich

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