Volume and Open Interest
fIgure 6.20 A Smoothed Volume Filter on the Daily Chart of USDJPY.
Source: MetaTrader 4average line, it is considered to be significant and may potentially lead to a top or
bottom forming in the stock or market. See Figure 6.20.setting up a two‐ or three‐sigma Volume filter Alternatively, we may also
filter out all volume except for the most significant surges using a two‐ or three‐
standard deviation (i.e., sigma) filter, also called a volatility filter. This is easily
constructed by applying either a two‐ or three‐standard deviation Bollinger Band
on volume, also referred to as a two‐ or three‐Sigma filter. It should be noted that
only the Bollinger upper band is used. A standard deviation oscillator may also be
used, but it is less useful as it does not provide the overlay by which an overexten-
sion can easily be identified as it crosses over the threshold. Figure 6.21 depicts a
three‐Sigma volume filter signaling the most significant volume surges, which tend
to result in the most significant tops and bottoms in the market.Volume filtered Inflection points
Many practitioners also use volume as a means of filtering out price inflection points.
They only use peaks and troughs that are considered significant, that is, those that
are associated with above average volume, to construct trendlines and channels. In
Figure 6.22, we shall use tick volume (transaction volume) as a basis for selecting sig-
nificant inflection points. We draw a simple tick volume overextension level or thresh-
old via visual inspection, making sure that only the most significant peaks in tick
volume appear at or above the threshold. Inflection Points 1, 2, and 3 are associated
with overextended tick volume and so are used to construct a channel. A trendline is
drawn from Point 1 to Point 2. A parallel line is then projected from Point 3. Notice
that price reacts to the channel at Point X, which represented a short‐term buying op-
portunity before the market reversed downward, violating the rising channel.
In Figure 6.23, we use the same daily chart of USDJPY to construct an al-
ternative price channel. This time we construct a trendline from Points 1 and 2
and project a parallel line from Point 3. We immediately notice a large bearish