THE HAndbook oF TEcHnIcAl AnAlySISVolume Distortions A surge in activities such as arbitrage, program trading, and
high frequency trading (HFT) may also distort and misrepresent the traditional mean-
ing or representation of volume. As such, the volume information that traders use
and rely on to read market action may not in fact be totally indicative of true volume
action in the classical sense.
Volume—Open Interest Interplay Open interest is simply the total amount of
outstanding contracts in the futures and options markets. Unlike stocks, all futures
and options contracts eventually expire. Open interest is therefore the number of
unliquidated long or short contracts. Each contract consists of a long and corre-
sponding short position. These contracts are in a sense still active, or open. Open
interest increases when a new long and corresponding short position are initiated,
and decreases when both the long and corresponding short position are exited.
Open interest remains unchanged when either the long or short position is replaced
by a new position, but not both at the same time.
Generally speaking, open interest is interpreted the same way as volume. It
is indicative of the level of interest or participation in seeing price rise or fall.
Open interest divergence is therefore read in the same way as non-price‐based
volume oscillators. When prices, volume, and open interest are all rising, this is
indicative of a bullish market, predominantly driven by buying pressure. Con-
versely, when prices are rising but both volume and open interest are declining,
this is indicative of a bearish market, predominantly driven by shorts covering
their positions and longs leaving the market. For declining markets, rising vol-
ume and open interest is bearish and is predominantly driven by short selling.
Falling volume and open interest is bullish in a declining market, mainly due to
the diminishing number of long positions being liquidated and short positions
being initiated. It shows that the market participants are less interested in seeing
the market decline further.
As far as trading is concerned a trader should look for appropriate buy signals
when price, open interest, and volume are all rising. Conversely, a trader should
look for a suitable exit in order to liquidate long positions if rising prices are ac-
companied by declining open interest and volume. In a declining market, traders
should look for appropriate signals to go short if both the open interest and vol-
ume are rising, and rapidly seek to cover all short positions when both the open
interest and volume start to decline together. In Figure 6.24, we observe a bullish
confirmation between volume and Silver prices with volume peaking at Point 1,
at the highest price. But we notice bearish divergence between open interest and
price. This is an early indication that many longs are liquidating as prices rise. We
subsequently see Silver prices retrace significantly.
It should be noted that the level of open interest may be indicative of the na-
ture of a potential reversal or breakout. For example, if open interest is very high,
the ensuing reversal may be significantly more rapid, due to the large amount of
open contracts liquidating and covering.
Volume versus tick (transaction) Volume In the over the counter (OTC) for-
eign exchange (fx) market, many brokers offer tick volume instead of actual volume.