Unveiling Crypto Market Insights - Volume and Open Interest

3月21日

GM Bitstampers!

In this week's post, we'll dive into a multidimensional approach to market analysis, focusing on tracking the movement of three sets of figures: price, volume, and open interest. Volume and open interest are commonly referred to as secondary or confirming indicators.

TL;DR:
- Volume and open interest (OI) are considered secondary (confirming) indicators, with price action taking precedence as the most important factor.
- Volume indicates the strength or urgency behind price movements. Higher volume suggests increased intensity or pressure.
- A breakout in price patterns should ideally be accompanied by higher trading activity to validate the signal.
- During a downtrend, heavier volume is expected during downward movements and lighter volume during upward rebounds.
- Technical analysts believe that volume tends to precede price movements, meaning changes in volume can hint at potential shifts in price trends before they occur.


Volume and Open Interest as Secondary Indicators
John J. Murphy highlights the relevance of volume and open interest in his book "Technical Analysis of the Financial Markets": "Let's begin by placing volume and open interest in their proper perspective. Price is by far the most important. Volume and open interest are secondary in importance and are used primarily as confirming indicators. Of those two, volume is the more important."

General Rules for Interpreting Volume and Open Interest
Murphy lays out fundamental rules for grasping volume and OI and how they relate to market trends: "If volume and open interest are both increasing, then the current price trend will probably continue in its present direction (either up or down). If, however, volume and open interest are declining, the action can be viewed as a warning that the current price trend may be nearing an end."

Interpretation of Volume for all Markets
Murphy provides general rules of interpreting volume in the markets: "The level of volume measures the intensity or urgency behind the price move. Heavier volume reflects a higher degree of intensity or pressure. By monitoring the level of volume along with price action, the technician is better able to gauge the buying or selling pressure behind market moves. This information can then be used to confirm price movement or warn that a price move is not to be trusted.

To state the rule more concisely, volume should increase or expand in the direction of the existing price trend. In an uptrend, volume should be heavier as the price moves higher, and should decrease or contract on price dips. As long as this pattern continues, volume is said to be confirming the price trend.

The chartist is also watching for signs of divergence. Divergence occurs if the penetration of a previous high by the price trend takes place on declining volume. This action alerts the chartist to diminishing buying pressure. If the volume also shows a tendency to pick up on price dips, the analyst begins to worry that the uptrend is in trouble."

Volume as Confirmation in Price Patterns
Several examples of proper use of volume as confirming indicator are provided by Murphy: "One of the first signs of a head and shoulders top occurred when prices moved into new highs during the formation of the head on light volume with heavier activity on the subsequent decline to the neckline. The double and triple tops saw lighter volume on each successive peak followed by heavier downside activity. Continuation patterns, like the triangle, should be accompanied by a gradual drop-off in volume. As a rule, the resolution of all price patterns (the breakout point) should be accompanied by heavier trading activity if the signal given by that breakout is real.

In a downtrend, the volume should be heavier during down moves and lighter on bounces. As long as that pattern continues, the selling pressure is greater than buying pressure and the downtrend should continue. It's only when that pattern begins to change that the chartist starts looking for signs of a bottom."

Volume Precedes Price
Murphy elaborates on the term "Volume Precedes Price" as follows: "By monitoring the price and volume together, we're actually using two different tools to measure the same thing - pressure. By the mere fact that prices are trending higher, we can see that there is more buying than selling pressure. It stands to reason then that the greater volume should take place in the same direction as the prevailing trend. Technicians believe that volume precedes price, meaning that the loss of upside pressure in an uptrend or downside pressure in a downtrend actually shows up in the volume figures before it is manifested in a reversal of the price trend."


Please note that one should take caution when including volume into analysis; changes in volume can also be attributed to lower trading activity on the weekends, changes in fee schedules, etc.

In the next post, we will describe how to interpret price moves and the strength of the market and apply the knowledge to the chart.

Do you consider volume and open interest as important parts of your analysis?

Let us know in the comments.