As a long time e-mini Trader, I believe that Volume is one of the most neglected variables in trading. Granted, the average trader does not have a wealth of information on volume trading at his or her disposal because volume has long been poorly understood or downright ignored. It is my contention that increasing your understanding of volume and its relationship with other trading variables can greatly improve your e-mini trading results.
Richard Arm’s book on equivolume is a wonderful spot to start your study of volume. My paperback copy of one of the older editions of the book is dog-eared and worn as I have read and reread the volume. Mr. Arms is an interesting fellow, and on first reading, it is difficult to fully grasp the volume (in relation to price) principles he explains. It’s only through rereading and learning the material that you can finally wrap your head around what he is trying to illustrate; it took even longer to observe his ideas at work on a live trading chart, but it can be done.
Further, there is a fundamental difference between trading stocks, which was Mr. Arm’s primary instrument of study, and relating those ideas to e-mini trading.
Why would stock trading volume principles vary from e-mini trading implementation of volume?
It’s important to remember that the New York Stock Exchange is populated with market makers who provide a never ending supply of shares in a given equity for all traders to either buy or sell. On the other hand, trading on the Chicago Mercantile Exchange of the CBOT (or any other futures exchange, for that matter) involves working in a zero-sum market environment. A zero-sum market is defined as a market where there is a buyer and seller for each contract. Of course, you as a trader no longer know who the corollary buy or seller of the contract you are trading; it is the exchange’s function to match prospective buyers and sellers together in an anonymous manner. As a trader, you simply know that you are either filled in a contract or not filled in a contract.
You will find this simple axiom to be helpful in e-mini trading in zero sum markets: As the price action approaches an area of support or resistance (SAR) you should pay careful attention to the volume level to determine whether or not the price is going to continue through the support or resistance. Generally speaking, when volume increases dramatically at the SAR point, it is often an indication that the price is not going to pierce the line in question; conversely, low volume at an SAR point is an indication that the price will continue through SAR.
Why?
As I mentioned earlier in this essay, futures trading is a zero sum game and there are a finite number of contracts in play during normal market action. As the price approaches support or resistance, many traders will exit their positions; usually with the thought that the price is going to change direction. On the other hand, a new group, or the exiting traders will begin to buy or sell (depending whether we are discussing support or resistance) contracts in anticipation of the market price changing direction. In short, this phenomenon can be described as a two-seated game of musical chairs, with long and short e-mini traders exchanging positions at potential direction change points to match their expectations of future price movement.
What is the evidence you can easily observe to confirm this process taking place?
As the process of e-mini traders exiting positions and new traders entering positions takes place the result will be a spike in volume. When I observe spikes in volume I generally look for confirming indications of a direction change and trade accordingly. Of course, this is but one volume function you can watch and we will examine other volume action in futures articles to expand upon our understanding of the topic.
In summary, I have stated that volume is poorly understood by most traders in e-mini trading and a careful look of volume can increase your comprehension of potential price action. Further, increased volume at SAR levels may indicate a change in direction, while lower volume may indicate the price action is going to continue through the support and resistance points. Finally, I have recommended Mr. Arms writing as a great point to increase your knowledge of volume effects in both zero-sum markets and markets that are populated with market makers.
