Derivatives volume numbers can provide interesting insights about the trading pattern and help in forecasting the future trend. Here is how to read them
If price is the 'King', volume can easily be labelled as the 'Vazir'. And as a derivatives trader, who's not so much into technical analysis and is unable to value the price surfing through research reports, volumes offer an amazing insight into the underlying trends. Before we come to analysing the same, let me tell you what volumes actually are.
Derivatives are traded in lot sizes in India and abroad. However, unlike international norms where lot sizes are fixed, Indian markets have the multiplier system viz. 1200 for Satyam and 100 for Infosys. Hence, comparing derivatives securities in terms of such multiplier units like 585200 units for Infosys Near Futures with 10180800 for Satyam Near Futures is a blatant mistake.
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Volumes have to be read in contract terms i.e. 8484 contracts for Satyam (10180800/1200) and 5852 contracts (585200/100) for Infosys. Now if one can see, the numbers are interpretable. Satyam traded around 45 per cent more than Infosys on 29 January 03. This was just a simple example, which highlights the utility of contracts over units.
Contracts are so important that even volumes in value terms i.e. in Rs crore are not as significant as the total number of traded contracts in a day. Apart from stock-specific volumes, traders can analyse aggregate derivatives volumes and segment-specific volumes viz. Index futures, stock futures, stock (Index) call options, stock put (Index) options etc.
Using volumes to trade: Using volumes as a trading tool is quite simple. Volumes should expand in the direction of the trend. If prices go up and volumes continue to rise, the trader can safely assume the trend to be up. However, in case volumes decline, the trend's existence is questionable. Volumes in such a case are an indication to the trader to scale down his longs and time his shorts.
Many such situations were observed in the derivatives markets in India. February 28-02 (Budget crash) witnessed such volume behaviour. The volumes peaked out on the Budget day at Rs 2300 crore. And though the markets continued to rise after that, the underlying traded volumes declined. This was the first indication for traders to cut out the longs and time the shorts. The market collapsed in less than two weeks.
The markets witnessed another trend from March to October 02. This time the trend was down. Volumes declined, with the decline clearly indicating that volumes were not reinforcing the bear trend and till the time the volumes improved, a long term trader could safely assume a 'No Long' situation.
During this period, March-October 02, the Nifty fell by almost 20 per cent. All this time aggregate volumes continued to decline till they suddenly spiked on 30 October (Nifty at 937), which incidentally was the bottom. The markets have not looked back since then.
Volumes are a good trading tool that can be used by a long-term investor to gauge broader trends, basically to time market peaks and bottoms. Yet, one needs a meticulous eye to use volumes for short-term trading cycles.
This is where segment volumes, scrip- and month-specific, come into play. Predicting the market in the short term is trickier, as the trader wants to trade at both crest and troughs during a long-term downtrend (uptrend). Short-term traders can watch out for the end-of-day volume spikes. For example, December 3, 02, witnessed the highest day-traded contracts in Nifty.
Nearly 18988 contracts were traded in the Nifty near futures. Such a high rise of around 80 per cent or more than the previous day was an important indicator. Since the volume activity came after about a 14 per cent unabated rise in prices from a base of Nifty at 927, it was a sign of distribution (selling pressure). The markets dipped by one per cent the next day.
There are a host of such examples for short-term trades. The only thing a trader needs to remember is that the principles for interpreting volumes don't change with the reduction of the trading horizon. But, the volume