Recently, I have been publishing less, focusing on possibilities of Volume analysis and tools helping with that. But before describing tools I need to look at the wider investment market. Even the most advanced analytic programs are just a tools, getting some data and transforming into more consistent form. The key importance, which we sometimes do not see or do not want to see, is the source of data, their quality and connection with the investment process.
The advertised image of investing is very simple: “You login into investment platform, pick asset, buy and wait until it grows and sell. To earn more, you can borrow capital to increase your profits”.
Unfortunately, it's not that simple. Even such basic concepts as volume can have several meanings. We can have volume, which describes the amount of traded shares or crypto coins, volume of transactions (only number of transactions without size), as well as tick volume, which only reflects the number of price changes per time without information about the source of movement.
What it comes from?
The world is dominated by derivatives
The simple picture presented in the advertisement is not the simplest and most profitable one for investment companies. The financial market has developed a number of instruments giving exposure to a given asset. These instruments have different characteristics:
1. Investing directly – It’s the easiest to understand exposure. When you buy a stock (piece of gold, wood or cryptocurrency) you're becoming the owner of the asset. The price of the stock will move up or down based on the performance of the company and other factors that impact its value. If the stock price increases, you can sell your shares at a profit, or if the stock price decreases, you may sell your shares at a loss. In addition, owning a stock can entitle you to receive dividends and other benefits of ownership.
2. Futures contracts - A futures contract is an agreement to buy or sell an underlying asset at a predetermined price and date in the future. Futures contracts are traded on organized exchanges, and the price of the contract is based on the expected future price of the underlying asset(Contango appears). Futures contracts can be used to hedge against price movements, or to speculate on the direction of the market. If the price of the asset moves in your favor, you can sell the contract at a profit, or if the price moves against you, you may have to sell the contract at a loss. The main role is to transfer risk (from producers), leading to lower product prices. E.g. In the extreme situation of April 2020 contacts for oil, which had nowhere to collect, the contracts had a negative price.
3. CFD - A CFD is a contract between a buyer and a seller to exchange the difference in the price of an underlying asset from the time the contract is opened to the time it is closed. CFDs are typically traded over-the-counter (OTC), and can be used to gain exposure to a wide range of markets and assets. With CFDs, you don't own the underlying asset, so you don't influence its price, but you can still benefit from its price movements. If the price of the asset moves in your favor, you can close the CFD at a profit, or if the price moves against you, you may have to close the CFD at a loss.
4. Forex - Forex trading involves buying and selling currencies in the foreign exchange market. The goal of forex trading is to profit from the fluctuations in exchange rates between currencies. Forex is traded over-the-counter through a network of banks, brokers, and other market participants. International forex market is something different than Forex offered by brokers, where Broker or 3rd company is the market maker !
|CFD & Forex
|Transfer of capital
|Impact on real price
|Lower the price*
|Lower the price*
|Based on transactions
|Based on transaction
|Based on underlaying
instrument & market
|Cost of keeping
|Possibility to move
* - Lowering the price does not only result from the transfer of risk, but also from the lack of ownership. The gold derivatives market is many times larger than the gold available to investors. If everyone investing in gold had direct exposure to this raw material, its price would be many times higher. Simply, the invested capital would be divided into available gold.
When starting investing or looking for new tools, it is easy to find many companies operating on the basis of Forex/CFD/binary contracts in the market maker model. Their ads are very aggressive.
Model broker-marker-maker – Investing or hazard ?
According to polish KNF* 70-80% of investors are losing money on forex and CFD market (depending on report year).
Investment companies offering Forex and CFDs usually operate in 1 of 2 models. They are a market maker themselves or use the services of an external market maker. Why market maker is important? If you make a transaction, the market maker is usually the 2nd side of the transaction.
Market maker is also the source of current buy and sell price, and source of fees connected with keeping position (rollovers, swaps, ect. ). Prices available for customer are based on the base instrument (real asset) prices, but they are not equal to them, and the rules for their calculation can be complicated and can dynamically change over time*.
It’s a closed eco-system in which customers are the only source of cash. Market maker earns when customers lose and loses when customers earns. The costs of running this eco-system (including advertising) are high, and when we add leverage, I'm not surprised that most people lose. The conflict of interest is obvious and many companies have been caught using many unfair practices towards their customers*.
Models in which the market maker is moved from the client by adding an investment company or software provider do not eliminate this conflict of interest, only adds some extra costs*.
As example “… NinjaTrader receives a portion of the commissions and fees charged to client’s accounts. …” - From https://ninjatrader.com/Conflict-Disclosure on 11.02.2023
When I look at this “investment” eco-system, it reminds me of the casino model. Casino that downloads draw results from an external source (stock market listing). Binary options (a bet with an investment company, e.g. the price of an asset in 5 minutes will increase or decrease) in my opinion, are simply gambling.
And basically, I wouldn't mind if it wasn't for the fact that when looking for investment materials and tools, I come across a beautifully packaged hazard and it's hard not to get lost in it.
*- In Poland KNF supervises financial markets and in their reports you can read about threats and customer rights on this market.
Which instruments are the best?
I believe that investing should be started with "real" assets and ownership model. The derivatives market should be left to advanced speculators and large financial institutions. I have not heard of an investor who would build a fortune on derivatives, but I can find many fortunes build on ownership. e.g. Warren Buffer. The fortunes of the world's richest people come from real businesses and the stock market, not derivatives.
You may ask, how in the ownership model gain exposure to the oil or uranium? You can't buy a tanker of oil or a block of uranium. That's true, but you can invest in producers, extractors, processing industries, or consumers industry. There are many ETFs in the world that allow you to build exposure to a given country, industry or raw material at a low cost. Unfortunately, EU citizens have very limited access to ETFs. (The EU, acting in the interests of citizens, restricts access to ETFs, but allows derivatives with a leverage of 1:30 – In this case it's hard for me to understand the interest of a citizen)
Some of you probably think that such investing is boring. In my opinion, fasten your seatbelts, because in 2023 or 2024 I expect a recession and a significant drop in valuations due to excessive leverage of the market. I do not know what will be the next Lehman Brothers, but the crash caused may be more violent, socially painful, but also create an opportunity to protect and multiply the capital held.
How does this translate to Volume and Tools?
· In the case of instruments listed on one exchange, the situation is simple. All public trading is known to us, the volume describes the migration of capital and has a direct impact on the price.
Situation is little complicated if asset is traded on few exchanges, but still we can combine data from different sources. In this case we should also remember about arbitration, than can be done by exchanges or investors.
· In the case of trading commodities or Forex (currencies) that do not have a central trading point, the total volume is not available.
· Futures volume has no direct effect on price, but it can be used to measure of market sentiment.
· On futures for commodifies, the contango effect also allows you to obtain information on the expected valuation of a given commodity at the time of expiration of the contract.
· Volume of CFD or forex has no direct correlation with underlaying asset price. It can be used to assess the sentiment or liquidity in the market.
· Some brokers provide volume of transactions performed in their eco-system, but as I discussed earlier, it is a closed ecosystem, the impact of which on the price is negligible.
· Information coming from the tick volume is doubtful to me, especially since the market maker can dynamically change the way the price is calculated.
· Information about leverage and the difference in long and short positions, however, carry valuable information. The saying that “On the market, the majority cannot be right” is not unfounded. If the majority of the market is leveraged and bets particular direction of the market movement, there is an increasing motivation (on market makers and large financial institutions) to move the market in the opposite direction at least for a moment and liquidate the leveraged positions.
What would happen if on a leveraged market the majority were right?
This scenario is impossible/not stable in the close market maker eco-system.We are dealing here with the flow of capital on the basis of a concluded contract. Market makers would have to pay huge profits to their customers, which would mean huge losses for them. Without no other source of funding most of this financial institutions would disappear overnight.
To sum up,
Volume analysis has many powerful tools, but most of them was created for volume data describing the price formation process. However, the investment market is diverse, we have different forms of investing, the impact of which on the price is different. The type of available volume also varies, which may make some techniques unusable.
Have a nice day and good luck in trading!
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