The search for an edge in trading is an ongoing endeavor. For some, it can be a new trading system; for others, price patterns are the most important trading signal. Both approaches look at market action. In contrast to this, looking at trader behavior may provide a clue to price action. The open, high, low and close metrics of a bar or candlestick may be a snapshot of where the market is, but it is not necessarily a projection of where price is likely to go. If price action were totally predictive, there would be no surprises in the market.
Traders always have sought ways to gain an insight into where others’ trades are positioned; now there are two sources of forex trader behavior data that map trader intentions and enable a sneak preview of what the crowd is up to. The first is the North American Derivative Exchange’s (Nadex) fixed payout options and the second is Oanda’s new tool box. Both provide valuable insights into the crowd. Let’s take a closer look.
In options trading, option volume and put/call premium function as sentiment indicators. When call premium is greater than put premium for the same strike, the skew is interpreted as market sentiment. If traders had no predominant expectation, the premiums for calls and puts would be equal. To date, for forex traders, such option data was restricted to options on currency futures. More recently, however, increasing volumes at Nadex are making its regulated binary option a useful source of sentiment signals. There are several reasons for this. The Nadex Binary Options are fixed payouts for weekly and intra-day expiration options. They pay out $100 per lot if the settlement value is in-the-money by expiration. Traders who buy and sell binary contracts are expressing an unambiguous intention about the direction of the market. How does this express trader intentions? When the premium is at $25, it can be interpreted that the probability of the price reaching $100 is 25%. This is not an actual probability, but the expectations of the crowd. Nadex covers more than 20 underlying markets and has a good concentration in the most traded currency pairs as well as crude oil, gold, the S&P 500 and the Dow.
As a result, the forex trader can, at any given moment in these markets, detect bullish or bearish sentiment. For example, an ask price of $80 on a particular strike shows that the trader is expecting the price to be above a particular strike price with an 80% probability. This establishes support. To find the equivalent resistance range, the trader wants to locate where there is an 80% probability that the price will not go higher. That would be the strike price with a $20 ask. The result is the ability of the trader to find a sentiment range in real-time. The Nadex bid/ask information is live with no delays.
Oanda now offers a set of trade data that also can be considered a trader diagnostic and behavior tool. For example, Oanda provides a summary of open positions held by its clients. We can see in "Who is doing what?" a snapshot of sentiment at 7:40 am EDT May 2 (there is a 20-minute delay). The crowd is shorting the EUR/USD with 61.46% bearish bias.
Oanda also shows the distribution of open orders. They describe it as, "A snapshot of the trigger points for all open orders held by Oanda clients (limit orders and Stop/Loss or Take/Profit orders on open trades). This information could be interpreted as an indicator of the client price expectations that are contributing to natural resistance and support levels."
"Order book" is divided into quadrants showing whether orders are buy vs. sell, and also whether trigger price points are below or above the market price at the time of the snapshot. The number of orders at each price level is shown as a percentage of the maximum number of all open orders during the past 24 hours.
Traders can use both Nadex and Oanda to obtain unprecedented predictive analytics on what trading direction the crowd is going as well as their expectations. Of course, these clusters or crowds of traders are a sample of the total market and the challenge remains whether to follow or fade the crowd, but knowing what they are up to gives you an edge.
Abe Cofnas is the author of "Sentiment Indicators" (Bloomberg Press). He can be reached at email@example.com.