From the June 01, 2011 issue of Futures Magazine • Subscribe!

New tools for the forex trader

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.

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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.

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