T he fundamentals of supply and demand make a market move higher or lower in the long run.

In
the short run (which can be hours, days, or even weeks depending on the time scale used), a market
can go in the exact opposite direction of the larger fundamental picture. This is because many
decisions are psychological judgments-based upon hopes, fears, greed, moods, and the like. Volume
and open interest can identify how traders are reacting to chan ging conditions. Analyzing volume
and open interest changes results in a determination of which contingent, the longs or shorts, is the
"strong hand." The position of the strong hand is the direction of the major price trend. The strong
hands are deemed the "smart money." Interpretation of volume and open interest changes are an
attempt to identify the smart money and determine what this contingent of successful traders is
thinking. Critics of technical analysis have a myriad of reasons. One comrnent often made is: The
underlying cash, or spot, market is the dominant market; therefore, why should the futures market,
a derivative, be analyzed? This is a valid question and merits a response. The difference between a
cash market price and a futures price is the "basis." The more stable this relationship, the easier the
analytical task of determining the health of a price trend. For a clear explanation of this link, refer to
Appendix C-"Basis." There is no question that the cash, or spot, market is much larger in total
tumover than the corresponding futures contract. Accurate statistics are difficult, if not impossible,
to obtain in an over-the-counter market. For instance, wh at was the tumover (volume) in spot
dollar-mark dealing in the U.S. interbank market yesterday? Since data availability is not timely, an
exact answer is not possible. However, tumover figures are important inputs to a technical
approach. Certain

2 CHAPTER I

additional questions:-Were new positions opened? Was it liquidation? Was the price rally short
covering?-also cannot be answered sufficiently. Futures markets, on the other hand, generate exact
rugh-Iow-c1ose price data as well as open interest statistics that a trader can use effectively. A
futures contract that has achieved a critical mass becomes a mkrocosm--dirninutive but analogous to
the large (interbank) system. Thus, futures c1earinghouse statistics can be used as a surrogate
without cash, or spot, market data. For example, if it was a high turnover day in interbitnk
dollar':"mark dealing in North American spot and forward transactions, it will be reflected in
increased trading activity in the deutschemark (DM) futures pit on the International Monetary
Market (IMM) in Chicago. If positions are being retained or rolled in the interbank market, no matter
whether there are speculative or legitimate corporate hedges, this phenomenon also should be
occurring in futures. The premise is that changes in futures open interest reflect what is occurring in
the [arger cash market. This prernise is central to the analysis of any futures market chart and is the
entire focus of this book.