So now that we understand about dow jones futures in detail, let me explain how the cash index and dow jones futures work together, and how we can use this knowledge to spot trading opportunities using a technique called volume spread analysis. Let me start by teaching you my chartist prayer which goes like this:
- May my assessment of today’s price action be based upon the facts, all of the facts and nothing but the facts. May I not be influenced by fear, greed, or the ill advised comments of others, which may be made in their interests and not my own. May I take into account the past history laid before me on this chart, and make my assessment based on my knowledge, and logic, and not my emotions.
Dow jones index chart - daily candle chart with volume indicator
This really says it all in a nutshell. Follow the above and you won’t go far wrong, in any of your trading. So let’s start by looking at a chart for the dow jones index from the last few days, which will have the single most important indicator – volume.
The chart above is for the dow jones index and shows the daily candles for the last few weeks, whilst at the bottom of the chart we have the most important indicator that I use in all my futures trading, and that’s volume. Now in this case we are looking at the cash market with real volumes of traded stocks on the index, illustrated by the vertical bars. The colour of each bar is irrelevant, but simply reflects whether the price action for that particular day was positive or negative for the index. As you will see, I have marked four key areas with different coloured ellipses to highlight various points which I would like to explain in more detail, and which I hope will get you started on your own journey of discovery, to to understand how price and volume analysis can help you in reading the market, and identifying those key turning points which only volume spread analysis can predict. If you study this technique, and practice, you will see this happening in every market and in every time frame where the instrument reports volume. For index trading we are blessed with volume in both the cash market and also the futures market, which gives us a unique insight and advance warning as the futures traders position themselves for a turn, having seen initial weakness in the cash a market. So let me explain the first signal which is the ellipse in red on the above chart, and then I will explain the others moving from left to right across the chart.
The two candles I would like you to concentrate on are those enclosed in the ellipse and look at the associated volume below, and in all volume spread analysis we are always looking for anomalies such as very high volume, very low volume, and their relationship with the resultant candle. The first candle ended the trading session marginally higher, but with a very narrow spread, but note the volume which is very high – what is this telling us? The candle is telling us that the dow jones index is struggling to move higher as the price action was contained in a very narrow range, but when we look at the volume this is very high, so shouldn’t the market have gone up a great deal more ? Clearly the market makers are struggling to sell at this level, indicated by the high volume with the market failing to rise, giving us a clear signal that the market rally is in trouble with the market makers selling aggressively but failing to move the index higher. This is a classic signal that you will see all the time, whatever the time frame of the chart. The market has risen on rising volume ( it takes effort to move the market both up and down) and suddenly we see a dramatic increase in volume ( effort) but the market fails to respond. This is equivalent to driving a car up a very icy road in the winter – more power is applied, but the car reaches a point on the slope where it refuses to go any further, simply maintaining its position on the hill, as more power is applied. This is much the same principle as is happening here on the daily dow jones index chart. The market is signalling that it is reaching a turning point and running out of steam. We wait for a confirmation signal which comes the following day – another classic trading signal, an upthrust or shooting star candle, a classic sign of a weak market. The market has attempted to rise, but has fallen back as selling pressure overcomes buying, indicating weakness and a possible turning point which is duly confirmed over the next few days.
The next signal comes a few days later ( blue ellipse), where we see extreme volume, coupled with a narrow spread down candle which immediately gives us a signal that the dow jones index is unlikely to fall far, as the selling pressure is now being absorbed as indicated by the high volume - after all, if this were selling, we would expect to see a wide spread down candle, but instead we have a day of narrow price action, which means that the selling pressure is being absorbed by the market makers, so the market is buying into the fall and preventing a further decline. Whilst the market continues lower for a few more days, the volume of each successive day is also falling, a clear signal that the move is running out of steam and we can expect a reversal higher in due course, which duly arrives with another classic technical pattern, of a hammer, doji cross, and inverted hammer, all signalling a reversal. The market duly moves higher, however, we note that the volume on each of the subsequent days is falling, whilst the spreads are narrowing as we reach the pink ellipse, both clear signals that the market is once again weak, and a few days later we see a reversal once again. Here again we have a classic technical signal, this time with a further doji candle followed by a hanging man, with the dow jones index moving lower once again.
The technique I have outlined above is called volume spread analysis and as I said at the beginning, cane be used in any time frame and in any market where volume is reported. In this case we have applied it to the dow jones index, and to trade dow jones futures, and as such we simply have two screens with the dow jones futures quotes on one screen, and the dow jones index chart on the other. We then analyse the dow jones index chart ( in whichever time frame), and once we see a signal in the cash market, look for any confirming activity on the dow jones futures chart by analysing the futures volume. If the professional traders have seen the signal in the cash market, then they will be positioning themselves for the move, either buying or selling in volume, and provided this confirms the move, then we can follow them by trading in the same direction, secure in the knowledge that our decision is based on the facts and nothing but the facts! If you would like to learn more about volume spread analysis then simply follow the link here, which will explain more of the fundamental principles behind this trading strategy. It will take time effort and patience, but once learnt you will never forget the principles, and is the perfect way to trade dow jones futures, in my view. You will of course need two live feeds, one for your futures charts with dow jones futures real time data, and the other charts for the real time dow jones index, however, both these should be relatively inexpensive.
So having looked at volume spread analysis for trading dow jones futures, can this be applied to any other markets, which of course it can, as in addition to trading stock index futures, I also trade several of the commodities futures and currency futures markets.
