Successful trading relies on the ability of the participant to analyze trends in the market, attempting to anticipate potential future trajectories of price. There are many different indicators and aspects of the market that a savvy trader needs to keep a pulse on. 

 

One of the necessary and potentially vital skills to learn is Open Interest. Let’s explore it.

 

What Is Open Interest?

Open interest represents the total count of derivatives (options and futures contracts) that are:

 

• Held by market participants
• Have not been settled and
• Are outstanding

 

This count is usually ascertained towards the end of the trading day and shows the number of contracts that are still open in the market.

 

In the derivatives trading market, there are always two parties associated with a trade, which are:

 

Buyer: Buys the derivative contract from the seller (the liquidity provider) and is considered to be long

 

Seller:  Sells the derivative contract to the buyer (the liquidity provider) and is considered to be short

 

For example, Mr A sells one futures contract to Mr B. In this case, the open interest will be “1”, as Mr B has the futures contract, which is still open in the market and is outstanding.

 

 

 

What Is The Difference Between Open Interest and Volume?

 

Open Interest and Trading Volume are frequently used terms in the derivatives market, and amateur traders often mix them up. 

 

Volume is the amount of derivative contracts traded in a particular trading session.

 

Whereas OI (Open Interest) is the number of outstanding derivative contracts in the market that are yet to be settled.

 

For example, on a particular trading day:

 

• Trader A sold 20 June ES (E-mini S&P 500) futures contracts
• Trader B sold 25 July ES (E-mini S&P 500) futures contracts
• Trader C bought 30 June ES (E-mini S&P 500) futures contracts

 

In this case, the volume will be 75 (20 + 25 + 30), which is the total of all the contracts traded in the market across that particular session.

 

The volume reflects the number of trades that happened in the trading day, whereas open interest is calculated only once (as the exchange closes for trading, wherever relevant).

 

 

 

Why is Open Interest Important?

Every good trader needs to keep up to date with the latest numbers coming out of the market, no matter what they might be.

 

Open Interest is one of those details that can potentially help traders identify market trends or shifts in momentum. It can also be used in conjunction with volume as confirmation.

 

The relationship between open interest and volume helps market participants identify bullish or bearish trends in a rising or falling market. The various common interpretations are:

 

In a market where the prices are rising:

 

Open Interest	Volume	Analysis
Rising	Rising	Shows the market is trending up strongly   Indicates the upward trend is likely to continue
Falling	Falling	Shows the the trend is still up, but momentum may be weakening Indicates that the uptrend may be stalling or even reversing

 

In a market where the prices are falling:

Open Interest	Volume	Analysis
Rising	Rising	Shows the market is in a strong bear market Indicates there may be further momentum to the downside
Falling	Falling	Shows the market is still down, but the selling isn’t as aggressive as before Indicates the market’s downward bias may be slowing

 

 

 

Analyzing Open Interest

In traditional derivative markets, open interest increases and decreases with the opening and closing of positions as follows:

 

Actions of Parties Involved In Trade	Effect on Open Interest	Quantum of Effect
If a buyer and seller open up a new position	Increases by the equivalent number of contracts transacted	By one count
If the buyers and sellers close their existing positions	Decreases by the equivalent number of contracts transacted	By one count
Both existing buyers and sellers pass or exchange their present positions to new buyers and sellers	No change	No change

 

 

 

 

To recap: increasing or falling open interest for a derivatives contract has different interpretations, which are:

 

• Rising Open Interest: Open interest rises more as traders take positions in the market, which indicates that:
  • additional money that is flowing into the market

In such a scenario, it may mean that the existing trend of the market will continue.

 

• Falling Open Interest: Open interest falls as participants close and settle their positions, which means that:
  • money is being removed from the market

In such a case, money is flowing out of the market, meaning the existing price trend may not be sustainable.

 

 

 

Conclusion

Open Interest is part of the market’s microstructure and can be used as an indicator by the savvy traders out there.

 

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