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Open Interest

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Open Interest is an active count of the day’s open, or “outstanding”, futures contracts. Note that it shows the long side or the short side, but not both. There’s a specific reason: All contracts have one buyer and one seller, which means that you only need to be aware of one side’s number. Open Interest, Price, and Volume all result in the overall picture of price action. Price moves according to supply and demand, while open interest and volume confirm price trends or warn of incoming divergences and trend reversals.

Open interest only includes derivative markets, futures and options. The number is not a live presentation. Since open interest shows the day’s outstanding contracts open interest always has a one-day delay. There are two numbers related to open interest. The first number is Total Open Interest, also called “At Close” open interest. This is all contracts currently in play within the market. The second number is “Change in” open interest, which is positive for increases in overall open interest and negative for decreases in overall open interest.

Each individual trade affects open interest. It can maintain the current level of open interest, increase, or decrease. The actual impact depends on the relationship of existing contracts before the trade to new contracts created by the trade. If a transaction matches a new long purchase and a new short sale, money enters the market and open interest increases. If a transaction matches a purchase to close an old short position with the sale of an old long position, money exits the market and open interest decreases. If a transaction matches the purchase of a new long position is with the sale of an old long position, or the sale of a new short position with the purchase of an old short position, open interest will stay the same.

The interaction of open interest and uptrends or downtrends imply the future direction of prices. If the open interest is rising in an uptrend, this is typically bullish. The new money’s transactions are entering the market and driving the price upwards. The uptrend will probably strengthen. If open interest is falling in an uptrend, this typically is bearish. The buyers in the uptrend may be closing out or taking profit while owners of short positions are buying to close out their positions. In both of those cases money is leaving the market, and the uptrend will weaken.

If the open interest is rising in a downtrend new short sale transactions are driving the price downwards. New money drives the price downward as it enters the market. Falling open interest in a downtrend is bullish. Money is exiting the market as long position holders escape their losses matched with short traders take profit, which indicates the trend is probably dying down.

Since each open interest represents a contract with one long and one short position and futures markets have very high inherent margin, dynamics are created between open interest and price. If the price moves with substantial amounts of open interest, the losing side will need to liquidate to avoid margin calls. In an upwards move, the short side needs to find new long buyers to close their losing positions. In a downwards move, the long side needs new short sellers to close their losing positions. If the open interest has built during a sidewinding market trading within a range, a larger group of people will need to correct their mistakes before they receive a margin call.

Open Interest versus Volume

Open interest combined with volume is extremely useful for forecasting long term price movements. This data is not presented in live. Both volume and open interest in the future’s markets are reported only after the close of the market.

The basics of volume and open interest as a forecasting tool are easily stated. If volume and open interest are rising together the trend will most likely continue. If volume and open interest are falling together the trend will most likely end or reverse.

For uptrends, continuation is directly correlated. When price is rising while open interest and volume are rising, the uptrend will be strong. When price is rising while volume and open interest are falling, the uptrend weakens and will probably turn downwards.

Downtrends are inversely correlated. When price is falling while volume and open interest are rising, the downtrend will be strong. When price is falling while volume and open interest are falling, the downtrend will be weak.

Open Interest versus Options

Open Interest occurs for options as well as futures. This number consists of the amount of open options on each individual put or call. The higher this number the greater the amount of outstanding options.

This number is actually used to compute the put call ratio, a consensus number used to infer the bullish or bearish expectations of investors in the marketplace. If there are more calls than puts the number is bullish and below 1. If there are more puts than calls the number is bearish and above 1. The higher this number is the more bullish investors are currently feeling.

The farther this number trends away from one, the more extreme investor consensus is feeling. When this number is extremely high relative to the past, it may be an oversold or overly short market primed for returns from the long side. When the number is extremely low relative to the past, it may be an overbought or extremely long market indicator, primed for short or inversely correlated asset returns. Note that the indicator should only be acted on after a reversal pattern or triggering reversal event.

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