What is Open Interest?
Open interest and a closely related factor, daily trading volume, can both be important factors to consider when trying to gain insight into market participation by other traders.
While price movements are of course very important, it cannot be the only factor considered.
Simply speaking, open interest is the number of pending contracts detained by market participants at the end of a trading day. It refers to the futures market generally.
Calculating Open Interest
If we know how many buyers or sellers there are with unfulfilled contracts, we know the open interest of the market.
1. The open interest position reported each day shows the increase or decrease in the number of contracts for that day.
2. Every trade completed represents a fulfilled contract and will have an impact on the open interest position for that day. Every new contract initiated will increase the open interest.
3. If one trader passes off their contract to another trader, this will not affect the open interest position.
Why Should You Look at Open Interest?
If you keep track of the open interest position in the market, then you can make some conclusions about activity in the market. This will help when looking at how your investments in the market are likely to change.
If the open interest increases, it means that new money is coming into the market. Whatever the present trend of the market is, it's likely to keep going in the same way. If, for example, open interest and prices both increase then the market is strong. If they move in different directions then the market is weak and the trend of the market might be changing. In that case, you might not want to invest in it.
Declining open interest, on the other hand, indicates that investors are increasing their liquidity. The market is liquidating, and the price trend is likely to change.
When the open interest stabilizes after a long period of increasing prices, then this can be an early warning towards the end of uptrends.