What is Open Interest and How to Use It?

Open interest can tell you about the flow of money into and out of the market, as well as the level of interest and market sentiment. Open interest can also help in confirming price trends, identifying reversals, and following the footsteps of institutions.

Open interest is one of the important technical indicators in futures trading. Open interest is the total number of outstanding futures contracts or options held by traders at the end of a trading session. You can find out more about open interest in this article!

What is Open Interest?

To understand open interest, you need to know that there are two types of transactions in futures trading, namely opening and closing transactions. An opening transaction is when a trader buys or sells a futures contract for the first time. 

A closing transaction is when a trader buys or sells a futures contract against an existing position.

Open interest only changes when there is an opening or closing transaction. If a trader buys or sells the same futures contract as an existing position, open interest does not change. This is because no new positions are created or deleted. 

Additionally, if a trader buys or sells a futures contract from another trader who already has a position, the open interest does not change, because there is only a transfer of position between traders.

Examples of Open Interest

The following are some examples of how open interest changes:

• If trader A buys 10 futures contracts from trader B who has no position, open interest increases by 10 contracts, because 10 new positions are created.
• If trader A sells 10 futures contracts to trader B who has no position, open interest increases by 10 contracts, because 10 new positions are created.
• If trader A buys 10 futures contracts from trader B who already has 10 futures contracts, the open interest does not change, because there is only a transfer of position between traders A and B.
• If trader A sells 10 futures contracts to trader B who already has 10 futures contracts, the open interest does not change, because there is only a transfer of position between traders A and B.
• If trader A sells 10 futures contracts to trader B who has 5 futures contracts, open interest is reduced by 5 contracts, because there are 5 positions removed.
• If trader A buys 10 futures contracts from trader B who has 5 futures contracts, open interest is reduced by 5 contracts, because there are 5 positions removed.

Open interest can be used to analyze the strength or weakness of price trends. This can be done by looking at the relationship with price movements and trading volume. In general, there are four possible scenarios:

• If price and open interest are increasing, this indicates a strong uptrend, because there is new money coming into the market, and long traders are more aggressive than short traders.
• If price and open interest are decreasing, this indicates a strong downtrend, because there is money leaving the market, and short traders are more aggressive than long traders.
• If the price increases and open interest decreases, this indicates a weak uptrend, as there is liquidation from short traders, and no new interest from long traders.
• If the price decreases and open interest increases, this indicates a weak downtrend, as there is liquidation from long traders, and no new interest from short traders.

Open interest can also be used to identify trend reversals. In general, there are two possible scenarios:

• If the price reaches a new high, but open interest decreases, this indicates a potential reversal of the uptrend, as there is a lack of new interest, and long traders are starting to take profits.
• If the price reaches a new low, but open interest is increasing, this indicates a potential reversal of the downtrend, as there is a new high in interest, and short traders are starting to close out their positions.

So, that was a discussion about open interest that you need to know. Hope it is useful!

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DISCLAIMER: This article is informational in nature and is not an offer or invitation to sell or buy any crypto assets. Trading crypto assets is a high-risk activity. Crypto asset prices are volatile, where prices can change significantly from time to time and Bittime is not responsible for changes in fluctuations in crypto asset exchange rates.