Open Interest
You should remember from Module 1 that open interest is another type of trading volume. It is used for futures contracts, and is a count of all the outstanding futures contracts that are out there. It is different to the contract volume traded on any particular day. Open interest is a running total of contracts. As there are two sides to every contract, a long and a short, it just counts contract numbers as a whole.
When futures are traded, the contract may be a new one, which would add to the open interest, or the trades may include traders liquidating their open positions, which would have the effect of reducing the open interest that is outstanding. In fact, one trader might be opening a position, and the trader on the other side is closing his position, so open interest would not change. Just from seeing the number of futures contracts traded on any day, you can’t really say what effect they have on the open interest. All you can know is that open interest cannot increase or decrease by more than the number of contracts traded, even if the transactions were all of one type.
The open interest is usually shown as a line, underneath the price chart and often included with the volume bar chart. Because of the expiring nature of futures contracts, you will normally see the open interest steadily increasing and then declining over time, as the expiration date approaches. Here’s a chart which shows that.
Open interest is taken as an indication of the liquidity of a contract, which means how easy it is to trade. If there are many people involved in trading the futures contract, then it will be simple to open or close a position in it, and you won’t get distorted prices because you don’t happen to find a buyer or seller when you want one.
I have to say that volume and open interest for futures and options contracts are not as straightforward as volume is on shares. The Dow Theory about volume was based on observation of share trading, and the addition of another variable with technical analysis of futures and options changes the obvious relationship of trading volume confirming a trend.
When both volume and open interest are increasing, along with an increasing price, it is a strong confirmation of the trend. Weak volume and open interest tend to confirm a declining price. But if open interest increases greatly in a sideways market, the market is likely to move lower as it is a sign that commercial interests are taking out more short contracts, as pointed out by Larry Williams in his book, How I Made $1 Million Trading Commodities Last Year. I’ll get into more detail about the differences with futures markets later.
Join the discussion