Open interest is the total number of active or open contracts for any given
commodity at the end of each day. It refers to the total number of contracts long
or short in a delivery month that have been entered into and not yet liquidated
by an offsetting trade or fulfilled by delivery. It measures the flow of money
into and out of the market. For each seller of a futures contract there must be a
buyer of that contract and they combine to create only one contract. Therefore,
to determine the total open interest you only need to know the totals from one
side or the other, buyers or sellers, not the sum of both. Open interest can
change in three ways:
1. If one new buyer buys from one new seller, open interest will go up as thereis a new contract being made.
2. If an old buyer sells to an old existing short. There will be one less opencontract and open interest will drop by one.
3. If an old buyer sells to new buyer, it results in no change, as it’s just thepassing of an existing contract to someone new.
By keeping track of the changes in the open interest at the end of each
trading day, you can get some information out of the market. Increasing open
interest means that new money is flowing in and that the present trend will
continue. Declining open interest means that the market is liquidating and implies
that the trend is coming to an end. Watching open interest and combining
it with volume and price direction can be a great method of preparing for the
end of a trend or confirming a move. Using price, volume, and open interest
together you can draw the following conclusions:
Price Volume Open Interest Indication
Rising Rising Rising Market is strong
Rising Falling Falling Market may weaken
Falling Rising Rising Market is weak
Falling Falling Falling Market may strengthen
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