Open interest refers to the number of outstanding contracts held by market participants at the end of the day. These are open contracts, yet to be offset by delivery or liquidation. This is distinct from volume, which measures the intensity of a price trend; open interest, rather, measures the flow of money into the futures market. The greater the number of long positions, the greater the open interest. In an entering market, longs buy, shorts sell; in an exiting or liquidating market, by contrast, longs sell and shorts buy, and open interest decreases. This signals traders' exit from the market.
When open interest increases, then new money is flowing into the futures market, perhaps flowing out of the stock market or real estate market. This adds strength to existing trends; after all, if the market isn't doing something right, why would investors with other opportunities be pumping more money into it? Conversely, declining open interest suggests that the market is liquidating and implies that the prevailing price trend is coming to an end.
Volume and open interest tend to move in the same direction, rising and falling together. Price, however, moves independently. The impact on the market for a security is as follows:
- When prices are rising but volume and open interest are declining, the market is expected to decline.
- When prices are falling but volume and open interest are rising, the market is at its weakest.
- When all three elements are rising, the market is strong.
- When all three elements are declining, the market is expected to strengthen as it approaches bottom.
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