Tips on Technicals - Open Interest
| Indicator type: |
Activity indicator |
| Used to: |
Identify the level of potential trading activity for a futures market, futures contract month, option or options series |
| Markets: |
All futures and options |
| Works Best: |
Only available for daily and longer analysis |
| Formula: |
N/A |
| Parameters: |
N/A |
| Theory: |
Open Interest is simply the number of contracts that exist, either short or long. The number of short positions equals the number of long positions by definition. Stocks do not report open interest, and although the number of shares outstanding can theoretically be used as a proxy, it is not analyzed technically. |
| Interpretation: |
When prices are rising, open interest should also be rising. This indicates that more bulls are entering the market and market momentum is strong. If it begins to flatten or fall, a divergence is set up and may indicate that the market is nearing a turning point. When prices are falling, the converse is not exactly true. Open interest can be falling or steady. Typically, market participants are less active in bear markets. If open interest begins to increase, it does not signal an immediate reversal, but usually one is near. Open interest, for those instruments that have it, should be increasing going into the reversal or breakout for confirmation.
Caveat: Futures and options data may spike during contract expirations due to rollovers into the new months.
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In figure 1, September CBT Wheat was falling throughout the first half of 1993 on rising open interest. In June, open interest fell by about 10%. A falling open interest after a trend generally indicates that it is time to close out open positions. By the end of the month, other technical indictors were signaling uncertainty and the market reversed course soon thereafter.
Figure 2 shows the September LIFFE Bund contract 1993 summer rally. As prices rose, the old bulls started to take their profits. If prices are rising and open interest is rising, it is safe to add to existing long positions. Note that open interest began to fall in August while prices continued to rise. New long positions were not indicated and the market (December contract not shown) traded flat in a wide range.
Here are the rules for trading with open interest:
| PRICE |
OPEN INTEREST |
CONDITION |
COMMENT |
| Rising |
Rising |
Bullish |
New bulls buying, old bears covering their shorts |
| Falling |
Rising |
Bearish |
New bears selling, old bulls taking their losses |
| Flat |
Rising |
Bearish |
In non-financial commodities, hedgers (producers of the commodity) are more likely to short the market to lock in delivery prices |
| Flat |
Falling |
Bullish |
Here, hedgers are covering their shorts |
| Rising |
Falling |
Bearish |
No new bulls are coming in to buy from the profit takers |
| Falling |
Falling |
Bullish |
Bulls have given up by selling to the short-covering bears |
| Rising or falling |
Flat |
Uncertain |
No change in open interest means that traders are looking for news on market direction and positions should be closed |
