What is open interest in trading and how to interpret it?

Open Interest is a metric used to measure the activity and liquidity of a given market. In conjunction with other indicators, Open Interest helps spot possible shifts in market sentiment. How is it calculated and how is it to be interpreted?

What is open interest?

open interest (or Open Interest in French) is a measure of the total number of open contracts in a given market or security that have not yet been settled or closed.

This metric is commonly used in the futures and options markets to assess the activity and liquidity of a particular contract or market. It is usually calculated daily and can be used to spot trends and changes in market sentiment. This indicator includes long and short positionsor the positions that bet on the increase and the decrease.

Open interest is not necessarily a direct indicator of the direction of price movement. It can be affected by a variety of factors including market conditions, supply and demand dynamics and investor sentiment.

A high level of open interest may indicate an increase in the price volatility of the monitored asset. Coupled with other indicators, Open interest can help a trader identify potential market tops or bottoms.

In conjunction with other indicators, open interest can help a trader identify potential highs or lows in the market. But how should we interpret increases and decreases in open interest?

When open interest increases

An increase in open interest indicates that new contracts are being added to the market. This can be a sign of increased buying or selling activity as traders and investors initiate new positions. An increase in open interest can therefore support the current trend of the price under study, both upwards and downwards.

When open interest decreases

A fall in open interest indicates that existing contracts are being closed or unwound. This may indicate a lack of interest or a shift in sentiment as traders and investors offset or liquidate their positions. Such a situation could lead to a long/short squeeze caused by a sudden price movement.

Interpret open interest based on other metrics

The table below shows an interpretation of market behavior based on price, volume and open interest changes.

open interest asset price volume of the pair mood of the market
Behaved rising rising bullish
Behaved fall rising bearish
Weak rising fall bearish
Weak fall fall bullish

This data alone does not appear to indicate with certainty the mood of the market after the open interest, but can be helpful in determination when accompanied by other indicators.

Example with Bitcoin (BTC)

Suppose a trader is interested in Bitcoin (BTC) and wants to trade it on the futures market. He decides to take a “long” position by buying a bitcoin futures contract. This would lead to an increase in open interest in Bitcoinas a new contract was added to the market.

Now imagine that another trader initiates a “short” position in Bitcoin using a futures contract. This would also lead to an increase in the open interest of a contractas a new contract was added to the market.

At this point, the open interest in the bitcoin futures market is two contracts. Both traders have opened positions, but neither has cleared or settled their futures contract yet.

Now suppose the first trader decides to liquidate his “long” position by selling the futures contract he previously bought. This would result in a reduction in the open interest in a single contract as one of the two existing contracts was closed or settled.

Conversely, if the second trader decides to liquidate his “short” position by repurchasing the previously sold futures contract, this will also result in a reduction in open interest.

In this example, open interest in the bitcoin futures market started at zero, increased by two as both traders opened their positions, and then decreased by two as traders closed their positions. Open interest can be a relevant metric for traders and investors to track market activity and liquidity.

Figure 1: Development of open interest on Bitcoin from March 2020 to December 2022

Conclusion on Open Interest

Relevant metric to track the evolution of a market’s activity, However, open interest needs to be examined alongside other indicatorssuch as price trends, volume and volatility.

Additionally, not all cryptocurrencies have futures markets and hence their prices cannot be studied using this metric.

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Graphic Source – Figure 1: CoinGlass

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