Updated Jan 29, 2022

What is open interest?

What is open interest?

The stock market is full of technical terms with deep meanings. It is crucial to understand these terms and their significance to become a successful trader in the stock market. One of these terms is called open interest. It refers to the number of options in future contracts active at the time. It indicates the number of securities that have not been closed at a given time. Market fluctuations significantly affect the open interest, due to which it increases and decreases with time. The formation of new contracts causes the open interest value to increase and vice versa. High open interests indicate there are several buyers and sellers for that security. Contrary, low open interest values imply that buyers and sellers are uninterested in closing positions. People can make liquidity and market activity using open interest.

Overview on open market

People associate the term open interest with future markets because it assists in measuring the flow of the market. Basically it is a total number of sold or bought contracts and not the addition of both. It refers to the futures and options markets.

How to calculate it?

Every completed trade impacts the open interest in the stock market. If both parties open a new position in the market, it adds one contract. On the other hand, if they close an existing position, it substracts a contract on the market. When one old trader transfers his position to a new one, open interest will not decrease or increase.

What is Open interest and volume?

In addition to open interest, volume is another significant concept people use to predict trends in the futures market. Open interest and volume are different concepts but have similar attributes, thus confusing new traders. Open interest is the number of open contracts in the share market. Its value always remains balanced because there is a buyer for every seller.

Volume refers to the number of contracts executed in one day. It increases by one if the contract gets sold and bought. It always stays at zero at the beginning of the day. As the number changes during trading hours, you get a clear picture of the volume. Open interest value is not as straightforward and discreet as volume. Unlike volume value, the open interest value may increase, decrease or remain unchanged throughout the day depending on the traders entering and exiting the market.

What are the advantages of understanding open interest?

Looking at an open interest value helps analyze the activity in the stock market throughout the day. As a thumb rule, an increase in this value indicates new money flowing into the stock market. In such scenarios, the present trend will continue shortly.

A decrease in the open interest value indicates that the market is liquidating. Liquidating of the market means the current price trend will end shortly. In this way, the knowledge of open interest value remains beneficial in predicting market trends.

If the open interest value levels off after the sustained price advance, it means that the bull market is about to end.

How to trade in the stock market with open interest?

You can use open interest value to predict market trends and use them to your benefit.

• If the number of open interests increases with an upward movement in price, it implies the existence of a bull market.
• When the number of open increased interest decreases but the price movement remains upward, it implies the existence of a bear market.
• Open interest and price movement are downward; it implies that the bear is taking charge.
• An increase in open interest and a decline in price action indicate a bearish market.

Can increasing open interest be a warning sign?

An increase in open interest indicates enthusiasm in the market, but it can be a warning sign in some scenarios. Do not enter the market if you see a lot of open positions with a significant price change. Even a small trigger can cause traders to panic during such scenarios, crashing the market.

Conclusion

Understanding concepts like open interest requires theoretical and practical knowledge of the stock market. Several risks are associated with the stock market, especially when the trader in question is a novice. It is crucial to seek expert advice when trading in the stock market.