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Trading Importance of Open Interest

Open interest, also known as Open commitments or Open orders, is a popular indicator which can be used for predicting, identifying and confirming trends. The indicator most favors futures and option traders but can also be used in stock trading.

In futures and options trading, open interest is the total number of contracts outstanding at a point of time. That is this is the number of futures/option contracts which are not exercised, expired or settled by delivering underlying instrument. In stock trading, open interest is the total number of buy orders available on market opening.

Markets disclose open interest on daily basis at the end of a trading day. Open interest is represented as a comparison to previous days open interest. Thus open interest can take both positive and negative values. Positive values means that open interest of one day is higher than previous day and negative value means just opposite. Remember, open interest is not equal to trading volume. Volume includes both open and closed position of a day where as open interest includes only open positions. Fore example, if a trade buys and sells a contract in same day, the volume value should be 2 (1 for buy and 1 for sell) but the open-interest should increase by just 1 because the trader who bought and sold the contract is now out of the market and the only open position remain for the trader who bought when the first trader sold.

Open interest itself can be a good indicator of trend changes. Increasing open interest indicates increased flow of money and thus the strengthening of present trend (can be up, down or sidewise). Decreasing open interest indicates reduced money flow and thus weakening of current trend. No noticeable increase/decrease in open-interest after a major price movement indicates that the present trend is consolidating and a possible market reversal or sidewise movement. Sudden increase or decrease in open interest indicates higher market volatility in near-future.

Open interest becomes much more powerful indicator when used along with price and volume indicators. Increasing price and open interest indicate a strong upward moving market. Increase in price but decrease in open interest indicates a weakening of upward moving market. Decreasing price and open interest indicate the consolidation of market movement. Decrease in price but increase in open interest indicates a weak market. If the open interest-to-volume ratio of a call stock option is low but rising then it indicate a future upward movement of underlying stock price. If the situation occurs in a put option then it indicates a downward price movement in future.

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