What is Open Interest in Technical Analysis?

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Description: Open interest is essentially the total number of outstanding or ‘open’ derivatives contracts that have not been ‘closed’ yet by the market participants for a particular instrument on a given day.

Unlike the equity segment, where the total number of outstanding shares issued by a company remains constant, open interest of futures and options contracts varies on a day to day basis and is dictated by the buyer or seller demand in the market.

For every buyer, there is a seller in the market. Hence, for every buyer of a contract, there is a seller for that particular contract in the market and together they create one open interest. In other words, whenever a ‘fresh new pair’ of buy and sell order enters a particular derivatives instrument, its open interest increases by one. If however, an old contract is sold to a new buyer the open interest remains unchanged.

Let’s understand the concept of open interest with the help of a table:

Days

Buyer

Seller

Notes

Open Interest

1

A

B

Mr.A buys 1 contract from Mr. B

1

2

C

D

Mr.C buys 5 contracts from Mr. D

6

3

D

A

Mr. D buys 1 contract from Mr. A

5

4

E

C

Mr. E buys 5 contracts from Mr. C

5

Day 1: Mr. A buys 1 contract from Mr. B. The open interest for the day is 1.

Day 2: Mr. C buys 5 contracts from Mr. D. As this is a new addition of 5 fresh pairs, the open interest from Day 1 increases by 5 contracts and the resulting open interest for Day 2 becomes 6.

Day 3: Mr. D buys 1 contract from Mr. A. Essentially, Mr. D covers 1 contract out of his 5 short contracts from Day 2 and Mr. A closes out his long position from Day 1. The total open interest drops by 1 contract and becomes 5.

Day 4: Mr. E buys 5 contracts from Mr. C. On this day a new entrant Mr. E comes to the market and purchases the 5 old contracts that were bought by Mr. C on Day 2. Hence, no new addition of ‘fresh new pair’ happens and the open interest remains unchanged at 5.

Open Interest vs. Volume

Although similar in nature, there is a subtle difference between open interest and volume. However, many people get confused while differentiating between the two. Let’s take an example to understand the difference between volume and open interest better.

Suppose, on a particular day, Mr. A (who holds 20 futures contracts) decides to offload his stake to a new buyer Mr. B. As this trade is essentially a transfer of the old contracts to a new buyer, no ‘fresh new pair’ is added and the open interest remains the same. However the trade accounts for an increase in the trading volume for the day by 20 contracts.

Open Interest Interpretations

Open interest gauges the flow of money into or out of a futures or options contract. While increasing open interest alerts us of new money coming into an instrument, decreasing open interest tells us that money is getting out of that instrument.

An increase in price along with an increase in open interest indicates that the upward momentum in price is likely to continue higher. Similarly, a decrease in price along with an increase in open interest indicates that the downward momentum in price is likely to continue further.

On the other hand, an increase or decrease in price coupled with declining or flat open interest indicates that the ongoing trend is likely to reverse direction soon.

The following table summarizes the relationships between price and open interest and their respective interpretations.

Price

Open Interest

Interpretation

Rising

Rising

Strong Uptrend

Rising

Falling

Weak Uptrend

Falling

Rising

Strong Downtrend

Falling

Falling

Weak Downtrend

Open interest is a very important confirming indicator to gauge the strength of a trend and hence is a very popular component in technical analysis.

One can find the open interest of a derivatives contract directly on the NSE website.

To further bolster your knowledge on other important technical indicators and oscillators and learn time-tested and proven advanced trading skills, please attend our Qualified Market Trader stock market course.

Follow Abhijit Paul:
Abhijit prefers to define himself with the 3is – investor-trader, instructor and influencer. He has over 14 years of experience in the Indian Financial markets, and is currently, a SEBI Registered Research Analyst and an active trainer. He offers unparalleled services in both training and advisory.

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