The
total number of outstanding or un-liquidated contracts
at the end of the day is open interest. Open interest is
the solid line plotted on the chart under its
corresponding price data for the day, but above the
volume bars. Remember that official volume and open
interest figures are reported a day late in the futures
markets and are, therefore, plotted with a one day lag.
(Only estimated volume figures are available for the
last trading day.) That means that each day the chartist
plots the high, low, and closing price bar for the last
day of trading, but plots the official volume and open
interest figures for the previous day.
Open
interest represents the total number of outstanding
longs or shorts in the market, not the sum of both. Open
interest is the number of contracts. A contract must
have both a buyer and a seller. Therefore, two market
participants-a buyer and a seller combine to create only
one contract. The open interest figure reported each day
is followed by either a positive or negative number
showing the increase or decrease in the number of
contracts for that day. It is those changes in the open
interest levels, either up or down, that give the
chartist clues as to the changing character of market
participation and give open interest its forecasting
value.
How
Changes in Open Interest Occur. In order to grasp the
significance of how changes in the open interest numbers
are interpreted, the reader must first understand how
each trade produces a change in those numbers.
Every
time a trade is completed on the floor of the exchange,
the open interest is affected in one of three ways-it
increases, decreases, or stays unchanged. Let's see how
those changes occur.
Buyer
Seller
Change in Open Interest
1. Buys new long
Sells new short
Increases
2. Buys new long
Sells old long
No change
3. Buys old short
Sells new short
No change
4. Buys old short
Sells old long
Decreases
In
the first case, both the buyer and seller are
initiating a new position and a new contract is
established. In case 2, the buyer is initiating a
new long position, but the seller is merely
liquidating an old long. One is entering and the
other exiting a trade. The result is a standoff and
no change takes place in the number of contracts. In
case 3, the same thing happens except this time it
is the seller who is initiating a new short and the
buyer who is only covering an old short. Because one
of the traders is entering and the other exiting a
trade, again no change is produced. In case 4, both
traders are liquidating an old position and the open
interest decreases accordingly.
To
sum up, if both participants in a trade are
initiating a new position, the open interest will
increase. If both are liquidating an old position,
the open interest will decline. If, however, one is
initiating a new trade while the other is
liquidating an old trade, open interest will remain
unchanged. By looking at the net change in the total
open interest at the end of the day, the chartist is
able to determine whether money is flowing into or
out of the market. This information enables the
analyst to draw some conclusions about the strength
or weakness of the current price trend.
Open Interest in Futures
