CoinMarketCap Academy dives into open interest, a popular technical analysis tool that helps traders understand the number of open positions on a certain derivative contract.
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What Is Open Interest?
Understanding Open Interest
Open interest represents the number of active positions in a derivative market. Either the number of open options contracts that have not been exercised at strike price or expired, or the futures contracts that are currently being held by traders. It decreases when more contracts are closed, expired or exercised than opened – and increases when more contracts are opened rather than closed, expired, or exercised.
Let’s look at an example. Assume the openinterest of a Bitcoin option is currently 6. After investor Jack buys 10 contracts of that option, the open interest of this specific option is now 16. When another trader closes 3 of these outstanding contracts, while Jack buys another 5, the open interest increases by 2, bringing OI to 18.
As you can see, closing positions decrease OI, while opening positions (whether long or short positions) increases it.
In futures and options trading, traders tend to look at open interest (along with other data points) to determine the strength of a price trend. If open interest increases, it shows new contracts are being entered – which many analysts view as confirmation of the trend. A decrease in OI suggests traders are closing their positions and the trend may come to an end soon.
Changes to Open Interest
A common misconception is that open interest is the total of all the buying and selling transactions – while in fact, open interest Is the total number of active contracts (or open contracts), whether that be a buy or a sell order. OI only changes when new buyers and sellers enter the market.
Example of Open Interest
Where To Find Open Interest Data?
In the equities market, open interest data can be found from sources like CME group, Barchart.com, Investopedia, OCC, Nasdaq and more.
For the crypto markets, some sources to find open interest data are:
- CoinGlass: aggregates open interest data for top coins across major exchanges
- CryptoQuant: provides open interest data for BTC/USD trading pairs on derivative exchanges
- The Block: provides advanced charts and data for open interest, volume, and funding rates for crypto futures
- Binance: provides open interest data for long/short ratio, taker buy/sell volume, and top trader long/short ratio for crypto futures contracts
- Coinalyze: provides open interest statistics for BTC perpetual and future contracts, as well as aggregated open interest charts for individual contracts on different exchanges
It's important to note that different sources may provide different data, so it's a good idea to compare multiple sources.
Open Interest vs Trading Volume
If Jim would have sold his 10 Ethereum contracts to a new trader entering the market, open interest would be unaffected – because the 10 active contracts are transferred from Jim to the new entrant. However, this transaction would still increase trading volume by 10 contracts.
The Importance of Open Interest
As an accurate barometer of market activity, open interest is a great tool to add to your toolbox. If open interest is low, it means there are few market participants, and therefore liquidity is expected to be low. Open interest varies per trading day, or even per trading session, as volatility causes new positions to be opened and closed in rapid succession.
Learn more about what liquidity is in this article!
Is Higher Open Interest Better?
High open interest usually indicates many market participants, ranging from institutions and hedge funds to average retail investors. Higher open interest is therefore considered better, because this high degree of participation suggests higher liquidity – which makes it easier to buy or sell in an options or futures market.
Is Open Interest Bearish or Bullish?
Open Interest is not inherently bullish or bearish – but careful analysis of the metric can help provide insights. Rising open interest usually means the market is increasingly interested in sustaining the trend, which at first thought can be considered a signal that confirms a trend.
However, if open interest grows too high, traders tend to consider it a warning of a potential trend reversal, because it suggests the trade is getting overly crowded.
How To Analyze Open Interest Data for Identifying Trend?
Studying open interest can help you decipher the strength of price movements, or to analyze divergence and ascertain if the market is bearish or bullish. Most traders operate under the following assumptions:
- If price increases and open interest increases too – the bullish move is strong.
- If price decreases and open interest increases – the bearish move is strong.
- If price increases and open interest decreases – the bullish move is weak.
- If price decreases and open interest decreases – the bearish move is weak.
In essence, the best is to combine open interest analysis with other technical indicators, to generate the most accurate conclusions.
What Happens When Open Interest Increases?
An increase in open interest means the total number of contracts increased and new money is entering that specific market, which can help sustain the current trend. Once open interest decreases, it shows that participants are closing their positions, and the price trend is coming to an end.
All in all, analyzing open interest can be a powerful technical analysis tool to add to your trading strategy, especially for options traders and futures traders. Nevertheless, as with all indicators, it is not foolproof, and does print false signals from time to time.
It is important to exercise risk management, and not use open interest on a stand-alone basis. The best traders combine multiple tools, such as price action analysis, chart patterns or moving averages and other market data into a trading system and look for confluence between these tools.
We wish you the best of luck in refining your trading strategies, and we hope this article proves to be useful on that journey.
Writer’s Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form. Please do your own research.