As the name suggests, Open Interest (OI) is the INTEREST that is OPEN. What is INTEREST? INTEREST is the POSITIONS of TRADERS. And What is OPEN? OPEN means OUTSTANDING. So, OPEN INTEREST means POSITIONS of TRADERS which are OUTSTANDING and not yet squared off. There are only two type of positions that a trader can take in the market. LONG & SHORT. Now, since for every LONG there is a SHORT and for every SHORT there is a LONG, so we don’t count OI as LONG + SHORT but either TOTAL LONGS or TOTAL SHORTS. They both would always be equal. So, as I said OI is a number that tells you how many futures (or Options) contracts are currently outstanding (open) in the market. So, Let us say the seller sells 1 contract to the buyer. The buyer is said to be LONG on the contract and the seller is said to be SHORT on the same contract. The open interest in this case is said to be 1 not 2.
HOW CAN YOU JUDGE BULLISHNESS OR BEARISHNESS WITH OI DATA
1.) If PRICE is rising and OI is rising, it means market is STRONGLY BULLISH.
DESCRIPTION: If PRICE and OI both are rising, it means that every new contract that is being added is dominated by bulls, that’s why PRICE is rising with every new contract addition. Never think that since PRICE is rising, more LONGS are being created than SHORTS. LONGS will always be equal to SHORTS just that LONGS are dominating SHORTS in the transaction, that is why PRICE is rising. See, it’s like a normal share transaction. Number of shares bought is ALWAYS EQUAL to number of shares sold. Then why PRICE rises or falls? It does so because of buying pressure or selling pressure. So, if buyers of a share are dominating the sellers, PRICE will rise and if sellers are dominating the buyers, PRICE will fall. But BUYERS will always be equal to SELLERS. So, OI is rising, means new contracts are being added. But since PRICE is rising with it, it means that LONGS are DOMINATING the transactions. Thus, market/share is STRONGLY BULLISH.
2.) If PRICE is rising but OI is falling, it means market is WEAKLY BULLISH.
DESCRIPTION: If PRICE is rising but OI is falling, it means that the rise in price is due to SHORT COVERING and not bullishness. See why is OI falling? It’s falling because positions are being squared off and number of open contracts in the market are reducing. But since PRICE is rising with it, it means that SHORTS are SQUARING OFF and dominating LONGS in the transaction. See, how would SHORTS square off? They will square off by BUYING. That is why PRICE is rising. So, PRICE is not rising because LONGS are dominating. It is rising because SHORTS are dominating the squaring off process. Thus, it can not be called BULLISH. It is WEAKLY BULLISH. It can be a TRAP for new LONGS.
3.) If PRICE is falling, OI is rising, market is STRONGLY BEARISH.
DESCRIPTION: If price is falling and OI is rising, it means that SHORTS are dominating the LONGS. And since OI is rising, it means that new contracts are being added. But, since price is falling, it means the new contracts which are being added are dominated by SHORTS not LONGS. Hence, it is STRONGLY BEARISH.
4.) If PRICE is falling and OI is falling, market is WEAKLY BEARISH.
DESCRIPTION: If PRICE is falling and OI is falling, it means that the fall in price is due to LONG COVERING or also called LONG UNWINDING. See why is OI falling? It’s falling because positions are being squared off and number of open contracts in the market are reducing. But since PRICE is falling with it, it means that LONGS are SQUARING OFF & dominating SHORTS in the transaction. See, how would LONGS square off? They will square off by SELLING. That is why PRICE is falling. So, PRICE is not falling because SHORTS are dominating and creating new positions. It is falling because LONGS are dominating the squaring off process. Thus, it can not be called BEARISH. It is WEAKLY BEARISH. It can be a TRAP for new SHORTS.
DISTINCTION BETWEEN VOLUME & OI
Just remember, volume is number of contracts traded and OI is number of outstanding contracts which are not squared off. Also remember that volume is measured daily and OI gets accumulated. Now, we’d understand the concept of open interest by creating some transactions:
Assume that a new futures contract is out of transactions for January expiry. All these transaction are happening in a single session.
Transaction 1: Faisal gets LONG 1 future contract which Nishant SHORTED
Open interest: 1
Transaction 2: Abdul gets LONG 1 future contract which SURESH SHORTED
Open Interest: 2
Transaction 3: Manu gets LONG 5 future contracts which Vishal SHORTED
Open Interest: 7
Transaction 4: Gaurav gets LONG 10 future contracts which Nitin Shorted
Open Interest: 17
Transaction 5: Naman gets LONG 1 Future contract while Abdul sells.
Open Interest: 17
Transaction 6: Nishant gets LONG one contract which Naman sells.
1.) Till transaction 4, everything is smooth as new contracts are being created so open interest and volume, both are rising.
2.) In transaction 5, you can see that volume increased but OI stayed the same. Volume increased because a trade of a contract happened. But OI stayed the same because no new contract was opened. Naman got LONG on the same contract which Abdul carried. Abdul squared his LONGS off by selling and Naman bought it by going LONG. So the LONG position holder just got replaced in the contract but no new contract was made so OI remains same.
3.) In transaction 6, you can see that volume increased but OI decreased. You must have understood the reason as to why Volume got increased. But the reason that OI decreased is that Nishant who was an existing SHORT, squared off the contract by getting LONG while on the sell side is Naman who is an existed LONG and squared off by going SHORT. So, one old LONG and one old SHORT closed their positions. Thus, one contract got closed and OI reduced by 1.
4.) Bottomline is that each trade completed on the exchange has an impact upon the level of open interest for that day.
5.) If both parties to the trade are initiating a new position ( one new buyer and one new seller), open interest will increase by one contract.
6.) If both traders are closing an existing or old position ( one old buyer and one old seller) open interest will decline by one contract.
7.) The third and final possibility is one old trader passing off his position to a new trader ( one old buyer sells to one new buyer or vice versa). In this case the open interest will not change.
I HOPE THE CONCEPT OF Open Interest IS CLEAR ONCE AND FOR ALL