Open Interest in Trading: Definition and Explanation
What Open Interest Is and How It Is Used by Traders
Open interest is the number of open contracts (commitments) for a particular market. Open interest is calculated for futures and options markets. Open interest is used as an indication of the strength of the market, and to gauge how actively traded a market is, but it is not the same as volume. Volume is also used as a strong indicator, and to show how actively a market is traded, but there are some important distinctions between it and open interest.
Open interest is typically shown along with the current price (bid, ask and last) and volume when viewing an option or futures quote (see attached chart).
How Open Interest Is Calculated
Open interest is calculated by adding all of the contracts that are associated with opening trades and subtracting all of the contracts that are associated with closing trades. For example, if three traders (trader A, trader B, and trader C) are all trading the ES futures market, their trades might affect the open interest in the following way:
- Trader A enters a long trade by buying one contract
- Open interest increases to 1
- Trader B enters a long trade by buying four contracts
- Open interest increases to 5
- Trader A exits their trade by selling one contract
- Open interest decreases to 4
- Trader C enters a short trade by selling four contracts
- Open interest increases to 8
Open interest becomes more complicated when you consider that each of the traders is buying/selling from someone else is who selling/buying. Sometimes both parties will be opening trades and increasing open interest, other times one party will be closing a trade and the other opening (no effect on open interest) and other times both parties could be closing trades (dropping open interest).
Open interest is not the same as volume. With volume, both entries and exits cause the volume to increase, but with open interest, entries cause open interest to increase, while exits cause open interest to decrease.
How to Interpret Open Interest
Open interest is often used as a confirming (or non-conforming) signal for the current price movement, but on its own, it does not provide any indication of the direction of the price movement. Open is just how many contracts are currently in open positions, but it doesn't tell who is long or short.
Increasing open interest shows that there is the strength behind the current price trend, because the number of contracts in play is increasing, which means activity is increasing and there's excitement about the move. Decreasing open interest shows that there could be a weakening of the current price trend. Traders are closing out their positions more rapidly than new traders are opening them. For example, increasing open interest along with an increasing price indicates that the upward price movement could continue, but decreasing open interest along with an increasing price indicates that the upward price movement may be about to reverse.
Open interest is also used to determine if a market is likely to be trending or range bound (choppy). Increasing open interest shows that the rate of new positions is increasing, which indicates that the market is being actively traded and more likely to trend. Decreasing open interest shows that the rate of new positions is decreasing, which indicates that the market may be entering a period of less active trading and is more likely to be range bound.
Little open interest in an option or futures contract means there isn't an active market for it; volume also provides this information. That said, even if there is a lot of open interest it doesn't necessarily mean a futures or options contract will do a lot of volume on a particular day. Since open interest reflects open positions, those positions can remain open, with little volume, until eventually, those traders want to close their position, which is when volume will typically creep up (or if they or new traders want to accumulate more positions).
Final Word on Trading Open Interest
Open interest is not the same as volume. Volume is how many contracts change hands in a day, where open interest only calculates open positions. Increasing open interest is typically viewed as a confirming signal for the current trend since more traders/positions are getting involved. When open interest starts to decline during a trend, a reversal or choppier price period may be near since traders are closing out positions instead of adding fuel to the fire.