Tuesday, February 14, 2012

Open Interest to determine trend

Open interest is an indicator often used by traders to confirm trends and trend reversals for both the futures and options markets. Open interest represents the total number of open contracts on a security. Here we'll take a look at the importance of the relationship between volume and open interest in confirming trends and their impending changes. (Check out an introduction to the concept of open interest in Intro To Open Interest In The Futures Market.)

General Rules for Volume and Open Interest
The chart below summarize the rules for volume and open interest.
Figure 1: General rules for volume and open interest

So, price action increasing in an uptrend and open interest on the rise is interpreted as new money coming into the market (reflecting new buyers); this is considered bullish. Now, if the price action is rising and the open interest is on the decline, short sellers covering their positions are causing the rally. Money is therefore leaving the marketplace; this is a bearish sign.

Figure 2: Bullish and bearish signs according to open interest
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