Learn about what Open Interest does as a technical analysis tool and why it only applies to futures and options contracts.
We include an example scenario and chart to teach you how you can interpret Open Interest in action and how the number of contracts is impacted by approaching expiration dates.
What Is Open Interest In Technical Analysis?
Open Interest (OI) is the number of contracts outstanding in the marketplace. It shows the overall activity in a market based on contracts with a future expiry date.
Open Interest only applies to futures and options contracts.
Changes in open interest may confirm price action or act as a warning of a potentially weakening trend.
An Example: Understanding Open Interest
A hypothetical situation is given next to help grasp the concept of Open Interest:
- A new futures contract expiration month is opened for trading. Currently, no one has bought or sold a futures contract.
- A trader (Trader #1) buys a futures contract, but in order for this to happen, someone has to sell that trader in the future. Therefore, for every buyer, there is an equal and opposite seller (Trader #2). When this transaction occurs, the open interest is increased from zero to one. There is now one contract outstanding in the marketplace.
- Trader #3 decides to sell a future and subsequently, another trader (Trader #4) has to buy that futures contract; therefore, open interest is now at two.
- Trader #1 goes to the marketplace and sells his/her futures contract. Trader #3 decides to buy back his/her short future. After the transaction takes place, Trader #1 no longer owns a futures contract. Similarly, Trader #3 no longer owns a futures contract. Effectively, the marketplace has one fewer futures contract outstanding. The open interest went down to one.
Here’s the example chart:
When Does The Open Interest Increase Or Decrease?
Generally, open interest increases over the life of the futures contract (note: futures contracts expire, same with options).
When futures contract months or quarters transition from one month or quarter to the next month or quarter, the future closest to expiration (called the “front month”) decreases in open interest, and the next futures contract (called the “back month”) increases.
This is shown with the chart of the E-mini S&P 500 Futures contract above.
How Does Expiration Impact Open Interest?
The chart above of the E-mini S&P 500 Futures contract shows both the March S&P 500 future and the June S&P 500 future as the futures near March expiration.
Note how the March and June futures contract open interest rises steadily over time; this is normal over the life of a futures contract.
Also note the dramatic decrease in the open interest of the March S&P future as the contract is nearing expiration.
In contrast, note the dramatic increase of the June S&P futures contract as futures traders “rollover” their futures positions to the next futures expiration contract (June).
How To Interpret Open Interest
Open Interest is a helpful tool in analyzing the strength of a price move. There are four main interpretations of Open Interest:
- If price increases and open interest increases, then there is strength behind the price move higher.
- If price decreases and open interest increases, then there is strength behind the price move lower.
- If price increases and open interest decreases, then there is weakness behind the price move higher.
- If price decreases and open interest decreases, then there is weakness behind the price move lower.
Interpretation In Practice: mini Dow Futures
The chart below of the Dow Jones Industrial Average mini-Dow futures contract illustrates two examples of price increases with corresponding increases in open interest:
Notice that after the first sharp run-up, open interest decreased during the price retracement. Seemingly, there was not much strength behind the price decrease.
The second strong bullish green candle occurred with a sharp increase in open interest, interpreted as a strong bullish signal that price increases might occur in the future.
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