What is “Open Interest” in futures? For every single futures contract of open interest there is a buyer who is “long” and a seller who is “short”. There are never more longs than shorts and vice versa. At the end of the day each contract that has not been closed out between the “long” and the “short” equals one digit of “open interest”.
If
open interest is increasing it means that there is an increase of both
buyers and sellers that are building a position or putting one on. This has nothing to do with volume increasing. Volume can decrease on a trading day and open interest can increase. Likewise, volume can increase on a trading day while open interest can decrease for that day. A single digit of “volume” is a transaction between a buyer and a seller but not necessarily between a long and a short. Now how does that make sense?
There are two types of buyers, those who are buying to initiate a “long” position, and those who previously sold “short”, and are now buying to close out a position.
If you are the buyer of a contract and you are going “long”, what affect will that have on open interest?
It
all depends on whether or not the seller who is selling it to you is
liquidating an existing “long” position or if they are initiating a
“short” position?
Next…
If you are looking to buy because you are closing out an existing “short” position, what effect will that have on open interest? Again
it would depend on whether or not the seller who is selling the
contract to you, is closing out an existing “long” position or if they
are initiating a “short” position. The two types of sellers
are those who want to sell and initiate a “short” position, and those
who were previously “long” and are selling to close out their position.
This is why volume or transactions don’t have to be between a “short” and a “long”, just a buyer and a seller.
The topic of open interest and volume along with their implications can be as confusing as it gets in this business. If
you are confused or having difficulty understanding this so far I would
suggest coming back again and re-reading before moving on.
Let’s look again at the scenario where you are buying to initiate a “long” position. If
the seller who sells you the contract was already “long” and closing
out their position, then open interest will stay the same. There is still someone short on the other side of that contract out there. So you have volume for this transaction but open interest does not change.
In
this same scenario, let’s say the seller of that contract to you was
instead actually someone initiating a “short” trade, than the open
interest will increase.
Volume can be down from a previous day and open interest can still increase and vice versa.
In
summary, if the NET buyers of the total contracts traded on a given day
want to initiate “long” positions and so do the NET sellers want to
initiate “short” positions, we will see open interest increase. If
the NET sellers of the total contracts traded are liquidating their
“long” positions and the NET buyers are also closing out their “short”
positions on a given day, then open interest will decrease. If
“longs” are buying or selling to other “longs”, and if the “shorts” are
buying or selling to other “shorts”, open interest will not change.
What
is also important to add to this conversation is that neither the
“longs” nor the “shorts” will make a greater profit in a single day. Money is never made or lost in the open interest as a whole. This is what it means when futures are stated to be a “zero sum” game. If
you make $1,000 in profits trading futures today, you can be sure there
are positions that have an equal $1,000 in losses today somewhere else
as well. Profits and Losses are debited and credited in equal amounts at the end of each day from those who traded or have positions on. In order for you to make $100,000 trading futures, other traders or investors will lose $100,000. One
should know their competition AND know themselves before considering
whether or not they can thrive or even survive in this business.
Lastly, the greater the open interest the greater the speculation and/or hedging and vice versa. I
believe this is extremely important in determining the probabilities
for supply and demand within the profile of the auction market in the
weekly time frame.
Questions for the readers: If open interest is increasing or decreasing is that bullish or bearish? What if volume is decreasing or increasing in either scenario? Are you bullish, bearish or neutral? What if the commercial traders are going NET long or NET short in each scenario? What if price is increasing or decreasing with each one of these different scenarios? Do you know which one of these scenarios gives you the greatest “edge” with your system? Ignore the changes to open interest and you may be wrong on what the changes to price, volume, and the COT report mean.
twitter: @ScottPluschau
Consulting: ScottPluschau@gmail.com
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Consulting: ScottPluschau@gmail.com
Members to Scott's blog are appreciated
Subscription: Trade with Scott's Entry and Exit Signals
