Open interest is a metric used to gauge the activity and liquidity of a particular market. Coupled with other indicators, open interest helps identify possible shifts in market sentiment. How is it calculated and how to interpret it?
What is open interest?
open-interest (or open interest in French) is a measure of the total number of open contracts in a particular market or security that have not yet been settled or closed.
This metric is commonly used in the futures and options markets to assess the activity and liquidity of a particular contract or market. It is usually calculated on a daily basis and can be used to identify trends and changes in market sentiment. This indicator includes long and short positionsrespectively the positions betting on the rise and the fall.
Open interest is not necessarily a direct indicator of the direction of price movement. It can be affected by a variety of factors, including market conditions, supply and demand dynamics, and investor sentiment.
High open interest may indicate an increase in the price volatility of the monitored asset. Coupled with other indicators, open interest can help a trader identify potential market highs or lows.
Coupled with other indicators, open interest can help a trader identify potential highs or lows in the market. But how should we interpret increases and decreases in open interest?
If open interest increases
An increase in open interest indicates that new contracts are being added to the market. This may be a sign of increased buying or selling activity as traders and investors take new positions. An increase in open interest can therefore support the current trend in the price studied, both upwards and downwards.
If open interest decreases
A decrease in open interest indicates that existing contracts are being closed or settled. This may suggest a lack of interest or a change in sentiment as traders and investors offset or liquidate their positions. Such a situation could lead to a long/short squeeze caused by a sudden price movement.
Interpret open interest based on other metrics
The table below shows an interpretation of market behavior based on changes in price, volume and open interest.
|Volume of the pair
These data alone obviously do not indicate with certainty the sentiment of the market according to the open interest, but can help to determine it if they are accompanied by other indicators.
Example with Bitcoin (BTC)
Suppose a trader is interested in Bitcoin (BTC) and wants to trade it in the futures market. He decides to initiate a “long” position by buying a Bitcoin futures contract. This would result in an increase in open interest on Bitcoinas a new contract has been added to the market.
Now consider that another trader initiates a “short” position in Bitcoin with a futures contract. This would also lead to an increase in the open interest of a contractas a new contract has been added to the market.
At this point, the open interest in the Bitcoin futures market is two contracts. Both traders have initiated positions, but neither has yet cleared or settled their futures contract.
Now suppose the first trader decides to liquidate his “long” position by selling the futures contract he bought earlier. This would result in a decrease in open interest to a single contract, as one of the two existing contracts has been closed or settled.
On the other hand, if the second trader decides to liquidate his “short” position by buying back the futures contract he sold previously, this will also result in a decrease in open interest.
In this example, open interest in the Bitcoin futures market started at zero, increased by two as both traders initiated their positions, and then decreased by two as the traders closed their positions. Open interest can be a relevant metric for traders and investors to track market activity and liquidity.
Figure 1: Evolution of open interest on Bitcoin from March 2020 to December 2022
Conclusion on open interest
Relevant metric to follow the evolution of the activity of a market, however, open interest must be studied alongside other indicatorssuch as price trends, volume and volatility.
In addition, not all cryptocurrencies have futures markets and therefore their prices cannot be studied with this metric.
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Chart Source – Figure 1: CoinGlass
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