Open interest is the number of futures contracts outstanding. It is the total number held by buyers or (“or” not “and”) sold short by sellers on any given day. For example, a long and short position makes up one open interest. Thus, the number of long interest is always equal to the number of short interest. As the number of traders enter or leave the market, the number of open interest moves up or down. The CME Group publishes a volume and open interest report daily.
Monitoring open interest along with volume can add further fuel to your profit engine. Here are six profit rules for analyzing open interest:
1) Uptrend prices, uptrend open interest: bullish. The longs are in charge and getting stronger. Shorts are also being replaced by new sellers.
2) Downtrend prices, uptrend open interest: bearish. The bears are in charge and adding new positions. Weak longs are being replaced by new buyers.
3) Uptrend prices, downtrend open interest: bearish. Smart money which originally mounted the rally are not liquidating and taking profits. New buyers at this point will not be as strong as the old longs. Weak shorts are also jumping ship and will be replaced by new shorts, who are fresh and stronger than the old shorts were.
4) Downtrend prices, downtrend open interest: bullish. The old shorts, smart money, are covering or liquidating and being replaced by new shorts. At this point, the new shorts are not as strong. Lower open interest means the longs are also jumping ship and will be replaced by fresh longs. In other words, “when the pool of losers is depleted, the party is over”.
5) Congested prices range, uptrend open interest: bearish. This assumes that the “hot money”, commercials and professionals, have taken the short side, and the uninformed public will very likely lose out in the end.
6) Congested prices range, downtrend open interest: bullish. This assumes that the “hot money”, more likely to be shorts, are covering. The weak hands are bailing out. Any rally from this congested area will be short-lived if the open interest numbers sharply collapse. Chart actions are generally more reliable when confirmed by volume and open interest. Lower in either signals a fake out.