Every week, the BeInCrypto editors collect questions from members of our Telegram community and answer the most interesting ones in a special material.
Today we’ll figure out what open interest (OI) is and why this indicator is worth keeping an eye on.
What is open interest
Open interest is the total number of open futures or options contracts. It is determined by adding up all open positions, whether long or short, then subtracting closed positions. Changes in OI are closely related to the price of a derivative asset and often act as a leading indicator, allowing one to predict the future direction of the trend.
BTC futures open interest. Source: Coinglass
For example, a simultaneous increase in the price of Bitcoin (BTC) and futures open interest usually indicates a continuation of the uptrend. Conversely, a drop in OI during a correction hints at an emerging downward trend.
How it is formed
If one trader opens a position expecting the price to rise at the expense of another trader who opened a position expecting the price to fall, the trade will create mutual obligations and increase open interest. Obligations under the transaction are secured by guarantees from each party. If the price moves towards the buyer, then the seller's margin will decrease and the buyer's margin will increase, and vice versa.
Here is a list of possible options for how the Open Interest (OI) value may change:
Buyer and seller open positions — OI increases Buyer and seller close their positions — OI decreases Buyer opens positions and seller closes — OI remains unchanged Buyer closes positions and seller opens — OI remains unchanged
Read also: Where to trade Bitcoin futures: top 7 options
What open interest can tell you
Understanding how open interest works can provide traders with valuable information.
A change in the number of open positions can serve as an indicator of a change in trend. Thus, an increase in the number of open orders means an increase in the inflow of funds, indicating a strengthening trend. Their decrease, in turn, indicates a reduction in the inflow of money and a weakening of the current trend.
Market Sentiment Analysis
To understand the current market sentiment, you can use open interest in combination with price and volume indicators. A simultaneous increase in open interest and price indicates an active upward movement of the market. However, if the price rises and open interest declines, this indicates that the market's upward movement is weakening. A decline in both open interest and price indicates a consolidation phase in the market. Conversely, a decrease in price accompanied by an increase in the number of open orders indicates market weakness.
Let's sum it up
The OI reflects the liquidity of the derivatives market, allowing you to better assess its volatility and adjust your trading strategy. However, it is worth understanding that it is not able to accurately predict the direction of the trend or guarantee the profitability of transactions.