Why Looking at Open Interest is Helpful

Open Interest is the total number of outstanding contracts in derivatives market that are held by market participants and which are not settled at the end of the day. Since for every seller there is buyer, in future market open interest refers to number of contracts which are not squared off.

Open interest is different from total volume traded in derivatives market because total volume refers to total number of contracts that are bought and sold in derivatives market while open interest only refers to contracts that are open, so it is not necessary that with rise in volume there is rise in open interest as well.

Open interest is used by many people in the stock market to conform a trend whether it is an upward trend or downward trend, there are 4 ways in which open interest can be examined

1. When there is rise in price of a stock along with rising open interest, it is considered as a signal that stock is strong and therefore it can be bought

2. When there is rise in price of a stock along with declining open interest, it is considered as a signal that stock is weak and therefore it should be sold.

3. When there is decline in price of a stock along with rising open interest, it is considered as a signal that stock will move further down and should be sold.

4. When there is decline in price of a stock along with declining open interest, it is considered as a signal that stock is about to stop falling and therefore it will rise and hence it should be bought.

From the above one can see that looking at open interest certainly helps in making decision regarding whether to buy or sell a stock. However looking only at open interest is not enough and sometimes other factors like global factors, domestic events and other unforeseen events regarding particular stock can make above analysis of open interest irrelevant.