Volume and open interest reported by the exchanges are significant factors to monitor when trading futures!
What is Volume?
Volume is the number of transactions in a futures or optiion contract made during a specified period of time. One buy and one sell equal two decisions but one trade or transaction and a volume of one. Volume is usually recorded for one trading session (like every day).
What is Open Interest?
Open interest is the total number of futures or options on futures contracts that have not yet been squared off or fulfilled by delivery. Open Interest is an indicator of the depth or liquidity of a futures market.
How is Open Interest Calculated?
If a new buyer (a long) and new seller (a short) enter a trade, open interest increases by one. However, if a trader already holding a long position sells to a new trader wanting to initiate a long position, open interest remains the same. And if a trader holding a long position sells to a trader wanting to get rid of his existing short position, open interest decreases by one.
Always trade liquid contracts that have high open interest and high volumes. Avoid illiquid contracts at all costs.
How to use Volume and Open Interest?
Volume and open Interest are secondary indicators and can be used to confirm other technical indicators in a chart.
If there is a big upside price breakout that is accompanied by heavy volume, then that only makes the upside move a stronger trading signal. Alnernatively, a big upside move or a move to a new high that is accompanied by light volume makes the move suspect.
Big price moves (up or down) accompanied by heavy volume are powerful trading signals. If prices make a new high or new low on lower than average volume, then that is an indication a top or bottom may be near or in place. Also, if volumes increases on price moves against the existing trend, then that trend may be nearing an end.
As a general rule, volume should increase as a trend develops. In an uptrend, volume should be heavier on up days and lighter on down days within the trend. In a downtrend, volume should be heavier on down days and lighter on up days to reinforce the direction of the trend.
Open interest can help the trader gauge if money is flowing into a market or if money is flowing out of a market. This is helpful when looking at a trending market. If both volume and open interest are increasing, then the trend will probably continue in its present direction, either up or down. If volume and open interest are declining, this can be interpreted as a signal that the current trend may be about to end.
High open interest at market tops can cause a steep and quick price downturn, and open interest that is building up during a consolidation, or “basing” period, can strengthen the price breakout when it happens.
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