Understanding Volume & Open Interest

Originally Posted by TATrader

Relationship between the prevailing price trend, volume, and open interest

Each trade completed on the floor of a futures exchange has an impact upon the level of open interest for that day.

For example, if both parties to the trade are initiating a new position ( one new buyer and one new seller), open interest will increase by one contract.

If both traders are closing an existing or old position ( one old buyer and one old seller) open interest will decline by one contract.

The third and final possibility is one old trader passing off his position to a new trader ( one old buyer sells to one new buyer). In this case the open interest will not change.

By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn. Increasing open interest means that new money is flowing into the marketplace.

The result will be that the present trend ( up, down or sideways) will continue. Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. A knowledge of open interest can prove useful toward the end of major market moves. A levelling off of steadily increasing open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market.

The relationship between the prevailing price trend, volume, and open interest can be summarized by the following:

Price Volume Open Interest Interpretation
Rising Rising Rising Market is Strong
Rising Falling Falling Market is Weakening
Falling Rising Rising Market is Weak
Falling Falling Falling Market is Strengthening

It is important to understand that the futures price chart only records the data. In itself, it has little value. By monitoring the price trend, volume and open interest the technician is better able to gauge the buying or selling pressure behind market moves. This information can be used to confirm a price move or warn that a price move is not to be trusted. This will provide you with valuable information to develop a suitable pricing strategy and an appropriate production-marketing plan for your farming operation.