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Using Open Interest To Gauge Market Sentiments In Futures Trading

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Market sentiment is the feeling or the tone of the crowd, also known as market psychology. It is a combination of all views, ideas and opinions and activities of participants in the market.

This is reflected by price movement of the securities. Rising prices will indicate a bullish market sentiment while falling prices will indicate a bearish market sentiment.

Market sentiment is probably one of the most important factors that drives the prices of the futures market yet it is an aspect of trading overlooked by traders.

One of the ways to gauge market sentiments is through open interest.

Open Interest

Open interest is the total number of contracts entered but not yet offset by a transaction or delivery for the day. In other words, these contracts are still outstanding or in open positions. Open interest is reduced when contracts are offset off their positions.

Open interest increases when there is money flowing into the market. It means that speculators are putting their confidence in the current market direction.

With this increase in open interest, it generally supports the current market trend and points to a continuation of the trend unless the sentiment changes due to new information.

On the other hand, open interest decreases when speculators want to pull out from the market. Thus, it implies that the current price trend is lacking in power as there is not enough significant money that has entered the market.

It is an indication that the trend will be coming to an end and a trend reversal may occur.

The graph above shows as open interest rises, the trend continues to be strong, in this case an upward trend.

Therefore as a rule of a thumb, rising open interest indicates a continuation of current price movements regardless it’s an upward and downtrend. Declining open interest gives a signal that trend is weakening and a trend reversal may occur.

When trading futures, you should make use of open interest to gauge market sentiments and to confirm the strength or weakness of current trade in line with your trade.

Learn more about volume and open interest here.

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