Volume and Open Interest
Most technicians in the financial markets use a multidimensional approach to market analysis by tracking the movement of three sets of figures- price, volume and open interest. Apart from price volume and open interest, there are also other important indicators. Open interest is used in derivative markets while volume is used in all markets as an indicator.
Volume : Volume is the number of entities traded during the time period under study.
Open interest : The total number of outstanding or unliquidated contracts at the end of the day is known as open interest. It represents the total number of outstanding longs or shorts in the market not the sum of both. (1) ^ Every time a trade is completed on the floor the open interest is affected in any of the following three ways -
| Sr.No. | Buyer | Seller | Change in open interest |
|---|---|---|---|
| 1 | Buys new long | Sells new short | Increases |
| 2 | Buys new long | Sells old long | No change |
| 3 | Buys old short | Sells new short | No change |
| 4 | Buys old short | Sells old long | No change |
So to sum it up, if both participants in a trade are initiating a new position the open interest will increase. If both liquidating an old position, the open interest will decrease otherwise no change.
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General rules for interpreting Volume and Open interest :
The rules for the interpretation of volume and open interest are generally combined because they are very similar. The table below will help in the interpretation -
| Price | Volume | Open Interest | Market |
|---|---|---|---|
| Rising | Up | Up | Strong |
| Rising | Down | Down | Weak |
| Declining | Up | Up | Weak |
| Declining | Down | Down | Strong |
If both volume and open interest are increasing, then the current price will probably continue in the present direction, and if volume and open interest are declining the action can be viewed as a warning that the current price trend may be nearing its end. The figure below will demonstrate the above fact that as the volume and open interest increases the price will continue its trend.
Interpretation of volume for all markets
The level of volume measures the intensity or urgency behind the price move. Heavier volume reflects a higher degree of intensity or pressure. By measuring the level of volume the technician is better able to gauge the buying or selling pressure. Volume should increase in the direction of price trend to make it a continuous pattern. If there is a divergence between price and volume, then the intensity is getting reduced and this can be a sign of reversal. This is the reason why volume is used as a confirmation indicator to price patterns. By the mere fact that prices are trending higher, it means buying is more than selling, and it stands to reason that greater volume should take place in the same direction as a prevailing trend. Thus volume precedes price.
Interpretation of open interest
There are four important points to remember while analyzing open interest :- • Rising open interest in an uptrend is bullish • Declining open interest in an uptrend is bearish • Rising open interest in a down trend is bearish • Declining open interest in a downtrend is bullish This can be seen in the chart below. The price rise is accompanied by falling open interest, while the price decline shows rising open interest. A strong trend would see open interest trending with price, not against it.
Conclusion :
Volume and open interest are important indicators for the markets, volume in all markets and open interest in the futures and options market. They can be used in conjunction with other price patterns to confirm the trend. Volume especially is an important indicator that helps to identify the intensity and strength in the market.
