Understanding Open Interest in Crypto Futures | by LBank Exchange | Jul, 2023

From the LBank blog.

Understanding Open Interest in Crypto Futures

Crypto futures contracts allow traders to speculate on crypto assets’ prices without owning the digital currency. In recent years, this derivative product has witnessed significant growth in popularity. Traders constantly seek valuable information to give them an edge in the market. Among various data points, insights into the actions of other traders are considered particularly valuable.

Open interest, also called open commitments or open orders, is a widely utilized indicator that holds significant value in identifying, and confirming trends. This indicator is particularly advantageous for traders involved in futures and options, as it empowers them to refine their decision-making process and make well-informed choices.

In traditional trading, open interest refers to the total number of buy orders available at the start of the market. In futures and options trading, open interest represents the total number of outstanding contracts at a given time. This includes futures contracts that have not yet been exercised, expired, or settled by delivering underlying assets.

Open interest is determined by summing up all the open positions, irrespective of whether they are long (buy) or short (sell), and then subtracting the closed positions. Changes in open interest are closely related to price data and often act as a leading indicator during the early stages of a trend formation. For example, if you observe an increase in the open interest of Bitcoin futures alongside a slight rally in the price of Bitcoin, it typically suggests that the upward trend might continue. Conversely, a decrease in the open interest of Bitcoin futures during a slight correction in the price of Bitcoin usually indicates an impending downtrend.

It’s important to note that open interest does not equate to trading volume. The volume includes both open and closed positions within a day, while open interest only accounts for open positions. For example, if a trader buys and sells a contract on the same day, the volume value should be 2 (1 for buy and 1 for sell), but the open interest should increase by just 1 because the trader who bought and sold the contract is now out of the market and the only open position remains for the trader who bought when the first trader sold.

Volume and open interest serve as crucial indicators for assessing the liquidity of futures markets, which is essential for executing trades and entering positions efficiently. In futures trading, volume represents the total number of contracts traded or the count of individual trades executed throughout the day. A higher volume indicates a more significant number of contracts changing hands. Typically, volume is graphically depicted on charts using bars or candlesticks.

On the other hand, Open interest refers to the overall count of active contracts maintained by traders at the close of a trading day. Essentially, it represents the total number of contracts that remain open and have not yet been closed or offset within the day.

Analyzing trading volume provides insights into the pressure or intensity behind a price trend. When volume is higher, it suggests a stronger trend and implies that the price trend is likely to continue. Technical analysis enthusiasts often believe that volume leads to price trends, meaning that changes in volume figures tend to precede reversals in price trends. Here are some comparative indicators involving volume and open interest:

  • Price Rising; Volume Up; Open Interest Up; Forecast: Bullish (Market is strong, confirming the trend)
  • Price Rising; Volume Down; Open Interest Down; Forecast: Bearish (Market is weakening, potential trend reversal)
  • Price Falling; Volume Up; Open Interest Up; Forecast: Bearish (Market is weak, confirming the downtrend)
  • Price Falling; Volume Down; Open Interest Down; Forecast: Bullish (Market is strengthening, possible trend reversal)

In crypto futures trading, a deep understanding and careful analysis of open interest data can provide invaluable insights for traders. Here’s why open interest holds great significance in the context of Bitcoin futures trading:

  1. Price Trends: Monitoring open orders can serve as a reliable indicator of trend changes. An increase in open orders signifies a greater flow of money, indicating the strengthening of the current trend, whether it is an upward, downward, or sideways movement. Conversely, a decrease in open orders suggests a reduction in money flow and a weakening of the prevailing trend. If there is no significant increase or decrease in open orders following a major price movement, it suggests that the current trend is consolidating, potentially leading to a market reversal or a sideways movement. A sudden surge or decline in open orders indicates higher market volatility in the near future.
  2. Market Sentiment Analysis: Open interest becomes even more powerful when used in conjunction with price and volume indicators. A simultaneous increase in open interest and price indicates a robust upward market movement. However, if the price rises while open interest decreases, it suggests a weakening of the upward market movement. A decrease in both open interest and price indicates a consolidation phase in the market. Conversely, a decrease in price accompanied by an increase in open orders points to a weak market.
  3. Liquidity Assessment: Since it reflects the liquidity of the futures market, it helps you have a better gauge of the volatility of the market and can adjust your trading strategy accordingly.

Incorporating open interest data into your Crypto futures trading strategy can undoubtedly offer valuable insights into market sentiment and potential trading opportunities. However, it’s important to address a common misconception surrounding open interest, particularly its predictive abilities. While open interest can provide indications of investor interest, it does not possess the capability to accurately forecast price action or guarantee the profitability of positions.

Open interest serves as a metric that reflects the level of investor engagement in a particular futures contract. High open interest indicates significant participation and suggests that market sentiment is more active. Conversely, low open interest implies less active participation. However, it’s crucial to recognize that open interest alone does not validate the correctness of investors’ views or ensure profitable outcomes for their positions.

Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.

This article came directly from the LBank blog, found on https://lbank-exchange.medium.com/understanding-open-interest-in-crypto-futures-beb91d6240de?source=rss-87c24ae35186——2

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