Definition
Open interest refers to the total number of outstanding derivative contracts, such as options or futures, that haven’t been settled. It measures the flow of money into the futures market and is used to gauge the market’s activity and potential future trends. Volume, on the other hand, refers to the number of shares or contracts traded in a security or an entire market during a given period and is a measure of the activity and liquidity of financial markets.
Key Takeaways
- Open Interest refers to the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset. On the other hand, Volume is the total number of shares or contracts traded in a security or market on a given day.
- Open Interest increases when a buyer and a seller create a new contract, and decreases when a buyer and a seller square off their positions. Conversely, Volume increases every time a trade is made, irrespective of whether a new contract is created or an old one is squared off.
- Observing both open interest and volume can provide a deeper understanding of trading behavior. An increase in volume along with an increase in open interest suggests that new money is flowing into the marketplace, which can indicate a trend’s strength. Conversely, an increase in volume along with a decrease in open interest suggests that the trend may be nearing its end.
Importance
Open Interest and Volume are crucial finance terms that play significant roles in financial markets, particularly in options and futures trading. Open Interest refers to the total number of outstanding contracts that are held by market participants at the end of the day.
It can provide insight into the liquidity of a particular market and is often used in confirming trends and trend reversals. On the other hand, Volume indicates the number of contracts that have been traded during a specific period and is used as a measure of market activity and liquidity.
Both Open Interest and Volume are significant because they can offer profound insights into market dynamics. When monitored together, they can provide important information about market trends, the strength of price moves, and the activity level in a specific instrument, thus aiding investors in making informed decisions.
Explanation
The purpose of Open Interest in finance is to give investors a glimpse into the liquidity and activity of a certain contract or market. Open Interest refers to the total number of outstanding derivative contracts, like futures and options, that are not closed or delivered on a particular day. It gives a measure of market participation level and also provides insights about the strength behind price moves.
When open interest is increasing, new money is flowing into the market, which might be a marker of strong ongoing trends. On the other hand, declining open interest suggests that the market is liquidating, and the prevailing price trend could be coming to an end. Volume, on the other hand, is a measure of how much of a given financial asset has been traded in a set period, typically a day.
The primary use of volume is to gauge the market’s sentiment about a particular asset. Traders use volume to confirm trends and chart patterns, providing useful clues about the direction of future price movements. Volume can also help identify periods of accumulation (buying) and distribution (selling). For instance, in a rising market, an increase in volume can suggest that the uptrend is gaining strength, while a decrease could indicate that a reversal may be imminent.
These insights can be incredibly valuable for traders and investors when making their investment decisions.
Examples of Open Interest vs Volume
Open Interest and Volume are two key metrics used in the trading world. Here are three real-world examples demonstrating the concept of these terms:
Example 1: Let’s say for Apple Inc., there are 1,000 open interest contracts for a specific Option with a strike price of $130 at the start of the day. Throughout the day, 200 contracts are traded between buyers and sellers. The volume for the day will be 200 contracts, but the open interest might not change if these trades were only between existing buyers and sellers.
Example 2: In the precious metals market, suppose on a particular day, the Gold Futures contract recorded a trading volume of 500 contracts. This indicates that during this day, 500 contracts were bought and sold. But if the open interest for this futures contract increased by 300 from the previous day, it means 300 contracts are being held to the next trading day; hence new capital is introduced into the market.
Example 3: Consider the situation in the stock market where Intel Corporation’s stock options have an open interest of 5,000 contracts for a particular strike price. Throughout the trading day, 2,000 contracts change hands. This means the volume for that day is 2,000 contracts. However, if 1,500 of these contracts were new contracts (created that day) and the rest were existing contracts, then the open interest would increase by 1,500 for the next day. These examples illustrate that volume refers to the number of contracts that are traded during a day, while open interest is the number of outstanding contracts at the end of the trading day.
FAQ: Open Interest vs Volume
What is Open Interest?
Open Interest refers to the total number of outstanding derivative contracts, like options or futures that have not been settled. It includes contracts that are bought, sold, or transferred, but not yet willfully closed.
What is Volume?
Volume refers to the number of shares or contracts traded in a security or the entire market during a given period of time, usually one trading day. It is a measure of the total turnover of shares.
What is the difference between Open Interest and Volume?
Open interest represents the total number of derivatives contracts that are not closed or delivered on a particular day, while volume indicates the number of contracts traded in a day. Therefore, volume can increase or decrease, but open interest can only increase.
How does Open Interest affect the market?
Open interest increase indicates that new money is flowing into the market. The result will be that the present trend (up, down or sideways) will continue. Reduced open interest indicates that the market is liquidating and implies that the prevailing price trend is coming to an end.
How does Volume affect the market?
High volume often implies higher liquidity and better order execution. A high volume surge can signal the start of a new trend, while a low volume could indicate a lack of confidence among traders. It is often used as a barometer of market sentiment or specific stock sentiment.
Related Entrepreneurship Terms
- Derivatives
- Futures Contract
- Options Trading
- Liquidity
- Market Sentiment
Sources for More Information
- Investopedia: It is one of the world’s leading sources of financial content on the web. It has an extensive library of articles and videos on everything related to finance, including topics like Open Interest and Volume.
- Fidelity: Fidelity Investments offers Financial Planning and Advice, Retirement Plans, Wealth Management Services and Trading. They also have a learning center with informative articles on various financial topics.
- NASDAQ: NASDAQ provides and shares information about the financial markets, equities, trends, and more. It provides real-time, comprehensive news, and important financial data.
- Charles Schwab: It is a finance and retirement company that provides a variety of services including education about various financial topics like Open Interest and Volume.
