I have been using price, volume and open interest (P-V-OI) data to analyze commodities ever since I began speculating. However, this type of analysis is not in wide practice anymore. During the past 30 years, a variety of indicators have been developed along with advances in technology, which have supplanted the use of P-V-OI. However, this does not lessen the importance of it. Compared to the past thirty-five years, the use of P-V-OI to analyse markets has never been more powerful than it is now.
I started openinterestanalyst.com (OIA), because professional money managers need a service that provides an all too rare tactical approach to markets. To this end, data analyzed by OIA gives clients insight into the supply and demand dynamics (purchases and sales) of commodity futures contracts. For years, I searched for such a service and never found one.
Each day, OIA provides a report on the interaction of P-V-OI of commodities that are heavily traded, and futures that may be in the process of making a major move. Simply stated, open interest is defined as the outstanding number of contracts that have not been liquidated. A futures contract comes into existence when 1 new buyer and 1 new seller are matched by the exchange to form 1 contract of open interest. For example, if total open interest is 100,000 contracts, this means there are 100,000 short positions and 100,000 long positions that have been matched to create total open interest of 100,000 contracts. Open interest declines when 1 existing long and 1 existing short both close out their positions, thereby decreasing open interest by 1 contract. Open interest does not change when an existing long and an existing short are replaced by a new short and a new long within the same day.
The next day, commodity exchanges publish final stats from the previous day's trading activity. OIA uses only the final report, not preliminary data, which is released the evening following the close of trading. OIA publishes a new report each day which provides an analysis of the previous day's action. The report is driven by data and devoid of hyperbole and prevailing market opinion. Although we make our share of incorrect calls, we are more right, than wrong and prospective clients can verify this by examining our track record. Of course, past performance is no guarantee of future performance.
Below, we are providing a convenient table that explains the relationship between price, volume and open interest.
Price Volume Open interest Market Action
Rising Rising Rising
Rising Declining Declining
Falling Rising Rising
Falling Declining Declining
On a daily basis, subscribers can follow price trends, and see how these interact with increases or decreases in open interest and volume. For example, if price moves higher and open interest increases, longs are in control. On the other hand, if price moves lower and open interest increases, shorts are in control. When open interest declines, whether it is on a price decline or advance, both existing longs and shorts are liquidating their positions.
Remember, open interest increases when both longs and shorts disagree about the direction of price. Open interest declines when both longs and shorts agree it is time to liquidate positions.
Volume is a very important part of our analysis. In essence, volume reveals the number of participants who are willing to trade a particular market, and this defines the power of the move, or lack thereof. Volume is the fuel that drives markets up and down and will occasionally give clues about what is likely to occur next.
Simply stated, open interest reflects commitments made by market participants and volume measures the intensity of money flowing in and out of the market.