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responds to your questions about today's futures markets.
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at http://Message-Boards.Traders.com. Answers will be posted there, and
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Dan O'Neil |
OPEN INTEREST AND WHAT IT SAYS
What is open interest and what can it tell me about a market?
Open interest is the total number of futures or options on futures contracts
that have not yet been offset or fulfilled by delivery. Open interest is
an indicator of the depth or liquidity of a market, which influences the
ability to buy or sell at or near a given price. Because good and timely
fills can be hard to obtain in illiquid markets, many traders see very
low open interest in a market as a reason to steer clear.
As an analysis tool, changes in open interest can be used to help confirm
technical signals, helping traders gauge how much money is flowing into
or out of a given market. This is helpful when looking at a trending market.
If open interest is increasing, then the trend will probably continue in
its present direction, either up or down. And if open interest is declining,
this can be interpreted as a signal that the current trend may be about
to end.
Open interest can have seasonal tendencies in some markets, higher at
some times of the year and lower at others, making the seasonal average
helpful in analyzing these markets. If prices are rising in an uptrend
and total open interest is increasing more than its seasonal average (five-year
average), new money is considered to be flowing into the market, indicating
aggressive new buying -- a bullish sign. However, if prices are rising and
open interest is falling by more than the seasonal average, the rally is
probably losing short positions liquidating (short-covering), and money
is leaving the market -- a bearish sign that often means the rally will
fizzle.
The same holds true in a downtrend. Open interest increasing more than
its seasonal average on the down move is a bearish sign, as new aggressive
sellers are entering the market. But if open interest is declining more
than the seasonal average on the down move, then it's likely that long
positions are liquidating their losing trades (long liquidation), and the
downtrend may be near an end.
Open interest can also be examined in conjunction with the Commodity
Futures Trading Commission's (CFTC) Commitments of Traders (COT) report
to see who's driving those numbers. Which leads us to…
FEAR OF COMMITMENT?
For a smaller trader, is there any point in paying attention to
the Commitments Of Traders report?
This is a good question to pair with our discussion about open interest.
After all, many veteran futures traders believe that open interest is best
used as a secondary technical indicator, mainly helpful in confirming other
technical signals on the charts. In other words, while traders won't base
their decisions solely on the open interest number, they will use it in
conjunction with other technical signals, or to help confirm signals. However,
open interest can be very useful in identifying and confirming market situations
and trading opportunities when examined in conjunction with the weekly
Commitments Of Traders (COT) report.
The COT is a weekly report issued every Friday by the Commodity Futures
Trading Commission (CFTC) providing a breakdown of each Tuesday's open
interest for markets in which 20 or more traders or hedgers hold positions
equal to or above reporting levels established by the CFTC. The COT report
breaks down large trader positions into commercial and noncommercial categories
by open interest. Commercial traders are required to register with the
CFTC by showing a related cash business for which futures are used as a
hedge, while the noncommercial category is composed of large speculators
-- namely commodity funds. The balance of open interest is qualified under
the nonreportable classification that includes both small commercial hedgers
and small speculators.
Many small traders believe that the most important aspect of the COT
report is the change in the net positions of commercial hedgers from the
prior report (number of short contracts subtracted from number of long
contracts). A positive result indicates a net-long position (more longs
than shorts), while a negative result indicates a net-short position (more
shorts than longs).
In general, commercials tend to hold a superior record to other trading
groups in forecasting significant market moves. Why? Large commercials
are generally believed to have the best fundamental supply and demand information
on their markets, and thus position their trades accordingly. Large commercials
also trade large size, which in itself moves markets in their favor.
Originally published in the January 2008 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
Return to January 2008 Contents
