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The “Evaluating Volume And Open Interest In Commodities " article examines and elaborates upon the benefits and advantages volume and open interest indicators offer to investors in the commodities and futures markets and how to identify the signals generated in order to help individuals identify profitable trading signals.
The underlying price of a commodities or futures contract is clearly the most important aspect of technical analysis. Volume and open interest are secondary in nature and are used principally as indicators confirming the price movement signals. Of these two secondary indicators, buying should be considered as more important. Open interest is of the least importance. Volume is the number of contracts traded within a time period under consideration. Open interest is the total number of outstanding contracts at the end of the trading day. Like prices for most goods, open interest can be seasonal in nature, and this should be taken into consideration when contemplating trades. Increases in open interests are only important if that rise is above seasonal norms.
How to analyze volume and open interest
Every astute trader in a commodities and futures markets will take into consideration volume and open interest information. Generally speaking, if prices are rising, volume is up, and open interest is up, then the market can be viewed as strengthening. If prices are rising, the volume is down, and open interest is down, the market can be viewed as weakening. If prices are declining, volume is up, and open interest is up, the market can be viewed also as weakening. When prices are declining, and volume and open interest are declining, the market should be viewed as strengthening.
What volume represents
Volume quantifies the strength of any underlying price move. Higher volume signifies the greater the probability of continued movement in the established direction. An investor, through careful observation of volume in conjunction with price action, has improved his ability to measure the underlying buying or selling forces of the market moves. This information will confirm underlying trends or that a reversal is about to happen. In simple terms, volume should rise in the direction of the underlying trend. When prices are rising, buying should be greater as the price moves increase and should fall on price corrections. When this happens, the price trend has been confirmed by volume activity.
Differentiating volume from open interest
Open interest is very similar to volume with certain clarifications. In a rising price environment, an open interest increase greater than seasonal averages signifies the inflow of funds into the market. This means long positions are rapidly accruing, signaling a strengthening of the upward trend.
If, on the other hand, prices are rising and open interest is falling more than seasonal averages, more likely than not, traders of losing short positions are buying. Capital is flowing out, rather than entering the market. This must be viewed as a bearish event; since the short covering has finished, the upward momentum will evaporate. Rising open interest in a downturn must be considered a weakening signal. This signifies that significant new short selling is occurring in the market. Such action increases the probability that the downward movement in prices will continue. When total open interest is falling more than seasonal averages together with declining prices, this downtrend is ephemeral by nature as it reflects simple liquidation of losing long investors. Here again, the downward movement of prices will be short lived once open interest has declined sufficiently to show that most losing long investors have finished selling.
Despite being of a secondary nature, volume and open interest aids in the confirmation of price patterns and relevant chart developments.
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