Open Interest vs Volume: Definition & Applications

Open Interest vs Volume: Definition & Applications

When you open a trading account, you can’t simply start buying and selling shares—first, you must do your due diligence and conduct the necessary market analysis. That said, analysing market situations is one of the most challenging jobs, and it is when indices, data, and indicators come into the picture to make the job easier. In this article, we will look at two market indicators: open interest and volume. 

They both are two useful indicators—especially if you plan on becoming an options trader—however, there are several misconceptions or misunderstandings on what they mean and how they work. So in this article,“open interest vs volume” we will learn what these two indicators are and how they differ from each other.

Definition of Open Interest

Open Interest (OI)—an indicator mainly referred to by options traders—is the total number of outstanding option contracts that have yet to be settled at the end of a trading day. It represents the overall amount of contracts held by market participants, including traders as well as investors. To put it another way, it refers to all open contracts that haven't been offset by a trade.

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Table of Content

  1. Definition of Open Interest
  2. Definition of Volume
  3. Open Interest vs Volume in the Indian Stock Market 
  4. Applications of Open Interest and Volume in Trading
  5. Conclusion

Definition of Volume

Volume—in options trading—is the total number of call or put contracts exchanged over a given time period in a particular market or security. It displays the total number of contracts that were purchased and sold over the course of a trading day or another particular time frame. This indicator "volume" that indicates the degree of activity in a specific market, is a gauge of the stock market's liquidity.

Open Interest vs Volume in the Indian Stock Market 

Open Interest & Volume are both indicators of market activity, or liquidity, but they differ fundamentally; so let’s look at the difference between Open Interest and Volume.

Interpretation: Open Interest is used to gauge how much interest there is in a given market or asset, whereas volume is used to gauge how active the market is. This means, low Volume may indicate a lack of interest in the market, while high Volume may point to a flurry of activity. On the other hand, high Open Interest may suggest traders continue to hold onto positions, while low Open Interest, on the other hand, may imply that traders have not hung onto positions, 

Timeframe: Volume is a measure of the market's activity over a specified time period, such as a trading day, week, or month, whereas Open Interest is a cumulative measure that is updated at the conclusion of each trading day.

Open Interest and Volume may exhibit some relationship, however they don't always go in the same direction. 

Applications of Open Interest and Volume in Trading

Now that we have looked at the differences between Open Interest and Volume, let’s look at how these metrics can be utilised in a variety of ways to examine market activity.

Trend Analysis: Open Interest & Volume can be utilised to spot market patterns when doing a trend analysis. For instance, rising open interest could mean that traders are growing more interested in a specific market or security. On the other hand, a decline in open interest may indicate that traders are losing interest. In a similar way, growing volume may signal a potential upswing in the market, while dropping volume may point to a slump.

Liquidity Analysis: Volume is a crucial indicator of market liquidity and can be used to gauge how simple it is to buy and sell a specific instrument. There is a lot of buying and selling activity when there is high volume, and this can result in narrower bid-ask spreads as well as better execution prices.

Support and Resistance Levels: Market support and resistance levels can be determined using open interest and volume. For instance, a large open interest at a certain price level may indicate that there is significant support or resistance there. In a similar manner, if Volume is strong at a certain price level, it can mean that the market is very interested in that level.

Option Trading: In options trading, open interest and volume are particularly crucial since they may be used to determine the level of interest in a specific option. A given option's high open interest suggests that many traders are holding it, which can improve its liquidity and narrow the bid-ask spread. When there is an abundance of trading activity in an option, it is said to have a high volume, and this can reveal information about the mood of the market and probable price fluctuations.

Market Sentiment: You may assess market sentiment and predict price movements using open interest and volume. For instance, if a stock or option has a high Open Interest and a high Volume, it may indicate that the market is optimistic on that particular security. On the flip side, if a security has a low Open Interest and low Volume, it may indicate that the market is bearish on that security.

Conclusion

In conclusion, Open Interest and Volume are two essential metrics for analysing market activity in trading and investing. Volume measures the volume of trading activity, whereas Open Interest measures the level of involvement or interest in a specific market or securities. Despite showing some similarities, they are interpreted differently; however, both indicators can be used to understand market sentiment, forecast price changes, and locate points of support and resistance. Additionally, if you are new to trading and need help understanding it, you may check out the user-friendly blinkX trading app, which provides online support and direction.

The total number of outstanding contracts that have not yet been resolved at the end of a trading day is added to determine open interest. Volume is determined by totaling the number of contracts bought and sold over a given time frame, such as a trading day, week, or month.

Yes, Open Interest and Volume can be used jointly. For instance, strong volume and open interest in a certain security may indicate that the market is bullish on that asset, which can be helpful information for traders considering a long position in the security.

Yes, using Open Interest and Volume as trading indicators has its limitations. For instance, Open Interest and Volume may not accurately capture the genuine emotion of all market participants and may not provide information on the direction of market moves.

Yes, Open Interest and Volume are especially important in the futures market because they can be used to gauge the level of interest and trading activity in a specific futures contract.

No, high Open Interest does not necessarily mean the market is bullish, or even bearish. It simply represents the number of outstanding contracts, and those contracts could be held by both bullish and bearish traders.