Any market study needs time, effort, and patience. As a result, it is critical to invest in a financial market with the appropriate amount of study and instruments at your disposal. Remember that market investments are exposed to a range of dangers and volatility, which is why every tiny indication and indicator can be crucial for traders.
Open interest and trade volume are two of the most often utilised indicators in financial market analysis. They are particularly useful for evaluating the market activity and sentiment in futures and options contract trading.
Both of these features are important technical indicators that traders use to determine price swings, price direction, and market liquidity. However, determining the difference between open and volume can be a bit confusing, especially for rookie traders. Take a look at these crucial elements to better grasp these two notions and what differentiates them.
Meaning of Volume
Volume refers to the number of contracts exchanged in a given period of time for a given security. Every option and future contract transacted between buyers and sellers of that securities is counted.It is reflected in the trading volume of a security if the contracts for that security are actively traded. A security's trading volume will be low if it isn't actively traded. The market exchange keeps track of these numbers. The total daily trade volume is calculated at the end of the day based on the updates throughout the day.
Importance of volume in trading
As a market activity indicator, trading volume is directly linked to the liquidity of the asset. As a result of this, traders should expect better order executions as a result of high trading volumes. If you're going to employ this indicator, you should focus on a security's average daily trading volume. Defined in this way, trade volume can be used to validate the relevance of specific price movements and directions.
Formula for calculating volume in options
The volume of an options contract is calculated by summing all of the opening and closing transactions. For example, if three traders (Trader 1, Trader 2, and Trader 3) are trading a certain contract .
Trader 1 initiates a long trade by purchasing 5 contracts; Trader 2 joins a long trade by buying 10 contracts; Trader 3 enters a short trade by selling 1 contract; and Trader 1 closes their trade by selling their 5 contracts. Because the sum of all open and closed contracts equals 21, the volume for that contract would be 21.
Meaning of Open Interest
It is the number of active or outstanding futures and options contracts for an asset at a specific point in time, which can be described as open interest. Those positions for securities on the market that have not yet been closed for whatever reason. A measure of trading activity for an asset, open interest reflects whether or not capital is flowing into its futures and options markets. Contrary to trade volume, open interest data is updated only once per day.
Importance of Open Interest
When new contracts are created, open interest rises, and when positions in an existing contract are closed by the buyer and seller, open interest falls. As a result, it's employed as a gauge of a security's liquidity and market activity. Open interest that is high or rising implies that a big number of buyers and sellers are interested in that security. Because there is an infusion of money moving in the market, trading in that security will be easier and faster. Low or declining open interest in securities, on the other hand, suggests that market participants are not taking any new positions and are closing out any existing ones.
Formula for calculating open interest in options
A given options contract's open interest is calculated by adding all of the opening and subtracting all of the closing transactions. Consider the identical scenario as before, where three traders are trading the same contract:
Trader 1 - Makes a long transaction by purchasing 5 contracts — Open Interest rises to 5 contracts.
Trader 2 - Enters a long trade by purchasing 10 contracts, bringing the total open interest to 15 contracts.
Trader 3 - Joins a short trade by selling one contract, increasing Open Interest to 16.
Trader 1- Exits their transaction by selling their five contracts.
As the deal comes to a close, open interest drops to 11.
What is the key difference between Trading Volume and Open Interest?
Trading volume and open interest are two terms used to represent the liquidity and activity of options and futures contracts.Open interest shows the number of contracts held by traders and investors in active positions, ready to be traded, whereas volume refers to the number of deals executed each day and is an important indication of strength and interest in a given trade. Furthermore, Volume is a running figure throughout the trading day, whereas open interest is only updated once a day.
When does Open Interest exceed Volume?
Open Interest will almost always be higher than Volume, as you will note. This is because volume refers to the number of times an options contract has been traded in a given day. This means that the volume value is reset to zero at the start of each trading day.
Open Interest, on the other hand, is the total amount of money invested in all open contracts. It doesn't go back to zero. As a result, trading volume will typically be substantially lower than the total number of contracts currently active.
When does Volume exceed Open Interest?
There are times when Volume exceeds Open Interest. When this happens, it signifies that trade on that specific day was unusually high, owing to new interest sparked by some sort of catalyst. When volume exceeds open interest, you can assume that parties are taking positions. Because Open Interest data is reconciled at the end of each day, new open contracts will not appear in the Open Interest value until the next day.
What role does volume and open interest play in determining striking price?
Volume and Open Interest are useful indicators for determining which option strikes to trade. It's possible to interpret big clusters of open interest and volume around certain strike prices as potential trading opportunities.
One of the most important jobs is market analysis, and Open Interest and Volume are essential instruments for this. Open interest is more closely tied to the buying and selling of positions in contracts than volume.
Both technologies are specialised to a certain period and sort of security that they pertain to, yet they have distinct roles to play in the larger picture. Though both signs are significant, the frequency with which they occur differs. Volume trading is updated constantly on the market exchange, and the end of the entire value is recorded. Open interest, on the other hand, is rarely updated.