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What is open interest in futures and how can it help forex traders?

Just as there are many ways to bell a cat, technical analysis of the forex markets also has different approaches. Some traders prefer to use fundamentals, while some focus purely on the technical analysis of the forex markets. Yet, some use other market information to be fully informed before making a trade.

There are different ways to do this. One among the many is to look at closely related markets. In doing so, traders can get a feel of the general trends in the forex markets. One of the markets that are closely related to the forex markets is the futures markets.

The futures markets are derivative contracts whose value is based on the underlying asset, which is the spot forex markets. Futures traders can be regular retail traders but it can also be large financial institutions and hedge funds.

Thus, trends can be ascertained by looking at various pieces of information. The futures markets tend to converge to the spot prices toward expiry. Thus, drawing upon this information traders in the spot forex market can easily garner additional market information.

This can be used to further validate their bias. Among this type of analysis, open interest is one of the many.

What is open interest?

Open interest in the futures market is simply the total number of outstanding derivative contracts that are not yet settled. Open interest is applicable in a number of derivative instruments, ranging from futures to options and other instruments such as interest rates and so on.

To drill this down to an even simpler version, open interest is the total net sum of open positions in the market. One can think of open interest as the number of open contracts or positions in the spot forex market.

So if you had bought a 1 lot EURUSD position, that would mark as 1 open interest, even though there was a seller who sold the 1 lot position to you at the price you asked for.

The term open interest simply means that positions that are not yet closed. Also, an important thing to note is that open interest equals the total number of contracts that are bought or sold. Thus, when a contract of 1000 units changes hands between a buyer and a seller, it is considered to one an open interest of one. Additionally, if there is another buyer for the same 1000 units, it would be considered as another open interest.

Traders tend to often mix up open interest with trading volume. But these two measure two entirely different things. One of the important aspects to consider is that open interest measures the market activity.

When open interest is close to zero, it means that almost all open positions are closed.

What can open interest tell you?

Open interest, especially from the derivatives markets can be a good way to indicate the strength of a trend. When open interest steadily rises over a period of time, it indicates increased market activity. During bullish trends, the net long open interest tends to rise. Similarly, in bearish markets, open interest on the short side starts to rise steadily.

This is because traders tend to open new positions during a trend while close out these positions towards the end of the trend. Therefore, whether the market is moving up or down, rising open interest will show you how strong the trend is going to be.

Forex traders can get the open interest information from various sources. One of the most commonly used sources for open interest is the weekly CoT or Commitment of Traders report.

This is the report that is released by the US based CFTC (Commodities and Futures Trading Commission). It showcases the weekly open interest change for a number of futures contracts including currency futures.

Using this information, traders can compare their analysis with the open interest, especially for trends and further validate their view. The open interest information can be applied to just about any spot markets. It can be precious metal such as Gold and Silver, commodities such as Crude oil and even forex currency pairs.

Now a days you can also find technical indicators that can show the open interest in the instrument of your choice. But one of the draw backs is that open interest information is available for major currency pairs.

Major currency pairs are those that trade directly against the US dollar such as the EURUSD, GBPUSD, AUDUSD, NZDUSD, USDJPY, etc.

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