Is The Market Going Up Or Down? Find Out By Using Open Interest

• August 10, 2005
• Chris Curran

Stock index
futures opened Tuesday’s FOMC-focused session higher and held their gap through
the first hour.  A higher-than-expected Wholesale Inventories report saw little
negative reaction as it probably led some optimists to believe that higher
inventories could be a bump in the Fed’s rate-hiking road.  Trying to trade the
strangulation range ahead of the announcement did nothing but make your broker
happy.  News that Greenspan and Co. had hiked short-term rates the expected
25-bp and was staying the previous course with respect to their bias was good
for new session highs, before the bulls took some money off the table.

The
September SP 500 futures closed out Tuesday’s session with a gain of +7.00
points, while the Dow futures posted a same relative gain of +74 points. 
Looking at the daily charts, both contracts posted a market structure low but
were stopped at their 20-day MA resistance, leaving a small gap still from last
Friday’s open.  For you daily 3-Line Break followers, the ES remains short
with a Break Price of 1247.75, while the YM remains short with a Break Price of
10717.

         

 

After hours,
CSCO hit analysts’ estimates with its usual batch of smoke and mirror,
“extraordinary” 1-time charges that the company has seemed to take for the past
20 quarters.  The only economic report on the table for Wednesday is the July
Treasury Budget at 2:00 ET, so the focus will likely shift to to the weekly API
and Energy Dept. numbers at 10:30.

What is open interest?

The number of contracts that are in existence at
any given time is referred to as “open interest.”  So, since for every
buyer there is a seller, and vice versa, if I’ve sold short 5 contracts, and
you’ve bought 5 contracts, what is the open interest?  Very simple. 
It’s 5 contracts.  What concerns us, however, is not so much the level of
open interest but the patterns of change.  For that purpose, we can define
the 4 types of participants in the market:

1.  Old bulls who have already bought and
are holding long positions.

2.  Old bears who have already sold, and are
holding short positions.

3.  New bulls who are looking to buy or in
the process of buying now.

4.  New bears who are looking to short or
are in the process of shorting.

In a bullish market, when an increase in open
interest is accompanied by higher prices, it means that new buyers are
continuing to enter the market.  They are still willing to keep paying
higher prices, so continued strength can be expected.  When prices are
still advancing but the open interest begins to go down, it means that new
buying has stopped and that the buying being done is primarily by old bears who
are exiting the market by covering their short positions.  Meanwhile, the
old bulls who held long positions are liquidating and taking profits.  So,
price advancing but open interest declining is a signal that the price trend may
be getting ready to reverse.  After an uptrend has been underway for
awhile, open interest must be viewed in a different light.  If the level of
open interest is extremely high, it indicates that there has been large public
participation and that the market may be vulnerable.  There are probably
few buyers left on the sidelines who have not already bought and so there is
little chance that open interest will continue to increase.  

In a bearish market, if prices are falling and
open interest is increasing, it means that new bears are entering the market to
sell short and should continue to push prices lower.  But when the open
interest stops increasing, or begins to decline, it is a sign that the new bears
are no longer willing to short at these lower prices.  The selling that is
taking places is primarily old bulls who are liquidating their long positions,
and an indication that the downward price movement may be coming to an end.

It is best not to try to interpret changes in
open interest on a day-to-day basis.  It’s much more meaningful to watch
for changes lasting from several days to several weeks.

 

Daily Pivot Points for 8-10-05

Symbol	Pivot	      R1	R2	R3	S1	S2	S3
INDU	10597.47	10657.28	10698.90	10758.71	10555.85	10496.04	10454.42
SPX	1229.64	1235.85	1240.33	1246.54	1225.16	1218.95	1214.47
ES U5	1232.00	1238.50	1242.75	1249.25	1227.75	1221.25	1217.00
SP U5	1233.23	1237.27	1240.23	1244.27	1230.27	1226.23	1223.27
YM U5	10608.00	10669.00	10706.00	10767.00	10571.00	10510.00	10473.00
BKX	98.99	99.31	99.65	99.97	98.65	98.33	97.99
SOX	470.88	475.15	478.78	483.05	467.25	462.98	459.35

 

Weekly Pivot Points for Week of 8-8-05

Symbol	Pivot	      R1	R2	R3	S1	S2	S3
INDU	10603.89	10653.33	10748.63	10798.07	10508.59	10459.15	10363.85
SPX	1232.63	1239.65	1252.87	1259.89	1219.41	1212.39	1199.17
ES M5	1235.17	1243.08	1256.42	1264.33	1221.83	1213.92	1200.58
SP M5	1235.17	1242.83	1256.07	1263.73	1221.93	1214.27	1201.03
YM M5	10614.67	10674.33	10776.67	10836.33	10512.33	10452.67	10350.33
BKX	99.45	100.13	101.38	102.06	98.20	97.52	96.27
SOX	475.21	482.32	493.46	500.57	464.07	456.96	445.82

 

Please feel free to email me with any questions
you might have, and have a great trading week!

Chris Curran

Chris Curran started his trading career at the
age of 22 with a national brokerage firm. He combines fundamentals and
technicals to get the big picture on the market. Chris has been trading for 15
years, starting full time in 1997, and has never had a losing year as a
full-time trader.