Open Interest in Commodities

1. The trading volume during the course of a year in actively traded commodities is sometimes as much as 10 to 20 times the size of the crop. This readily provides a continuous and liquid market.
2. The open interest is the number of purchase or sales commitments which traders have entered into and which remain outstanding. It is the number of unliquidated contracts and not the joint total of sales and purchases. It represents both the number of long positions still in the market and the number of shorts.
3. Open interest only increases when new purchases are offset by new sales. If a new purchase is offset by the sale of a previously purchased contract, then there would be no change in the open interest. Decreases in open interest occur when previous purchases are sold and are offset by the buying in of previously sold contracts.
4. By watching changes in the open interest in conjunction with price changes, a clue can be obtained as to whether or not the market has been strengthened or weakened by recent trading.
5. It is best not to try to interpret day-to-day changes in open interest unless the changes for a particular day are exceptional. The price change on the exact day or days of significant changes in open interest may not be as important as subsequent price action immediately following the shifting of positions. It is best to watch changes for periods of time ranging from a few days to a month and especially while important price chart formations are taking shape.
6. It is important to know just who the buyers and sellers are. If the buyers are largely speculators and the sellers are largely hedgers and board of trade members, then a big bull movement coupled with a large open interest produces an almost certain large bear movement before the end of the crop year. After all, the open interest in a particular contract time. If it were built up by a large bull movement, its liquidation will force a large bear movement much to the consternation of the convinced bulls. The bear potential is there, even if an actual shortage develops, because, in order for the bulls to take their profits, they must sell. From a practical standpoint, it is almost impossible for an actual shortage to occur. The reason is that, when a real shortage seems imminent, prices will rise high enough to price the commodity out of the market. The more convincing the bull argument is, the more profitable the bear side becomes, because there is a larger number of people to take profits and/or become disillusioned. They are always incredulous at the decline in prices in the face of obvious shortages.
7. It is important to watch the individual open interest of the nearest contract as it approaches first notice day, if this open interest is especially high, since all these contracts must soon be liquidated.
8. When the open interest gets too high in any commodity, it becomes vulnerable to drastic price reversal, such as happens when something occurs to fundamentally change prevailing public opinion. Many traders do not realize that futures contracts are not made between a bull and bear speculator, but are made between the public and the board of trade. If you are long, the Board of Trade member is short. Normally the public, the professionals, the hedgers, the farmers, the exporters, and other trade interests more or less balance on another. However, any imbalance is absorbed by the members of the Board of Trade at a price concession, of course.

Seasonal Patterns

1. The open interest in a commodity tends to increase and decrease in a more or less fixed seasonal pattern. These patterns do not vary much over the years, so that changes can be anticipated fairly closely.
2. The seasonal changes are very substantial for open interest and any observed changes in open interest must be compared with the expected seasonal change. Volume changes also follow seasonal patterns, although they are not as wide and as significant as the open interest changes.
3. The seasonal changes in the open interest result from the changes in hedging requirements. Thus, the seasonal change in the open interest follows the same general pattern as seasonal changes in the visible supply of a commodity i.e., as seasonal changes in the amount of a commodity that is in commercial storage. The volume of hedges in a market increases as a commodity is put into storage in excess of current requirements and the volume of hedges decreases as the commodity is taken out of storage to meet requirements. These changes in the open interest which are purely seasonal in nature are relatively unimportant in the sense that they can help one to detect technical market strength or weakness. The changes in the open interest that are most important in helping one to make deductions are those that are net changes after allowing for the seasonal trend.
4. Total open interest in a particular commodity can vary appreciably from one season to the next, but the percentage changes during the season keep close to expected patterns.
5. When comparing changes in open interest to the seasonal trend always compare the percentage changes.

Rising Prices

1. When the open interest is increasing, it means that new positions are being established. When the increase in open interest is greater than seasonal and is accompanied by higher prices, it means that the buyers are more aggressive. They are still willing to keep paying higher prices and hence, continued strength is still to be expected.
2. 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 only short covering. The declining open interest also means that the traders who are long as liquidating and taking profits. They too, lack confidence in the markets ability to keep advancing. Therefore, prices advancing but open interest declining, is a signal that the price trend may be getting ready to reverse.
3. After an uptrend has been underway for some time, if the open interest tends to expand rather rapidly, it is indicative of increased public participation. The larger the open interest, the more vulnerable the price structure becomes. The public is generally associated with the long side of the market. Should a rumor or adverse piece of news materialize, the public might decide to liquidate. A cumulative effect results, and prices begin to tumble.
4. After a broad price advance accompanied by a larger than normal increase in the open interest and by abnormally heavy trading volume at the top of the advance, the market usually is in a weak technical position.

Declining Prices

1. Sometimes open interest builds up in an bear market. If this occurs at the harvest time, it is due to hedging pressure, if at other times, it is due to speculative shorts. In any event, a bullish potential is built up. The large open interest must be liquidated before the end of the contract by the bears covering their shorts, thus producing a good-sized bull movement.
2. If declining prices are being accompanied by an increase in the open interest, it means that the new sellers are being more aggressive than new buyers. New traders are willing to keep selling, even though prices have already declined. Somewhere along the line, however, those who have long positions will realize they are wrong and begin liquidating their old positions, thus tending to reduce the open interest. Thus, the interpretation is that the market is technically weak.
3. When the open interest actually begins nto decline when prices are declining, it is a signal that :
   • New sellers are no longer wiling to enter the market at these lower prices.
   • The selling which is taking place is primarily long liquidation, either voluntary or due to margin calls. Once the bulk of it is completed, there will be little new selling power in the market to meet new buying, and prices will recover.
   • The decline in open interest also means that those who had previously established short positions are now taking profits. They also believe the market will not go down much farther. In other words, a price downturn accompanied by declining open interest is an indication that the downward price movement may be coming to an end. This indicates a stronger market.