What Is Open Interest In Crypto & How To Use It
Key Takeaways:
- The quantity of live derivatives contracts for a digital currency is known as open interest. Perpetual, futures, swaps, and options contracts are examples of this.
- Understanding open interest allows traders to assess the current market momentum. A rising open market may suggest a continuation of the current market, whilst a decline may indicate the current market phase will end.
- Open interest often does not offer to buy or sell indications. Instead, it offers information on market understanding, trend momentum, and an asset's liquidity.
In the crypto world, experienced traders must employ a variety of well-planned strategies to stay ahead of the curve. While many implement the use of a live-updating price chart, there are several alternatives that can provide just as much insight into the crypto market state. One such strategy is trading with open interest. Open interest is an easy metric to understand and integrate into trading plans of all skill levels and financial situations. This guide will walk investors through what open interest is, how to trade with it, and any pitfalls to look out for.
What Is Open Interest?
When the cryptocurrency markets first opened up, they were primarily used by people who would simply buy, hold, swap, and sell individual coins. Over the past decade, the digital currency industry has evolved substantially, as the gap between the crypto and traditional financial markets continues to slowly close. A major development of the sector has been introducing derivatives contracts for experienced crypto traders.
Every time a derivatives contract is not resolved between the two involved parties, it is considered “open”. In simple terms, open interest is the number of active derivatives contracts for a digital currency. This can include perpetual, futures, and options contracts. Open interest can provide investors with useful data on volatility, volume, trends, and momentum.
Pros of using open Interest in trading:
- Data is relatively simple to interpret at an entry-level, especially when paired with price action and volume
- A powerful crypto trading analysis tool that can provide valuable insights into liquidity, volatility, market sentiment, and particularly momentum
- Is a form of technical analysis that doesn’t rely on crypto charting patterns or technical indicators
Cons of using open interest in trading:
- Open interest data incorporates active derivatives contracts from the past 24 hours – so it is a lagging indicator
- Without context, open interest volume can be misleading – for example, new money flooding the derivatives market may be mostly short positions
- Open interest is most useful for opening a derivatives contract – which is not recommended for those new to trading
- Altcoins can have their open interest data manipulated by “whales” to artificially inflate/deflate the asset’s value
How Does Open Interest Work?
For beginners that want to learn how to trade crypto with open interest, you must first understand what derivatives contracts are as it plays a vital role in how open interest can be used to your advantage.
Derivatives are financial agreements between two (usually) independent parties to make a trade under certain circumstances. This way, investors can speculate on the price of a digital currency without needing to worry about storing it in a secure wallet. There are four main types of derivatives that a crypto trader will encounter:
- Futures contract. Likely the most common form of derivative, a futures contract is an agreement to buy or sell a cryptocurrency at a predetermined price and date at some point in the future. Traders can go long (bullish) or short (bearish) on these contracts. For example, someone might agree to sell 0.5 BTC if it hits $30k before the end of the month. If it doesn’t hit this price before the pre-determined time, the futures contract will expire.
- Perpetual contract. Perpetuals are almost identical to futures contracts with one key difference – there is no expiry date.
- Options contract. Options contracts (also known as “oppies”) allow traders to buy or sell a digital asset at a certain price (called a “strike price”). However, they are under no obligation to execute the transaction at that price, if they decide not to. They can instead let their options expire (or sell them), mitigating potential losses.
- Swaps. Swaps are like any other crypto swap, except instead of being based on a live spot price, the transaction occurs based on a pre-determined rate.
Open interest is the cumulative value of active derivatives contracts for a certain trading pair. The open interest volume is almost always measured in 24-hour intervals, so investors can see how much more/less money is in the derivatives market over the past day. Several cryptocurrency futures and margin platforms such as Bitfinex will provide data on the open interest.
How Open Interest Can Help Crypto Traders
1. Analyze the current market momentum
In very simple terms, rising open interest can suggest a continuation of the current market trend, while declining open interest may suggest the ongoing market phase is coming to an end.
This is because traders that are confident with the current trend will inundate the market with new money – for example, opening short positions in a bearish market. When a larger majority of traders become disenchanted with the trend, they will likely liquidate their positions – leading to a shift in momentum. Therefore, open interest can be a useful depiction of market sentiment similar to other useful indicators like the Bitcoin rainbow chart and the fear and greed index.
There are a few fundamental pieces of data that traders should analyze alongside open interest. These are price action and volume.
| Price | Volume | Open Interest | Market Momentum |
|---|---|---|---|
| Rising | Rising | Rising | Strong |
| Rising | Falling | Falling | Weak |
| Declining | Rising | Rising | Weak |
| Declining | Falling | Falling | Strong |
- Rising price, volume, and open interest: This suggests an influx of new buyers into a bull market. An investor might enter a long position once confirming entry points with other forms of technical analysis.
- Rising price, declining volume, and open interest. Even though the price action is positive, this situation is considered a weak market that may shift to a bearish trend. The rationale is that the crypto is only increasing in value due to short traders covering their positions.
- Declining price, rising volume, and open interest. During a clear bear market, the increase in open interest is most likely to come from new traders entering short positions. Therefore, this suggests the continuation of a strong downward trajectory. Of course, there may be significant news that is causing the changes in market money, making further analysis vital.
- Declining price, volume, and open interest. All three metrics falling can signal a strong bear market continuing on its merry way. However, it can also in fact indicate a trend reversal – with the price decline potentially caused by long liquidations. Investors can keep an eye out for the majority of these positions being liquidated, which will occur when the open interest numbers start to flatten. Once this happens, the liquidation is likely to be completed and the price may begin to trend upward.
Open interest can also tell us when the potential top or bottom of a market will occur. After a trending period of rising open interest, if these figures start to flatten it suggests the market will follow suit and a reversal may be imminent. The greater the drop in open interest data, the more powerful the trend reversal may be.
2. Analyze long & short positions
Certain platforms will support a breakdown of open interest data. This allows traders to pore through specific contracts and their positions. For example, it is much more useful for someone to know that the ETH/USD trading pair is up 5% in long contracts than knowing it is down 10% in overall open interest. Platforms like Coinalyze and Coinglass will represent the difference between short and long derivatives contracts as a ratio.
Solana derivatives contract open interest dataFor example, the above data shows us that the 24-h trading volume for Solana was stable, while the amount of open interest increased significantly. On top of this, the price action was rather positive: +0.94%. We can also see that the ratio of long/short derivatives contracts has improved over the past 24 hours – especially on Binance, the world’s most popular trading platform for crypto. This suggests that Solana’s bullish momentum will carry on in the short term.
If the data is available, investors can go one step further to find the highest and lowest strike prices of a cryptocurrency. This may provide potential support and resistance levels that can help inform a stop-loss/take-profit trading strategy.
Long and short ratios on Binance.Benefits Of Using Open Interest In Crypto Trading
- No charting is required. Charting software and apps for crypto can be confusing and off-putting for newcomers to technical analysis. Open interest numbers are just that – numbers represented in a table. They are easy to interpret and can be a gentle introduction to more complex forms of trading research.
- Simple guidelines to follow. Open interest data is relatively simple to assess at a basic level. Following simple guidelines (like rising open interest volume = strengthening trend and vice versa) can provide valuable insight into the crypto market’s current momentum.
- Particularly useful for options traders. Experienced crypto traders will likely find open interest a vital form of analysis when using an options trading platform. More in-depth open interest data can provide information on popular strike prices for certain crypto assets, giving traders a good indication of potential support and resistance levels.
Downsides Of Using Open Interest In Crypto Trading
- Lack of context. Open interest data in isolation can be extremely misleading and provides minimal insight. It must be paired with information such as price action and trading volume for market sentiment to become a little clearer. Additionally, open interest data needs to be broken down into long/short positions as well as liquidation numbers to make its interpretation more reliable.
- Lagging indicator. Open interest data is based on the previous 24h of derivatives trading – meaning it represents historical information. Therefore it generally needs to be combined with a leading indicator to observe buy/sell signals and predict trend directions. Relying on open interest data can leave investors slow to react to a constantly-moving market, resulting in significant opportunity costs.
- Only measures derivatives markets. Open interest data can provide useful information for traders of all crypto markets – but it is most beneficial for derivatives traders. Unfortunately, derivative contracts are considered riskier than normal trading contracts and are only recommended for those with ample trading experience. Although open interest is easy enough to interpret, it will take an advanced crypto user to get the most out of the data.
How To Trade With Open Interest
1. Pick a cryptocurrency pair to trade
Open interest is usually displayed on a per-security basis, so the first step is to decide on which crypto to trade. Generally speaking, investors will have more luck finding open interest information for bigger market-cap assets, such as Bitcoin (BTC), Ethereum (ETH), and Litecoin (LTC). However, with a little extra effort, open interest data can be found for altcoins like Dogecoin (DOGE), Solana (SOL), and many more.
2. Find open interest data
Open interest data can be acquired from several sources, although the quality of the information may differ slightly. For example, some crypto exchanges may provide open interest data (such as Binance) which will show investors all of the currently-held derivatives contracts for a certain asset. However, this may only cover Binance users – and not provide information from the hundreds of other crypto exchanges.
Independent platforms such as Coinalyze will show open interest data for a suite of coins – including BTC, SOL, and ETH – and from a variety of exchanges. Some websites will require new users to create an account to access the data, whereas others will be available for free.
Solana open interest statistics.3. Interpret open interest data
Just looking at open interest data from the last 24 hours isn’t particularly useful for crypto traders. Instead, investors should be looking at the overnight amount of open interest compared to historic data. With such information, it is fairly easy to identify short-term trends and momentum based on a couple of key principles:
- If open interest is up while prices are rising, this suggests a strong bull market
- If open interest is up while prices are declining, this suggests a potential trend reversal and bear market
- If open interest is down while prices are rising, this suggests a potential trend reversal and bear market
- If open interest is down while prices are declining, this suggests a potential trend reversal and bull market
4. Apply context to open interest data
Price action and open interest are not enough data points for investors to accurately predict momentum shifts, trend reversals, and future market sentiment. Open interest data must be paired with further technical indicators such as MACD, the RSI indicator, or fundamental analysis before it is used as part of a trading strategy. For example, there are instances where open interest data is actually paradoxical. An increase in open interest during a bear market may actually indicate an influx of “short” sellers.
So even though there’s “more money” in the crypto, the new traders hold bearish positions and will continue to drive a declining market. It’s important to try and find individual derivative data to provide context to the open interest information. For example, Coinalyze categorizes 24h open interest into long and short, making it easier for investors to determine where the market sentiment is heading.
Crypto futures market open interest and liquidations data.5. Execute trading strategy using open interest data
Open interest data should form just part of a well-planned trading strategy, no matter whether the information is being used by a seasoned veteran or a total novice. For example, if Bitcoin is experience a significant pump in overnight open interest, while its volume and price are also rising, this all points toward a bullish signal.
Open interest data isn’t very good at finding entry/exit points in crypto, so this signal should be confirmed with further technical analysis (particularly Fibonacci retracements or the Ichimoku Cloud). When confirmed, investors might want to set up a long position on Bitcoin at a price point that suits their overarching strategy. Adding in stop-losses and take-profits – at values determined by further technical analysis – can help significantly mitigate risk.
Frequently Asked Questions
Open interest does not typically provide buy or sell signals without confluence. Rather, it provides insight into market insight, trend momentum, and the liquidity of an asset. Open interest should be combined with other forms of technical analysis to formulate and execute a trading strategy.
Open interest in crypto can be interpreted simply – rising open interest can mean that the current trend is maintaining (or even strengthening). Alternatively, declining open interest may indicate that a price run is slowing and could potentially reverse. Remember that these guidelines are very general and deeper diligence should always be performed.
Conclusion
Open interest can be a very useful tool for crypto traders of all skill levels to add to their Swiss army knives. It is a form of analysis that doesn’t rely on charting, volume, or price action, providing investors with a unique dataset to help paint the current market’s picture.
On its own, open interest is little more than another piece of information for traders to consider. However, with deeper analysis (researching long/short positions and liquidations) and combined with other leading indicators, open interest can help inform a successful crypto trading plan.
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