Why is open interest important for futures trading?

First of all, you need to pay attention to the open interest size trend and the price trend. It is known that if demand for an asset begins to grow, the price begins to grow with it. This happens because buyers begin to dominate sellers and new participants are ready to buy the asset at a higher price, since there is not enough of it for everyone at the current price. This begins to accelerate the price until the number of sellers and buyers balances out or a large seller appears who is ready to sell a large amount of the asset at the current price, thereby satisfying the increased demand. At this point, the price growth stops and the movement in the opposite direction begins.

But the main danger here is the analysis of open interest without taking into account other indicators. Imagine the situation. The market experiences a collapse in the value of some asset (against a negative news background or simply because some large player sells a large volume) and immediately after the sale, the open interest indicator drops sharply. This is the closing of long positions of overly optimistic traders who enter the deal late, believing that the price will continue to grow. After collecting liquidity (closed long positions), you can observe the growth of open interest. And here are two main traps with insufficient analysis: firstly, the «low base» effect occurs (this is when some indicator is at low values and even a small increase relative to the base value shows a good increase in percentage), and secondly, this growth of open interest indicates that traders are starting to open short positions, hoping to earn money on the fall.

Pay attention to the upward trend of the open interest indicator. It can be assumed that market participants are slowly gaining a position on the coin. Perhaps they know something or are simply optimistic in anticipation of some news. This is accompanied by a slight increase in price, but what do we see next? At some point, a large amount of new money starts to enter the asset, which sharply moves the price up. But at this point, traders who have been slowly building up their position already have trades open at a lower price and they just need to wait for the moment when the pressure from buyers begins to weaken in order to sell the asset at the highest possible price. Which is what happens. And as can be seen from the sharp decrease in volumes and open interest, this brings the price down, an avalanche-like closing of long positions of participants who entered the deal too late. The asset’s liquidity is collected, which is taken by these early traders.

It is also important to understand that the open interest indicator is formed on each exchange. In this case, using data aggregators (such as Coinglass or Coinmarketcap) for analysis can play a cruel joke. In addition to the fact that the open interest value is received by aggregators with a delay, aggregators simply summarize the indicators from different exchanges to form a general picture of the market. And a situation may arise when a sharp increase in open positions (and, accordingly, an increase in open interest) begins on some exchange, but this does not affect the value of the asset, since its volumes on this exchange are small and, despite the relative growth, do not affect the price.