If you have been an active trader or have considered it then you have probably heard of the term open interest. This popular indicator is extremely popular in the cryptocurrency space as it can be used to predict future price trends and market sentiment.
But you are probably wondering, what is Bitcoin’s open interest and why is it important?
Don’t worry. In this article, I will be answering those questions and much more. So without further ado, let’s jump right in.
Open interest refers to the number of open orders in any given market and time. This calculation sums both long and short positions while also subtracting closed positions.
What is Bitcoin’s open interest?
Bitcoin open interest refers to the total number of outstanding derivative contracts in the market. These contracts include both futures and options that have not been executed.
It is calculated by summing the total long and short positions that are open while also subtracting closed positions. For instance, if there were 10 long positions, 10 short positions, and 5 closed positions the open interest would be 15.
In others words, open positions are added to the total, and closed positions are subtracted. This determines the overall liquidity of open positions and capital flows.
Why is Bitcoin’s open interest important?
Bitcoin’s open interest is important as it acts as a trading indicator. Oftentimes, it can indicate an upcoming market move or overall trend. Ultimately, it acts as a measure of both cash inflows and outflows.
This can be analyzed to determine whether there is a strength or weakness in the market. For instance, typically speaking when the open interest increases and the price is rising it indicates strength in the market.
This is because there is increased interest and trading activity in the underlying assets with new buyers entering. In this case, the inflows outnumber the outflows.
Conversely, if the open interest increases in a bearish trend this shows that participants open sell orders at a faster rate than buy orders are opened. This could also be an indication of negative sentiment.
Overall, an increase in open interest indicates that the current trend will continue as new capital enters. Whereas a declining open interest may indicate the current trend is ending.
For example, if the price is declining with open interest it could indicate that long positions are being liquidated and therefore there are a large number of forced sellers. At this point, the majority of sellers are likely to have exited the market and closed their positions.
As a result, the odds of a trend change decrease dramatically.
Open interests correlation to Bitcoins price
As you can see from the above chart, Bitcoin’s open interest has a positive correlation with price. As price increases so does open interest and vice versa.
Both price and open interest peaked in November of 2021 indicating a change in trend and a transition to a bear market. That being said, since June of 2022 price has decreased however open interest has stayed the same which indicates a weakening of the trend.
All in all, when combined with the price it is a great gauge of market sentiment.
Is higher open interest better?
In most cases, higher open interest is better for traders. This is because there is greater liquidity in the market and therefore the difference between the buy and sell contracts is smaller.
In other words, the market is healthier with less spread. Ultimately, the odds of traders getting filled at good prices decreases.
Is open interest bullish or bearish?
Open interest does not indicate a bullish or bearish trend unless it is combined with other indicators. All in all, it is a sign of the strength of the market and how likely the current trend will continue.
If you want to view this article in a more visual format then please check out my video below:
As you can see, open interest is a fantastic indicator to determine the overall strength and health of the crypto market. In my opinion, this metric is a fantastic addition to anyone’s trading tools.
It can not only provide an edge on the market but also provide indications of an upcoming bull or bears trends. I hope you found this article useful and thanks for reading it.
Want to learn about Bitcoin dominance? Click here to check out my previous article.