Volume and Open Interest: Metrics That Give Clues on Commodity Price Action

In the world of trading commodities, it is vital to look for as many clues as you can find when choosing what to invest in. Taking a deep look at the markets means you must practice restraint and hard work. That hard work can pay off when you are able to match up the pieces of a complex puzzle.

There are two types of analysis you should do when choosing investments. Technical analysis entails the study of charts, price flow, and patterns. Fundamental analysis relies on the supply and demand picture.

Two of the best tools you can use to learn about the market's flow and sentiment in all commodities that trade on futures are volume and open interest. These two metrics often validate or invalidate price moves. Volume and open interest are vital metrics when it comes to knowing about price flow.

What Is Volume?

Volume is the total number of futures contracts traded in a market. The higher the volume, the more actively traded or more liquid a futures contract or commodity is. Technical analysts use volume as a tool. It's used as a tool because it confirms a price trend. When a market starts moving higher or lower in price, the analyst will waste no time viewing the trading volume during the price move.

Rising volume along with rising prices often confirm strong bull market action. Rising volume along with falling prices will confirm strong bear market action.

Experts also employ volume as a tool to spot trend reversals. When falling volume comes with rising or falling prices, an analyst will most often conclude that a market is running out of steam in one way. It then becomes time to search for a correction point—usually, support or resistance—where the price will reverse from the current trend.

While volume is one vital tool, open interest is one more good metric for traders and investors to keep a close watch on.

What Is Open Interest?

Open interest is the total number of open and not yet closed long and short positions in futures contracts for a commodity. While volume counts every contract that trades, open interest only counts those contracts that still have open market risk. This is a key tool when it comes to finding what investors are thinking and doing at certain times.

Rising open interest shows the strength behind a move. If a market is moving higher or lower and rising open interest comes along with that move, it often verifies the way the move is going and that the price will keep going the same way. Open interest going down can mean that a market is going into a period of less active trading because market participants are not taking new positions and are closing out the ones they have.

Commodity exchanges such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE) publish volume and open interest data daily. In some cases, this is done in real time.

The Commodity Futures Trading Commission (CFTC) publishes data called the Commitment of Traders to report on Fridays each week. This report breaks down open interest according to a few classes of traders. It also outlines whether they are holding long or short positions. The CFTC report lists positions held by producers, merchants, processors, users, swap dealers, those managing money, other reportable positions, and non-reportable positions. This breakdown of open interest can be very helpful when it comes to knowing who is doing what in a certain futures contract.

Using both volume and open interest as part of your complete look at the markets will help you become a better trader or investor. Volume and open interest are two vital pieces when it comes to solving the puzzle of markets and forming a wise and studied opinion on prices going up or down.