Why is Futures Open Interest data important for equity market investors

Now, while with the stocks there is a finite number of equity available and can be accounted for against their physical (now electronic) availability for trading, with derivatives, such accountability gets generated by total number of fresh contracts created. This does not necessarily mean total number of Buyers and Sellers. In this sense it is different from Volume.

Let us understand with the help of an example.

Mr. X Buys a Futures Contract, Mr. Y Sells a Futures contract.
Volume = 1, Total OI = 1
Then, Mr. A Buys a Futures Contract, Mr. B Sells a Futures contract.
Volume = 2, Total OI = 2
Afterwards, Mr. B Buys back the Futures contract and Mr. X Sells his Futures Contract.
Now, Volume = 3 but Total OI = 1
This is because one of the futures contracts got unwound.
That's sumps up the brief on what is OI.

Now, this same example holds the essence of the analytics hidden into OI number as well. Despite of a heavy volume activity only increment in OI will give us a reasonable evidence of incremental trading interest into a particular stock. Similarly lowering OI will signal loss of trading interest into a particular stock.

Now, let us try to incorporate the price into the entire mix. Imagine there is 10 percent increment in stock futures OI and the stock for that day is up by 3 percent. Is it safe to say that the all those Mr. Xs and Mr. Ys who were buying futures were buying it with an intent to acquire it at even higher price? In such a situation the overpowering buyers are pushing the price up. The reason for buying at even higher prices could be the very expectation that the stock has a short-term potential to rise, and one is anxious not to miss that expected momentum.

Similarly, consensus expectation of upcoming weakness can be sensed with meaningful (10 percent+) rise in OI and above normal fall in price of the stock.

To summarize the importance of OI data with a meaningful change in Price and OI following combinations can help us give following respective indications of consensus expectation of forthcoming move.

OI Up + Price Up = Bullish
OI Up + Price Down= Bearish

OI Down + Price Down = Bulls Unwinding (Time to book Profit in Buy Trades)
This data is generally meaningful when there is a preceding rally in the stock.

OI Down + Price Up = Bears Unwinding (Time to book Profit in Sell Trades)
This data is generally meaningful when there is a preceding fall in the stock.

There we have it, Futures OI data and its importance as an indicator of market expectation of momentum.

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