To summarize:

• Open interest refers to the total number of outstanding contracts that have not been settled or closed. It represents the number of contracts that are still open and haven't been squared off.

• Volume, on the other hand, refers to the number of contracts traded during a specific period, such as a day or a week.

While volume measures the trading activity, open interest measures the outstanding positions in the market. Think of open interest as the "unfinished business" in the market, while volume represents the "daily activity".

Let's use an example to understand the difference between open interest and volume. On Monday, Mr. Raju, a futures market speculator, purchased 100 Nifty futures contracts. This increased the open interest to 100, and the volume for the day was also 100. Mr. Yashwant was the seller in this transaction. On Tuesday, Mr. Raju bought another 100 Nifty futures contracts, increasing the total open interest to 200. However, the volume for Tuesday was only 100, representing the number of contracts traded that day. 

Let's break it down:

• Monday:

  • Mr. Raju buys 100 Nifty futures (open interest increases by 100)

  • Volume is 100 (number of contracts traded)

  • Total open interest: 100

• Tuesday:

  • Mr. Raju buys another 100 Nifty futures (open interest increases by another 100)

  • Volume is 100 (number of contracts traded)

  • Total open interest: 200

Notice that the volume on Tuesday is still 100, but the open interest has increased to 200. This shows that the number of outstanding contracts (open interest) has grown, while the daily trading activity (volume) remains the same.

Open interest is cumulative, while volume is daily. Every buy/sell transaction is a pair. When Raju sold 150 Nifty futures on Wednesday, the volume was 150. If he sold to Yashwant, open interest decreased to 300 (squaring off). If he sold to a new buyer Chandru, open interest remained at 450 (no squaring off). The purchase price/profit/loss doesn't affect open interest, which only considers unsettled contracts. 

• Open interest represents the total number of outstanding contracts, while volume represents the number of contracts traded daily.

• Each buy transaction has a corresponding sell transaction, forming a pair.

• When a trader sells contracts, the open interest decreases if the buyer is the same as the original seller (squaring off the position). If the buyer is a new party, the open interest remains unchanged.

• The purchase price, profit, or loss doesn't affect the open interest, as it only considers unsettled contracts.

The example illustrates that:

• Monday: Raju buys 100 Nifty futures (open interest: 100, volume: 100)

• Tuesday: Raju buys another 100 Nifty futures (open interest: 200, volume: 100)

• Wednesday: Raju sells 150 Nifty futures

  • If Yashwant buys them, open interest decreases to 300 (squaring off part of the position)

  • If Chandru buys them, open interest remains at 450 (new buyer, no squaring off)

The uses of open interest

Open interest data alone has limited value, but when correlated with volume and price changes, it offers meaningful information:

• Rising volumes, prices, and open interest indicate a continued upward trend.

• Falling volume and open interest, despite rising prices, suggest a potential trend reversal.

• Increasing volume and open interest, paired with falling prices, indicate a weak market.

• Decreasing prices, volume, and open interest suggest a bottoming market.

• When all three (prices, volume, and open interest) decline, the market has likely bottomed out.

These insights can help traders and investors make more informed decisions by analyzing open interest in conjunction with volume and price changes.