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Open Interest and the Foreign Exchange Market

Foreign Exchange Market Pie Chart

Open interest is a very important way of gauging the market sentiment that you can use to trade.  There are a lot of traders who use market sentiment to trade on the foreign exchange market.  It is important that you know what open interest is and how you can use it to trade on the foreign exchange market.

The Foreign Exchange Market and Open Interest

People who have traded in futures will know what open interest is.  One of the problems with open interest on the forex spot market is that the information can be hard to find.  As the spot market is an over the counter trading system there is no exchange to keep the necessary data.  With this being the case traders will need to look at the open interest data for currency futures which does have easy to access data.

Using the Spot and Futures Market

Many traders may wonder why you should look at the futures data for the spot market.  The market sentiment of futures does influence the spot market much like how the spot market influences the futures trade.  It is possible to get open interest information for the futures market because these are traded through a physical exchange.  The prices of the futures and spot markets do move in tandem.  This is why it is possible to use the futures information for the spot market.

What is Open Interest?

Knowing where you can get the open interest data is important, but only if you know what open interest is.  Open interest is the number of positions that have been opened for a currency pair in total.  These positions will still be open when the data is collected which is why they fall into open interest data.

The Relationship between Open Interest and Prices

The open interest for a currency pair will increase when new money is placed in the market.  This increase in the money on the market will affect the price of the currency pair.  The more money is put into a trend the longer the trend is likely to last.  This means that when the open interest in a pair increases the price of the pair will also increase.

However, open interest does decrease at certain ties.  When traders close their trades this shows a change in the market sentiment and can cause a change in the trends of the currency prices.

Trading with Open Interest

It is important that you understand how trading can be affected by the use of open interest.  When you use open interest to gauge market sentiment you can determine the longevity of a trend.  If there is an increasing amount of open interest then you should open a position on the trend.  However, if you see a decrease in open interest then you should wait for the downturn which is likely to come.  At the first sign o the downturn you can trade on this trend to make a profit.

Of course, you have to be careful when you are doing this because there is no way to accurately predict what the market will do.  If you think a downturn is coming you need to find indicators that show that the trend will not reverse soon.

 

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