Market Structure Masterclass
A Brief Introduction
to
Open Interest & CVD
By Pat
What is open interest?
Open interest is a term commonly used in the cryptocurrency markets to refer to the total number of outstanding contracts or
positions that have not been closed or settled. Or another way to describe it is that open interest represents the total number of
contracts or positions that are held by market participants in a given market or instrument.
In the context of cryptocurrency derivatives trading, open interest is particularly important because it reflects the total number of
contracts that have been created by traders looking to either buy or sell a particular cryptocurrency at a specific price, and which
have not yet been closed or settled.
This metric can be used as an indicator of market sentiment and can provide valuable insights into the level of participation and
interest in a particular cryptocurrency. Large increase of OI can suggest that there is significant interest in a particular market,
while low levels of open interest can indicate a lack of interest or participation in that market.
When using open interest correctly with any trading methods you already use can assist you in making better decisions towards
that given trade and understand what is actually happening within the price action.
How to interpret it.
OI Increasing :
-Adding Liquidity to the market.
-If OI is rising then we have a clear indication that contracts are being opened. More liquidity moving into the market. Supporting
the trend of current price action.
OI Decreasing:
-Exiting Liquidity in the market.
-If OI is decreasing this is an indication that contracts are being closed and liquidity is leaving the market. Sometimes we can
view this information as a potential squeeze in the market or just participants de-risking positions/closing for profit.
Taken from
https://phemex.com/academy/what-is-open-interest-crypto
Below is a small chart you should keep to hand to help you understand price against open interest and what
it might mean for that current price action:
Why is it useful?
Gauge Market Sentiment - Open interest can provide insights into market sentiment by giving an idea of the number of traders and
investors that have an active position in a particular market. High open interest can indicate a bullish or bearish sentiment depending on
whether the majority of the positions are long or short.
Confirm Price Movements - An increase in open interest along with a price increase or decrease can confirm the strength of the trend in
the market. For example, if Bitcoin's price is rising and there is a consistent increase in open interest, it suggests that the upward trend is
strong and likely to continue.
Monitor Market Liquidity - High open interest can indicate a liquid market with many participants, while low open interest can suggest
that the market is illiquid with few active participants. This information can be useful when considering entering or exiting a position.
Identify Potential Breakouts - A significant increase in open interest can indicate a potential breakout in the market. For example, if open
interest in a particular asset increases significantly, it can suggest that a significant move is about to occur.
Overall, open interest can be a valuable tool for analyzing the crypto markets and can provide insights into market sentiment, liquidity, and
potential price movements as I have already mentioned. It is important to keep in mind that open interest should be used with confluence
of trading methods.
Chart below shows the open interest across multiple exchanges and how it reacts to price action. You can
see back in early bullrun the large increase in OI with price. Strong trend.
https://www.coinglass.com/BitcoinOpenInterest
Chart below shows the OI for BTC/USD contracts for each exchange and the change we have seen in that
given time period.
https://www.coinglass.com/BitcoinOpenInterest
Chart Examples of Open Interest.
Shorts Opening. Decreasing price with rising open interest.
Longs opening potentially attempting the breakout. Later are seen closing out after the breakout failed
In the image below you can see the decreasing price and decreasing volume telling us that longs are closing
out. In the middle we had a small push higher with an decrease in open interest. Shorts closing out.
Remember There are 4 main things OI & Price can tell you:
- OI up + price up = longs opening
- OI up + price down = shorts opening
- OI down + price up = shorts closing
- OI down + price down = longs closing.
With open interest over time it is better to use it hand in hand with some sort of delta data also. Delta, price direction and
open interest are some of the best tools you can use as a collective to tell you what is truly happening with price.
Footprint charts are a good start getting screen time watching price action/delta/open interest to understand market
movements.
If you do not have access to footprint data then you can also use the website known as cOINALYZE, which is what the
previous charts have been posted from. In the next section I am going to give you a small introduction to using
Cumulative volume delta with OI and why they are best to use together.
What is Cumulative volume delta (CVD)?
Cumulative volume delta is a tool used by traders to understand the relationship between price and volume within an asset. It is a way of measuring the net
difference between buying and selling volume in a particular asset over time.
Cumulative volume delta is calculated by taking the difference between the total buying volume (bids) and total selling volume (asks) for each candle on a chart
and adding up those differences over time to create a cumulative total. This can is usually displayed as a line chart, which traders can use to identify what is
actually happening within the candle and evidently come to potential trading opportunities.
The theory behind cumulative volume delta is that when buying volume exceeds selling volume, the price is likely to rise, and vice versa. By tracking the
cumulative volume delta, traders can see whether buying or selling volume is leading the market, and use that information to make trading decisions. This will
bring me to cvd div’s later, an indicator when the market is showing signs of absorption (when price and CVD does not move hand in hand).
For example, if the cumulative volume delta for a particular market is rising, it suggests that buying volume is increasing relative to selling volume, which could
indicate that the price is likely to continue rising. If the cumulative volume delta is falling, it suggests that selling volume is increasing relative to buying volume,
which could indicate that the price is likely to fall. You want to see price go hand in hand with CVD in whatever trend that particular asset is in.
Overall, cumulative volume delta is a useful tool for traders to gain insights into the underlying dynamics of a market, and to identify potential trading
opportunities based on changes in buying and selling volume. OI and CVD go hand in hand when it comes to analyzing an asset. It can help you identify what is
truly happening within that specific candle.
Understanding where delta comes from:
To understand cumulative volume delta it is important to understand where delta comes from first. An easy explanation and to understand.
Delta is the combination of Asks + Bids. (Sellers + Buyers = Delta). It shows you the difference in market orders at each price of the asset. If Delta is positive ( Δ >
0 ) then there are more buyers. If Delta is negative ( Δ < 0) then there are more sellers at that given price. I will visualize this for you shortly. To make it easier to
follow.
Will show you delta within the candle to understand this better. Calculation for delta is (-) Sellers + (+) Buyers = Delta.
On the right I have done a small example how we calculate the
CVD following on from the delta calculation in the last page.
Bids/Asks -> Delta -> CVD.
Should make it more clear how when CVD increases so does
price and vice versa for the downside. Which brings me to the
next part of noticing when price does not go hand in hand with
CVD and how to react to this.
The image below is showing you CVD and price going hand in hand. Decreasing price with decreasing CVD.
Sellers in control. Then rising price and CVD we can see that buyers are back in control.
CVD Divergences:
These are very important when using CVD and price and can be great tools to notice when entering trades. You want to mainly
focus on absorption rather than exhaustion with these. The absorption divs are far stronger than the exhaustion ones.
The absorption bear divergence shows us that buyers are aggressive and attempting to push price higher, but price does the
opposing thing and forms a lower high while cvd makes the higher high. This is buy absorption.
The bullish divergence is seen on the far right. Sellers attempt to push price lower seen with a lower low in CVD while price
makes a higher low. This is signs of selling absorption and the chance there could be a reversal in play.
As always these methods
should be used in confluence
with other trading methods
of your own.
Now let us look at the open interest and price examples from earlier. We can implement CVD into these to
help us get a real understanding of what is going on.
Our first example was shorts opening. We can confirm this with decreasing CVD. Shorts opening =
declining CVD because new sell orders are being are opened thus meaning sellers are in control.
Price - Down
OI - Up
CVD - Down
= Shorts opening
The second example was longs attempting to play a breakout which eventually lost momentum. We can see
CVD rise with price/oi on the way up and decrease with price/oi on the way down. Most likely the late
longers were forced out of their trades which led to the impulsive move down and fast drop in OI.
On the final example we see some what price going hand in hand with CVD. Apart from the little exhaustion
divergence we see. Price made a lower low while CVD made a higher low. Possible signs of exhaustion from
sellers which lead to a bounce and the close out of some open interest (Price bounces, OI dropped, CVD
rises = shorts closing/taking profit).
On the right here you can see that CVD makes a lower low
meanwhile price makes a higher high. This is great signs of
absorption.
I have to remind you this is just an example. Usually you want to
be looking for signs of absorption at some sort of key level or POI.
If you are attempting to trade a reversal in the middle of no-man's
land then chances are the trade will not go in your favour.
Lower time frame divergences are best. M30 and below. You
want to see the div swing points fairly close to each other.
Overtime the further apart the swing point and the longer price
stays away from each other the less effective the divergence will
be.
Recap and some bonus information:
-For a strong trend you want to see price go hand in hand with CVD. But it is not the worst thing if it does
not, usually means you have something to capitalize on, we are traders we look to trade both ways.
-Longs closing = selling pressure. CVD down, OI down.
-Shorts closing = buying pressure. CVD up, OI down.
-Longs opening = buying pressure. CVD up, OI up.
-Shorts opening = selling pressure. CVD down, OI up.
There are multiple different ways cvd, price and oi can move together. These are just the 4 main ones you
should understand first.