Open Interest is the number of open contracts of a given future or option contract. An open contract can be a long or short contract that has not been exercised, closed out, or allowed to expire. Open interest is really more of a data field than an indicator.
A fact that is sometimes overlooked is that a futures contract always involves a buyer and a seller. This means that one unit of open interest always represents two people, a buyer and a seller.
Open interest increases when a buyer and seller create a new contract. This happens when the buyer initiates a long position and the seller initiates a short position. Open interest decreases when the buyer and seller liquidate existing contracts. This happens when the buyer is selling an existing long position and the seller is covering an existing short position.
By itself, open interest only shows the liquidity of a specific contract or market. However, combining volume analysis with open interest sometimes provides subtle clues to the flow of money in and out of the market:
Rising volume and rising open interest confirm the direction of the current trend.
Falling volume and falling open interest signal that an end to the current trend may be imminent.
The following chart shows Copper, open interest (the solid line), and volume (the dotted line).
I drew a trendline ("A") when both open interest and volume were increasing. This confirmed the upward trend of prices as shown by the trendline ("B").
I then drew a vertical line ("C") when open interest and volume began to diverge. From this point, volume continued to increase while open interest decreased sharply. This warned of an end to the rising trend.