Rule 1—If prices are in an uptrend, and open interest is rising, this is a bullish sign. The bulls are in charge.
They are adding to positions and making the money, thus becoming more powerful. There are undoubtedly
shorts who are being stopped out, but new sellers are taking their place. As the market continues to rise, the
longs get stronger and the shorts get weaker.
Rule 2—If prices are in a downtrend, and open interest is rising, this is a bearish sign. The bears are in
charge in this case. They are adding to their positions, and they are the ones making the money. Weaker
longs are being stopped out, but new buyers are taking their place. As the market continues to fall, the
shorts get stronger and the longs get weaker. Another way to look at Rules 1 and 2; as long as the open
interest is increasing in a major trend, it will have the necessary financing to draw upon and prosper.
Rule 3—If prices are in an uptrend and open interest is falling, this is a bearish sign. The old longs, the
“smart money” (after all they have been right to this point) are taking profits, they’re liquidating. They are
replaced to some extent by new buyers, who will not be as strong on balance, but the declining open interest
is an indication the weak shorts are also bailing. They will be replaced to an extent by new shorts who are
stronger than the old shorts were.
Rule 4—If prices are in a downtrend and open interest is falling, this is a bullish sign, The mirror image of
Rule 3. The smart money, the shorts, are covering or liquidating. They will be replaced to a degree by new
shorts not as strong as they were, but the declining open interest indicates the weakened longs are throwing
in the towel to a major degree. They will be replaced by fresh longs who were not as weakened by the lower
prices as the old longs were. Another way to look at Rules 3 and 4; when the pool of losers is depleted, the
party will be over.
Rule 5—If prices are in a congestion range, and open interest is rising, this is a bearish sign. The reason is
the public generally plays the long side. Rising open interest in a trading range affair assumes the
commercials and professionals are taking the short side, and the uniformed public will most likely lose out in the end.
