By: Montana Timpson
Average daily trading volume is a key metric in a litany of professional active trading strategies. As the avid professional investor knows, sizeable interest in a security can indicate waxing or waning investor sentiment, suggest predictive price changes and even trigger news coverage, all of which are likely to affect the price of a security over time.
Understanding the metrics that contribute to calculations of average daily trading volume and general interest in a security is imperative for active traders, which begs the frequent question:
What is the difference between average daily trading volume and open interest?
Defining Average Daily Trading Volume
Trading volume is an indicator of market activity of a security and directly reflects a security’s liquidity in the market. High trading volumes suggest that there is an active interest for the security in the market. Average daily trading volume (ADTV), specifically, is the average number of shares traded within a day in any given security. In full, average daily trading volume is the average of how many shares (stock market) or contracts (futures and options market) change hands in a day.
Defining Open Interest
Open interest, in contrast, is a futures and options term that describes how many contracts are open that have not yet been exercised, expired or closed. Open interest is a data field found on the majority of option quote displays, along with implied volatility, options volume, ask price and bid price.
Open interest increases when new contracts are created and decreases when positions in an existing contract are closed by the buyer and seller. Therefore, it is often used as an indicator of the liquidity and market activity for a security. High or rising open interest indicates that there is a large number of buyers and sellers for that security, which, in turn, implies that trading in that security will be easier and quicker since there is an influx of money flowing in the market.
Understanding the Difference
Average daily trading volume is the raw amount of how many contracts change hands in a day, while open interest measures how many transactions were used to open or close positions, thus tracking the number of contracts which remain open.
Both ADTV and open interest are crucial factors that can influence the decision-making process for active and professional traders, especially those trading contracts. The two metrics make up an important part of any active trader’s toolkit and can help identify opportunities as well as potential entry and exit points in the market — key for any professional investor.
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