Chart Analysis · Lesson 10 · Advanced
Open Interest and Funding Rate as Crypto Sentiment
You interpret the four open interest rules and read the funding rate as a sentiment indicator for perpetuals.
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The four OI rules
Open interest is the number of open contracts. Murphy's four rules: price up plus OI up equals new money (bullish). Price up plus OI down equals short covering (bearish). Price down plus OI up equals new shorts (bearish). Price down plus OI down equals longs liquidating (bullish).
The four OI combinations
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Funding as sentiment
High positive funding (early 2021 above 100 percent p.a.) signals mania and proximity to a top. Strongly negative funding (summer 2021) signals panic and a bottom. Extremes are a contrarian signal.
Test yourself
The price falls and the open interest rises at the same time. What is behind this?
- New short selling, bearish
- Longs liquidating, the downtrend is about to end
The funding rate is extremely positive, longs are paying a lot. How do you read that?
- Overheated long sentiment, near a top, careful
- A strong trend, a clear buy signal
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The key points at a glance
- Price up plus OI up equals new money, bullish. Price down plus OI up equals new shorts, bearish.
- Very high OI at tops is dangerous, a liquidation cascade feeds itself.
- Extreme funding is a contrarian signal, when everyone thinks alike they are usually all wrong.
Deep dive
How does the funding rate work?
A perpetual has no expiry date and is anchored to the spot price via the funding rate. When the perpetual trades above spot, funding turns positive and makes holding a long more expensive until the gap shrinks.
- Usually every 8 hours, and when positive longs pay shorts
- In early 2021 rates rose past 100 percent annualized at times: mania
- Strongly negative funding like summer 2021 signals panic and proximity to a bottom
- Extremes are a contrarian signal, and with leverage funding eats your return
Open interest in a range amplifies the breakout
Open interest is the number of open contracts, counting only one side. When OI builds up during a sideways phase, the later breakout charges up: the wrong-footed side has to close and pushes the move along.
- Flat or falling OI at new extremes warns of a reversal
- Price up on falling OI is short covering, which carries less
- Price up on rising OI means genuine new longs opening
- Always combine OI with funding to spot squeezes
Liquidation cascades: when high OI becomes a weapon
Very high OI near a top is dangerous because leveraged positions have fixed liquidation prices. Forced selling pushes the price, which triggers the next level. The cascade feeds on itself and produces the infamous vertical wicks. On the demo exchange you see OI and funding live next to the chart.
- High OI plus one-sided funding means reduce risk, do not add
- Read the long-short ratio and wallet sizes as additional signals
Sources: Murphy, Elder, Goodman
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