By definition, open interest (OI) means the total number of open contracts on a security or index (NIFTY) , that is, the number of future or options contracts that have not been exercised or expired. Hence, we can say that the open interest position at the end of each day represents the net increase or decrease in the number of contracts for that day.
For example, If A and B buy two Reliance options each today, the open interest at the end of the day is FOUR. On day 2, if A sells one of his options to C (who is a fresh buyer), at the end of the day 2, the OI will remain FOUR (since one buy by C has been compensated by one sale by B). But consider the situation where, A and B have retained their options and C has bought a newly written option (by an initial seller or the so called writer of options).The OI at the end of day 2 will be FIVE. In other words, increase in OI is a reflection of new contracts coming into the market. What then would be the significance of OI variations vis-à-vis market trend ?
If market is on an uptrend and OI is rising :Bullish signal for the index/stock derivative (more calls being written).
If market is on an downtrend and OI is rising :Bearish signal for the index/stock derivative (more puts being written).
If market is on an uptrend and OI is falling :Bearish signal signifying a decreased interest for buying fresh calls. This may precede a trend reversal.
If market is on a downtrend and OI is falling :Bullish signal signifying a squaring off of existing positions in anticipation of a trend reversal.
If the market movement is sideways and OI is rising :This suggests that a trend in either direction is likely soon.
If the market movement is sideways and OI is falling :This suggests that the trend less movement will continue.
Thus open interest is just one of the indicators among many that help us to take a call on the likely direction of the market. It has to be considered along with other technical indicators before taking any decision.