How to Use Open Interest for Intraday Trading or Trading?

Open Interest (OI) is one of the very useful indicators in future and options (F&O) to trend in a particular stock or broader market index trading in the derivatives market. You can use the open interest (OI) data to find out the sentiments of the traders towards a particular stock or indices. You can also analyze the current trend and expected price movement.

For intraday trading or for short-term trading in the F&O segment with the short-term weekly or monthly you can use the open interest to get insight of the stocks trading under this segment. And to use the OI effectively in trading you need to properly read, understand and interpret the open interest (OI) data with examples. That we are going to discuss here.

What is Open Interest in the Stock Market?

Open Interest or OI is the total number of contracts in options and futures or derivatives market held by the traders that are active right now. These positions are still open in the market and not closed, which means neither expired nor exercised within the time frame.

Open interest keeps changing on a daily basis with the fresh position created pushing the OI up, while when existing positions are closed or exercised the OI decreases. When OI increases, traders create a long position in the stock or in the underlying security or main index like Nifty. When OI decreases, it means, traders create a short position in the stock or underlying security.

How to Read Open Interest Data?

Reading the OI is very simple if you have gathered the daily traded contracts of the different stocks and indices. When you see the data of OI, it will be available in the number of contracts which means currently this much quantity of contracts are open in the market.

In the stock market, there are two types of traders – a buyer and a seller and in the derivatives market when a seller sells and a buyer buys 1 quantity, it is counted as 1. Here in the derivatives market, the total number of contracts traded is also called the total number of volumes.

But while reading the OI, make sure it is a number of future contracts or options contracts or both. However, when you see trading details of a stock or index future it shows only the number of futures contracts and when you see an options chain, it shows the number of contracts of that particular security of a particular month contract with a change in the OI.

How to Understand Open Interest?

To understand the OI, you need to understand how OI is calculated. As we have told you earlier, when two parties (buyer and seller) enter into a fresh position, the open interest is increased by one contract, and when they close their position or exercise their contract, the open interest decreases by the same number. But at the same time, multiple buyers and sellers enter or close the contracts then a net increase or decrease of IO is considered.

Let’s make you understand through an example, in a derivatives segment when a seller sells 1 contract and the buyer buys the same contract, it is counted as a single contract, though the buyer is in the long position, the seller is in the short position in the same contract. The increase in the open interest reflects the flow of money into the market, while a decrease in the OI indicates that money is flowing out of the market. And if there is no change in the OI, it means the money is neither coming nor going from the market.

How to Interpret Open Interest?

When you understand the relationship between the volume of trade and the change in price of the underlying security or index you can interpret the open interest. And there are various situations when OI changes with the price change that are listed below.

Situation 1

When open interest increases and the price of the underlying security or market index also increases, it means the market is bullish or the price of the underlying security will go up.

Situation 2

When open interest decreases and the price of the underlying security increases, it indicates the market is bullish but there is a chance of trend reversal and the market will turn bearish.

Situation 3

In this situation, when OI increases but the price of the market index decreases, it indicates the market is bearish and there could be panic selling in the market or underlying security.

Situation 4

In this combination of OI and price change, when the OI decreases and the price of the underlying security or the broader market index also decreases, then it is considered that the sentiment of the market is bearish.

© 2024 Crivva. All Rights Reserved.