Master the Art of Trading Strategy with Open Interest | Motilal Oswal

Trading Strategy with Open Interest Data

An Overview

One of the most effective techniques you can use to gain from asset price changes is intraday trading. But, it also carries a little bit more risk. This is because intraday trading involves buying and selling an investment within a single day, and when the market does not move in your favor, you could suffer big losses.

Due to this, while engaging in intraday trading, it's indeed essential to use strategies that can precisely forecast the price action of assets. By doing this, you may reduce the likelihood that the market will move against your expectations. The open interest strategy for intraday trading has become such a well-liked trading strategy.

You can learn a lot about investor sentiment as a reliable predictor of future price movement—from intraday-long positions. But first, let's quickly review what exactly intraday open interest would be before we examine how you may use it.

Understanding Open Interest

Derivative transactions, such as futures and options, are related to open interest. In essence, it is the total amount of active contracts that remain after a trading day. Now, the open interest increases whenever a new position is opened. Moreover, the open interest decreases as soon as the position is closed.

As a result, an increase in open interest for an investment essentially indicates that more investors are purchasing the asset. In a similar vein, if open interest declines, investors are likely to liquidate their holdings and the price direction is likely to alter. As a result, you may somewhat foresee variations in price trends by just keeping an eye on open interest and its different variations.

Understanding Volume

Traders need to be aware that open interest, as well as volume, is not the same thing. The amount of contracts exchanged in a day is referred to as volume. Regardless of whether a contract extension was formed or a current agreement was transacted, volume is a representation of the number of contracts that have happened between the buyer and the seller. The primary distinction between open interest (OI) but also volume is that the former shows how several contracts are open and active, whilst the latter shows how many were executed.

Price Action: What Is Its Role?

The price action is another element that should be considered while talking about OI. In the context of trading, price movement refers to the way the price of securities fluctuates as time passes on a graph. It alludes to the direction of a given security's price movement, either up or down.

Most traders utilise volume along with OI, price, and other market indicators to analyse the market. Generally speaking, a booming market is one where the price is growing, the volume is increasing, and the OI is increasing. On the other hand, even when the price is increasing, a weak market exists if the other two indicators are declining. 

How To Use An Open-Interest Trading Strategy For Intraday? 

While open interest is a strong indicator on its own, many traders combine it with a particular asset's trading turnover and price movement measures to make more precise forecasts. These are the three metrics and how to use them in open interest trading strategy for intraday trading.

1. The market is seen as bullish if investor sentiment increases together with price increases.

2. The market is bullish but it could quickly turn bearish when there is a decline in open interest combined with a price rise.

3. The market is deemed bearish and investors are possibly selling in a hurry when there is a rise in open interest combined with a significant decline in the price.

4. The market is seen as bearish whereas if open interest declines at the same time the price declines.

Tips To Use OI To Evaluate Market Performance

Here are some pointers for traders who want to utilise OI to monitor market performance:

  • The market experiences a significant influx of cash when the OI is moving higher and the price movement is also moving upward. It indicates that there are purchasers, and as a result, the market is seen as positive.
  • Money may be leaving the market whenever the price movement is rising but the OI is declining. This indicates a bear market.
  • Price dropping sharply when OI is sky-high still indicates a negative market situation. This is due to the apparent loss experienced by individuals who purchased at the peak. In such a case, there is a chance of panic selling.
  • If the prices are falling and the OI is also declining, it indicates that holders are under temptation to sell their shares. This denotes a bearish market.

OI is important since it indicates how many active or open contracts are present in the market. OI rises when more contracts are acquired. The open interest falls off once a contract is closed off.


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