Open Interest Analysis to identify stock market trends

How Open Interest Analysis helps to identify market trends?

by Elearnmarkets on Derivatives

Open Interest defines the total number of open or outstanding contracts presently held by the market participant at a given time. Open Interest Analysis really help to identify stock market trends.

In simple language, it helps a trader to understand the market scenario by only showing a number of futures contracts that have been changed hand during the market hours. Open interest mostly used by the Future and options contract traders. Open Interest or OI changes day by day depending on the outstanding contracts.

Let’s take an example to understand the whole picture.

There are four participants in the market A, B, C, D, and E.

On 1st July, A buys 10 contracts from B => OI 10
2nd July C buys 20 contracts from D => OI 30
3rd July A sells his 10 contracts to D => OI 20
4th July E buys 20 contracts from C => OI 20

So, we can understand how OI changes depending on the change in hand of contracts.

Hence,

  • When a new entrant trades with a new entrant in F&O market Open Interest goes up
  • When an existing position holder squares off with entry of a new entrant, open interest remain unchanged
  • When two existing position holders square off their positions we see open interest go down

Have a look on basic Open Interest Analysis

Open Interest Analysis

How does Open Interest Analysis help to Identify a trend?

A trend can be defined by price upward and downward direction but the sustainability of that trend is questionable. There are some important factors which backs up the price to take a certain direction. OI is one of the factors and a reason for a sustainable trend as well as trend reversal.

When the price is going up or down and the future open interest increases alongside the price at a certain level then we can expect that the price movement is going to sustain. In other hand when a trend is present in the market and a sudden fall in futures open interest is visible then we should be doubtful about the trend. There is a chance of trend reversal.

Open interest increasing means fresh money is flowing into the market and decrease in open interest suggest money outflow from the market. Buyers move the market up by investing fresh cash into the market while seller does the opposite. Oi increases when the fresh contract exchange hands. A trend depends on the how much fresh contracts is exchanging hands with the new price move. If the fresh cash does not flow into the market, if the fresh contract does not exchange hands, then we should be doubtful about the trend.

How to find Open Interest?

There are multiple sources where we can find out the open interest. The most reliable source is nseindia, this is the site of National Stock exchange (NSE) here you will find out the last day’s Open Interest as shown in the picture. However, data are updated at the end of the day (EOD).

open interest chart oi spurts

For investment or trading in future contracts we can take the help of this data. There is another way where we can find open interest and this is specially for the options trader.

Extracting meaning out of option chain

The option Chain of any stock gives us a great understanding of how the bulls and bears are placed in the markets. Normally bulls participate by selling put options and bears participate by selling calls.

We must understand one important point that due to inherent time decay in options, there are generally a large number of option sellers in the market. Large amount of option open interests at any particular strike price is point of significance. If there is a significant gap-up or gap-down opening in the market contrary to the open interest build-up then the unwinding of the open interest pushes the market more in gap-up /gap-down direction due to sheer urgency of short covering. Sharper the gap up or gap down, generally more impactful the follow up short covering of options in that particular direction.

Let us look at the example of Yes Bank. The stock had been already in an up-trend. However, there were fair amount of call writing at 370, 380 and 400 strike price. As Yes Bank opened gap up there were goo amount of short covering at 370 and 380 calls. Simultaneously there were strong put additions in 360, 370 and 380 strike prices. That pushed the stock even higher during the initial phase of the day.

option chain equity derivatives
yes bank price graph

Selection stock with Open Interest criteria through StockEdge:

You can perform Open Interest Analysis in the StockEdge application. StockEdge also provides you the open interest data at the of the end of the day (EOD).

Finding the Open Interest in the StockEdge application is really easy. Just tap on the ‘stocks’ button from the home tab. Type name of the stock in the search bar (remember the stock has to be listed in the Future and Options segment) and check it’s OI.

stockedge screen 1
stockedge screen 1
stockedge screen 1
stockedge screen 1



There are also much more exciting features available in the StockEdge application. From learning about the stock market to invest in stocks, this application accomplishes each and every requirement related to the market.

Read about How to use Open Interest to increase profitability

Bottom line:

Open Interest Analysis should be done as a supportive tool along with technical analysis. It is important to look on them both at the end of the day and during the day. For stocks which are in F&O segment high open interest build-up in futures and options are good indication of market direction. This is not a straight forward tool though and requires experience to judge the impact of open interest build-up at various stages of any expiry. So to master the art, we suggest traders and investors to study the open interests of stocks with regularity and discipline. For learning more you can view this video series starting with this video.

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Disclaimer

Elearnmarkets.com wants to remind you that all our content is created solely for the purpose of education. No strategy, stock, commodity, fund or any other security discussed here is any way a recommendation for trading or investing. Elearnmarkets.com will not be any way responsible for trading losses incurred by any individual or entity for trading with real money. Please take advise of certified financial advisers before trading or investing.

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