Trading Commodity Using Open Interest - The #1 Blog on trading, personal investing! Best Tips for Beginners

Header Ads

Trading Commodity Using Open Interest

Intraday trading is a self-explanatory term that is used to describe trading that occurs in a day. One of the concepts an intraday trader has to understand is open interest.

What is open interest?

Simply put, open interest (OI) is the sum total of the outstanding contract numbers held at the end of every trading day. These are positions that are yet to be closed; ie, open. Open interest is a measure of the overall activity level in the futures and options market. 

 Every time two parties, ie, the buyer and the seller initiate a fresh position, the open interest increases by a single contract. If the traders or closing the position, then the open interest is lowered by a single contract. If the buyer or seller passes on their position to a fresh seller or buyer, then the open interest does not change.

In F&O Market Open Interest (OI) plays a significant role for taking decisions in intraday trading as well as initiate a contract.

Open interest is the Number of existing contracts held by buyers or sellers for any market for any given day. Open interest reflects total long positions or total short position.

Open Interest (OI)  rises when a new buyer and a new seller comes to the initiate a position in Stock market. Open Interest (OI) decreases when a long and a short position is closed. When both long and short position closed  OI falls one contract. Open Interest is unchanged when a Long position is closed and a new long position is initiated against it. The same applies to short position.

 

Buyer                                                                    Seller                                Open interest

Fresh Buyer                                            Fresh Seller                        Rises

Fresh Buyer                                            Previous buyer                 No Change

Previous seller  buys to Cover                    New Seller                       No change

Previous Seller buys to cover                     previous Buyer                 Decreases

Open interest Reflects market sentiment. When Buyers and sellers don’t feel the market will not move in their favor they will exit their contracts and OI Decreases. Open interest is a good indicator for seasonal changes, for intraday changes.

When Open Interest Increases Price falls safer to go short because intraday traders likely to push the prices lower.

When Open interest is rising but the price is range bound means More selling pressure.

When OI decreases but the price is range bound means more buying pressure.

Open Interest decreases sharply  during rally bulls are profit booking and bears are getting ready to sell.

Open Interest decreases sharply  during decline bears are profit booking and Bulls are getting ready to Buy.

A change of 10 % in OI means a signal to reversal  more than 30 % change expect immediate change in Direction of the particular contract.

If the OI has increased, it means that the market is seeing an infusion of money. If the OI is down, it means that the current price trend is nearing its end. 

In this sense, the OI is an indicator of changing trends in prices.If the OI has increased, it means that the market is seeing an infusion of money. 

If the OI is down, it means that the current price trend is nearing its end. In this sense, the OI is an indicator of changing trends in prices.

Traders should also understand that open interest is not the same as volume. Volume refers to the number of contracts traded in a day. Volume is a reflection of the number of contracts that have occurred between seller and buyer; irrespective of whether a new contract has been created or an existing contract has been transaction. 

The basic difference between OI and volume is that while open interest indicates the number of contracts that are open and live, volume indicates how many were executed.

One more parameter that one needs to keep in mind while discussing OI is the price action. Price action in trading terms is how the price of a security moves on a graph, plotted over a period of time. It refers to the upward or downward price trend of a certain security.

Most traders use volume in association with OI and price to analyse the market. The general rule of thumb is that when the price is rising, and the volume and OI are up, then the market is strong. On the other hand, even though the price is rising, if the other two parameters are down, then it is a weak market. Here’s a chart that helps you understand the rules for open interest and volume:

If you are a trader, here are some tips to use OI to see market performance:


– When the OI is on an upward trend and the price action is also seeing an upward trend, it means that the market is seeing an infusion of money. It means there are buyers and therefore, the market is considered bullish.

 
– When the price movement is upward but the OI is dropping, money may be exiting the market. This is the sign of a bear market.

 
– If price makes a sharp drop and OI is very high, it still means that the market scenario is bearish. This is because those who bought at the top now seem to be losing. There is the likelihood of panic selling in such a scenario.

 
– If the prices are on a downward trend and the OI is also dipping, it means holders are under pressure to liquidate their positions. This is a sign of a bearish market. It may also be indicative that selling may peak soon.

In conclusion, OI is of significance because it tells you the number of contracts are live, or open in the market.

 When new contracts are added, OI increases. When a contract is squared off, the open interest decreases. 

Volume is another term that is often used in conjunction with open interest. Volume is indicative of how many trades were conducted on any given day. 

But it does not carry forward into the next day. OI, on the other hand, has implications on the next day, and is live data in that sense.

Open interest, price and volume information put together helps intraday traders to understand the position of the market. It gives an intraday trader an idea of whether the market is bullish or bearish.