Open Interest is a term that every futures and options trader comes across. In fact, OI data is very important to find the stock or market direction. A trader in the stock market must be aware of the term. Moreover, by understanding the concept of option open interest the trader can make higher returns. To put it another way, open interest helps in determining the momentum of the market. In this article, we shall understand the term open interest.
Meaning of Open Interest
OI is the outstanding buy or sell position in futures and options contract at the end of each day. The market participants build the outstanding position.In addition, the change in open interest has a direct impact on the stock prices and markets.
Let us now understand how a change in the OI takes place.
# Before know OI , Must to Know :
How Open Interest Changes ?
The change in OI takes place when a trade is initiated between two parties. Consequently, the open interest increases, decreases or remains the same. Let us take an example and understand how open interest changes.
- Suppose a new buyer takes a position in GMR Infra. by purchasing from a new seller. In this case, the OI will increase by one contract.
- Suppose an old buyer and an old seller decide to close their positions in GMR Infra. This will lead to a decline in OI by one contract.
- Suppose an old trader passes off his position in GMR Infra to a new trader, in such case the OI will not change.
Change in open interest gives an indication in relation to the movement in the price of the stock. Therefore, let us understand such indications.
What Change in Open Interest Indicates ?
For traders, open interest is of tremendous importance. To repeat, change in OI helps to understand the movement of stock price. For example, if the OI is increasing, it means the flow of money in the market or stock is increasing. Therefore, it suggests that the current trend in the price of stock i.e. upward, downward or sideways shall continue. On the other hand, if the OIis decreasing, it means that the current trend in stock price is over because the market is liquidating.
Even though open interest is the indicator of movement in the stock price. However, the investor should not always rely on it blindly.
O.I. Can Mislead
The OI change can mislead the investors especially when there is some news or event related to the stock. For example, if the results of a company are expected to be bad, the open interest will rise and the price will fall. However, if the company posts good results then OI can change quickly. In fact, the traders are trapped when sudden reversal takes place. Therefore, it is recommended that position in stocks at such times be avoided as it can lead to heavy losses.Thus, it becomes very important to put a stop loss in place.
Adding more to the above information. If the company has given poor results as per the expectation of the market, but it has given a positive guidance. Therefore, in this scenario as well the OI can reverse at a rapid pace. Many times we notice that stocks surge even after giving poor results. This is because of the positive guidance. When the guidance in relation to the future is positive, it is very much possible that call writers start covering their shorts. Thus, OI begins to fall and the stock price rises.
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