How open interest can show stock trends

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Open Interest is the third most important indicator after price and volume. It is defined as is the number of contracts outstanding at the end of a day. Open Interest is very important for any Future and Option Trader. To understand open interest, lets first understand how Futures and Options are traded. Futures and Options are created out of thin air when two traders enter into opposite sides of the agreement. If we take the example of options, because options are created out of thin air, when you trade an option, you are either entering into the contract or getting out of it.

How Open Interest is calculated Open interest goes up or down based on how many new traders are entering the market and how many old traders are leaving. The total number held by buyers or sold short by sellers on any given day.

The open interest number gives you the total number of longs, and the total number of shorts. For example, if two open interest options trading are initiating a new position one new buyer and one new selleropen interest will increase by one contract.

If both traders are closing an existing or old open interest options trading one old buyer and one old seller open interest will decline by one contract.

The third and final possibility is one old trader passing off his position to a new trader one old buyer sells to one new buyer. In this case the open interest will not change. This can be summarized in the following table:. For those of you who are familiar with volume, the interpretation of open interest movements along with price are very similar to volume. Just as when price goes up on rising volume, it is a bullish sign; so it is with open interest.

In fact, here are the rules for trading with open interest:. With the introduction of intraday data for futures and options in Investar, you can now use the intraday screener to scan all the NSE futures for those futures that are gaining on high open interest in open interest options trading specifically in 5-min, min, min and min timeframes.

This can give an additional confirmation, e. Open interest also gives you key information regarding the liquidity of a future or option. If there is no open interest for an option, there is no liquidity for that option. When options have large open interest, it means they have a large number of buyers and sellers, and open interest options trading more liquidity and this will increase the odds of getting option orders filled at good prices.

So, all other things being equal, the bigger the open interest, the easier it will be to trade that option at a reasonable spread between the bid and ask. Volume for a futures contract is simply the number of contracts that have been traded on a particular day. Volume does not distinguished between how many contracts were opened or closed long or short. It also does open interest options trading give a clear picture about how many contracts were opened and are still open in the market, while Open Interest is a cumulative total of all the open contracts at the end of the day.

While volume open interest options trading reset each day, the open interest carries over to the next day. Your email address will not be published. This can be summarized in the following table: In fact, here are the rules for trading with open interest: Price Open Interest Interpretation Rising Rising Bullish Rising Falling Bearish Falling Rising Bearish Falling Falling Bullish With the introduction of intraday data for futures and options in Investar, you can now use the intraday screener to scan all open interest options trading NSE futures for those futures that are gaining on high open interest in intraday specifically open interest options trading 5-min, min, min and min timeframes.

Differences between Open Interest and Volume Volume for a futures contract is simply the number of contracts that have been traded on a particular day. Always to the Point n informative……… A true follower of yours ….

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It is safe to say that most novice traders in the world are not trading options properly. If we know this, then all we have to do is find the area where most traders are making mistakes and then take the opposite position.

We will then have a high probability for success in our trades. Open interest is a statistic unique to options and futures trading. Open interest is the total number of contracts that are currently in existence and have not been offset by closing trades. This is different than volume which is the number of contracts traded for the day.

If you were to buy an option to open a position and the person who sold you the option is also opening a new position, volume would increase by one and open interest would increase by one.

If you then sold your option to someone else who did not have a position, then volume would increase but the open interest would not change as you transferred your interest to someone else. Open interest would have decreased if you had sold your option to someone who had already sold an option and was buying to close their position.

Since both of you are closing positions, the option contract is not needed anymore and open interest goes down even though the transaction increases the volume reported. Understanding open interest can seem confusing at first, but our instructors at Online Trading Academy do an incredible job at making difficult concepts easy to understand in the classroom. Open interest is important to stock traders and investors as well as option traders. Open interest shows us where traders are putting their money.

Remember that the novice traders are the ones who usually buy options. We can use the knowledge that sellers tend to make money to predict potential price movement for stocks just before the expiration of the stock options. There is a concept in the markets called option pain. When a seller of an option sees the price of the stock move to where they would lose money, they are feeling pain.

By looking at where the open interest of a stock or ETF is, we can make assumptions on the price levels where there would be a lot of pain. Where there is a large amount of open interest, there is also a large probability that the price will not close there by expiration.

This is because if it does, then the sellers of those options would stand to lose a lot of money. In an effort to profit from large option or futures positions, institutional traders will often buy or sell the underlying stock in an effort to push prices to a point where the close will benefit them. This means that the price will often close on options expiration day just above or below the price where the greatest open interest lies and the least amount of pain would be felt.

There is a term for this action, pinning. These traders attempt to pin the price of the stock or ETF to profit from a derivative position. Pinning is illegal in most exchanges in the world and traders who participate in this high volume trading in an effort to manipulate prices could face penalties. The problem is in catching the culprit and the SEC punishing them. But does it really work? That is where the largest open interest happened to be.

Since prices opened above this range in the morning, traders should have been looking for opportunities to short the ETF until it settled into the range suggested by the open interest. So, what can a retail trader do about this pinning? Recognize that it does happen and either stay out of the market or trade the momentum.

Trading this can be very risky as you need to be quick in your decision to enter and exit when the momentum is slowing, not reversing. It is not for everyone, but if you are prepared you may be able to profit from this pinning that occurs in the markets every expiration day. Watching the potential pinning activity in the week before option expiration and also the open interest on the weekly options can also assist those traders looking to make profits on short-term swing trades as well. Trades should only be entered based on supply and demand zones.

The open interest information provided here is only a decision support tool. To learn how to identify the zones accurately and efficiently, visit your local Online Trading Academy office today. Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever.

Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.