Learn how to use Open Interest effectively in Trading

Hey there, fellow traders and curious newcomers! Let's embark on a journey to demystify the enigmatic world of Open Interest (OI) and discover how it can be your secret weapon in the ever-evolving realm of trading and investing. In this blog post, we'll break down Open Interest, explore its practical implications, and unveil the unique strategies it offers. So, grab your coffee and let's dive into the fascinating world of OI - The Power of Open Interest in Trading.

Understanding Open Interest: The Building Blocks of Trading

What is Open Interest?

Open Interest, or OI in trading lingo, is like the heartbeat of the market. It's the number of derivative contracts that are still open, meaning they haven't been bought and sold simultaneously. Picture it this way: when you buy a derivative contract (be it an Option or a Future), but you don't sell it, you've just given birth to an open interest. It's like your trading baby, waiting to mature in the market.

In essence, Open Interest signifies the total number of derivative contracts that are currently active and in play. These contracts can be either Bought only or Sold only. In other words, you can buy a contract and not sell it, or sell a contract and not buy it. Both these scenarios increase the Open Interest count. Conversely, when you buy and sell a contract, it's closed, and the Open Interest decreases by one.

Open Interest is not limited to one type of contract. It's present in both Option and Future contracts, spanning across various indices and stocks. Here's a pro tip: the Open Interest generated in the Options segment wields substantial influence, accounting for a significant chunk of market volume, typically around 82 to 85 percent. So, understanding the sentiment of option players can give you a keen insight into the broader market sentiment.

Open Interest as Support and Resistance

Now, here's where the magic happens. All the open contracts in the options chain are, in a sense, option sellers. The big players often engage in option selling as a way to hedge their positions, which creates a fascinating dynamic.

Call writers become a force of resistance, while put writers form the foundation of support. When you see Open Interest in the options chain, you can consider it as support or resistance levels. You might be wondering, "Why should I bother with another set of support and resistance when I have my trusty technical charts?" 

Well, here's the kicker: Open Interest adds a layer of depth. It allows you to gauge the intensity of support and resistance based on OI and the Change in OI, which you can't glean from traditional methods.

Practical Applications: Using Open Interest to Your Trading Advantage

Now that we've got the basics down, let's explore how you can put Open Interest to work for you.

Reading the Battle in Open Interest

Imagine this: You're looking at an Open Interest position in Nifty, and you spot multiple strike prices, like 8400, 8450, 8500, 8550, and 8600. Let's focus on strike price 8500.

At 8500, you see Call Writers with 10 lakh contracts (for simplification), which acts as resistance, and Put Writers with 11 lakh contracts, forming a support base. It's like a battle between 10 lakh people and 11 lakh people. At first glance, the put writers seem stronger. But, hold on, things are about to get interesting.

As time passes, the put writers start increasing their positions. The 11 lakh starts growing to 12 lakh, then 13 lakh, and it keeps going up. This surge indicates that the put writers are taking the upper hand, and the opposition, in this case, the call writers, must either fold or escape. If you come across such a situation, consider it a golden opportunity.

Now, let's consider another scenario. Put writers are gaining ground just as before, but call writers are not retreating in significant numbers. This hints at a tug-of-war where the call writers are not ready to concede. To regain the upper hand, they might start building positions at strike prices like 8600 and 8700. As more people join their cause, the tide turns in their favor.

This game of back-and-forth between bulls and bears plays out within the framework of Open Interest. The shifting of positions from one strike to another indicates an impending move in that direction. These pivotal levels where bulls and bears are almost evenly matched are known as pivot Strike at least I call it Pivot Strike. It's like a moment of indecision before a powerful move takes place.

Leveraging Change in Open Interest

Open Interest isn't static; it's a dynamic tool that you need to monitor regularly. This dynamism extends to the support and resistance levels it creates. By tracking the change in OI, you can gauge the strength and direction of these support and resistance levels. It's like spotting leaks in a dam before it breaks.

How to use Open Intrest in Trading

Best Ways to use Open Interest in Trading

By comparing two images of Open Interest positions, you can see how the balance of power shifts. In the first image, call writers seem stronger, but in the second, the put writers are steadily increasing their positions. This signals a potential upward move. Keep a close eye on Nifty Futures' price, the date, and the time to stay in the loop.

Updated Scenario On Nifty

Nifty Open Interest

When examining the current Open Interest chart of Nifty - The Nifty Option Chain Analysis, a conspicuous pattern emerges. At the 18900 strike, there's a substantial Call Open Interest of approximately 30.5 lakh contracts, while the Put Open Interest at the same strike hovers around 9.6 lakh. 

Notably, there are robust indications of proficient put writers at the 18800 and 18850 strikes, both in terms of Open Interest and Change in Open Interest. This collective data strongly suggests that these levels may serve as a formidable support for Nifty. In the visual representation, the green bars denote Call Open Interest, while the red bars represent the Put Open Interest.

Taking Action: Entry, Stop Loss, and Profit Booking

So, can you actually use Open Interest to make trading decisions? Absolutely!

Entry: Always be on the lookout for pivot levels in any index or stock. Remember, these levels are dynamic and change over time. As you've witnessed in our examples, when the pivot level shifts, a corresponding move often follows. This can be your signal to enter a trade in the direction indicated by Open Interest.

Stop Loss: Once you've assessed the market direction, you can place your stop loss just above or below the pivot level. If you're a dedicated follower of OI, you'll notice that a 10 or 20-point stop loss is often sufficient for Nifty. However, keep in mind that individual trade conditions can influence your stop loss as well.

Profit Booking: It's not just about entering a trade; it's also about exiting with a profit. Look to book your profits around the second pivot levels. You can even consider trailing your stop loss to maximize your gains.

In Conclusion: The Key to Becoming a Pro Trader

In the world of trading, there's no free lunch, and easy money is hard to come by. However, Open Interest is like a hidden treasure map that can lead you to success if you're willing to put in the effort.

We hope this blog post has shed some light on the practical use of Open Interest. If you have any questions or queries, drop them in the comment box below, and we'll be happy to help you navigate this exciting journey.

So, in your trading adventures, don't forget to keep a watchful eye on Open Interest, the unsung hero of the market, and use it to your advantage.

Frequently Asked Questsions about Open Interest (OI)

What is Open Interest, and why is it important in trading?

Open Interest is the total number of derivative contracts that are still active and open. It's crucial in trading because it helps traders gauge the market sentiment, identify support and resistance levels, and anticipate potential price movements.

How can I use Open Interest in my trading strategy?

You can use Open Interest to make more informed trading decisions by watching for changes in OI and identifying pivot levels where bulls and bears are closely matched. These levels can serve as entry and exit points for your trades.

Why is it essential to monitor the Change in Open Interest?

Monitoring the Change in Open Interest allows you to assess the strength and direction of support and resistance levels. It helps you stay ahead of potential market moves and make timely trading decisions.

Can Open Interest be applied to different trading instruments, such as Options and Futures?

Yes, Open Interest is relevant to both Options and Futures contracts, covering a wide range of indices and stocks. You can use it in various trading scenarios to improve your strategies.

How do I determine the pivot levels using Open Interest?

Pivot levels are identified by observing Open Interest at specific strike prices where the number of call and put writers is closely balanced. When these levels shift, it indicates a potential market move, and you can use this information to your advantage.

Is Open Interest suitable for traders of all levels of experience?

Yes, Open Interest can benefit traders at all levels. Beginners can use it to understand market sentiment, while seasoned traders can fine-tune their strategies with the insights it provides.

Should I solely rely on Open Interest for trading decisions?

While Open Interest is a valuable tool, it's essential to use it in conjunction with other technical and fundamental analysis methods. It should be a part of your broader trading strategy.

How often should I monitor Open Interest in my trading activities?

Open Interest is dynamic, so it's advisable to monitor it regularly. Keep an eye on it as market conditions change to stay updated on potential opportunities.

Can I set stop loss and take profit levels based on Open Interest data?

Yes, you can use Open Interest to determine stop loss and take profit levels, especially in relation to pivot levels. This can help you manage risk and maximize your profits.

Are there any resources or tools that can help me track Open Interest effectively?

Many financial websites and trading platforms provide Open Interest data. Additionally, there are analytical tools and trading software that can assist you in monitoring and interpreting Open Interest for your trades.

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