The Art of Selecting Stocks Using Open Interest for Intraday & Momentum Trading

Ever feel like trading indexes such as Nifty and Bank Nifty is a breeze compared to trading individual stocks? Many find it simpler because they don't have to sift through countless stocks for their intraday and momentum trading. Their minds are at ease with index trading - Nifty for some, Bank Nifty for others - without the hassle of endless choices.

Do you ever find yourself in a similar predicament, unsure which stocks to focus on for your trading endeavors? Well, you're in luck! I'm about to unveil my personal method for selecting stocks for intraday and momentum trading using Open Interest. This article serves as your ultimate guide to Open Interest Trading Strategy and stock selection. Let's dive into this exciting journey together.

Now that we've touched on the allure of index trading and the relief it brings from the complexities of stock selection, let's delve into a key concept that underpins our strategy: Open Interest.

So, what exactly is Open Interest?

Consider Open Interest as a vital liquidity gauge within the market. It signifies the total number of unfulfilled contracts for a specific asset, whether it's indices or stocks - options and futures, that remain unclosed. Essentially, it reflects the number of active contracts awaiting resolution. It's crucial not to mistake Open Interest for Volume.

But why does Open Interest matter?

Well, it gives us crucial insights into market sentiment and activity. A rise in Open Interest suggests growing investor interest in a particular asset, signaling potential strength or momentum. Conversely, a decline in Open Interest may indicate waning interest and potential price reversals.

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In the context of stock selection for intraday and momentum trading, monitoring Open Interest can help us identify hotspots in the market - those stocks that are garnering significant attention and activity. By understanding Open Interest trends, we can make more informed decisions about which stocks to include in our trading radar.

Understanding Open Interest in Futures and Options

Open Interest plays a crucial role in both Futures and Options contracts, each with its own distinct value and significance. Let's take the example of a popular stock like Reliance, which actively trades in the Futures and Options (FNO) segment. Here, you'll find Open Interest in both its Futures contracts and Options contracts, and these metrics complement each other.

However, in this article, we'll focus on utilizing Open Interest in Futures contracts alongside future stock prices for our stock selection process. If you're intrigued by Option Open Interest, you can explore option chain trend and analysis.

Open Interest and Price Relation

Once you are clear about future OI and Option OI, we head towards decoding the relation between Open Interest and Price.

Price and Open Interest are constantly fluctuating, being inherently dynamic. When these two elements converge, they offer valuable insights into market trends. Understanding the nuances of Build Ups, there are four distinct types: Long Build Ups, Short Build Ups, Short Covering, and Long Unwinding. Let's delve into each for a clearer perspective on future prospects. However, it's worth noting that interpretation may vary slightly for Options.

Also Read: Turning Panic into Opportunity: Leveraging OI Surges to Navigate Post-March Market Trends

Meaning of Long Build Ups

A Long Build Up occurs when the price surges in tandem with Open Interest. This indicates an uptrend in the stock, portraying bullish sentiment and robust price strength. Particularly noteworthy are instances where price fluctuations exceed 2%, signaling significant Long Build Ups.

Future OI Build Ups and its Interpretation
Future OI Build Ups and their Interpretation

Meaning of Short Build Ups

Short Build Ups occur when Open Interest increases while prices decline. This phenomenon signals a robust bearish trend, with prices displaying evident weakness. Notably, if price movements exceed a 2% threshold, these instances are deemed as significant Short Build Ups.

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Meaning of Short Covering

In this market, when prices rise but Open Interest decreases because contracts are closing, it's called Short Covering. This suggests a mild bullish sentiment, but it's not as strong as Long Build Ups, which usually happen in downtrends. If short covering continues for a long time, it could signal a trend reversal. And when Short Covering occurs alongside Long Build Ups, it indicates market strength.

Meaning of Long Unwinding

When both Open Interest and prices decrease, it's called Long Unwinding, suggesting potential trend reversals. It often occurs in stocks experiencing prolonged upward trends. If it persists, it may briefly halt the uptrend. While prices drop during Long Unwinding, it's somewhat bearish, though not as strong as short build ups.

Also Read : Guiding Through the Option Chain: A Beginner's Handbook

Long Build Ups and Long Unwinding - A New Perspective

We noticed a decline in the stock price as traders closed their long positions. This typically occurs for two reasons: either they intend to establish new long positions or they anticipate the end of the uptrend.

To determine whether traders are initiating fresh positions or pausing the trend, look for patterns. If Long Build Ups and Long Unwinding occur cyclically together in a stock or index, it indicates a sustained bullish trend. Otherwise, it suggests a potential pause in the uptrend.

Short Build Ups and Short Covering - A New Perspective

We observed a price increase as traders closed their short positions in the stock. This typically occurs for two reasons: either they intend to establish new extensive short positions or they anticipate the end of the downtrend.

To determine whether traders are initiating fresh positions or signaling a pause in the trend, look for patterns. If Short Build Ups and Short Covering occur cyclically together in a stock or index, it indicates a sustained bearish trend. Otherwise, it suggests a potential pause in the downtrend.

Stock Selection for Momentum Trading - Intraday & Swing Trading

Now that you grasp the concept of build-ups, it's time to choose stocks for momentum trading. We'll employ a free tool to aid our selection process, such as the Opstra Future Dashboard. Feel free to utilize any tools that suit your preference.

This dashboard categorizes stocks based on the build-ups we discussed earlier. Personally, I favor selecting stocks for long positions from the Long Build Ups and Significant Long Build Ups categories. Conversely, for short positions, I lean towards stocks listed under Short Build Ups and Significant Short Build Ups.

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For illustrative purposes, I'll choose three stocks: Petronet LNG and Coal India for long positions, and Chola Finance for a short position. It's important to note that this is not a recommendation for trading these stocks.

Long Build Ups on Petronet
Petronet LNG Future OI Build UPs
Long build up on Coal India
Coal India Future OI Build Ups
Short Build Ups on Chola Finance
Chola Finance Future OI Build Ups

Once I've chosen the stocks, I utilize the Future Build Ups Scanner to assess the trend strength. This tool offers two OI Builds: one highlighting intraday build-ups and the other providing a broader perspective over the last 5 days. These insights help me gauge both short-term and medium-term trends in the stocks.

Currently, Petronet exhibits Significant Long Build in both short and medium-term views, while Coal India displays Significant Long Build and Short Covering. Conversely, Chola Finance indicates Short Build in both short-term and medium-term perspectives.

Seems Confusing? Let me break it down for you.

Preference on Short and Medium Term OI Build Ups

I prioritize these trend cycles for short-term and medium-term OI build-ups:

  1. Significant Long Build Ups and Significant Long Build Ups
  2. Significant Long Build Ups and Long Build Ups
  3. Long Build Ups and Long Build Ups
  4. Significant Long Build Ups + Short Covering

For short positions, these preferences can be applied:

  1. Significant Short Build Ups and Significant Short Build Ups
  2. Significant Short Build Ups and Short Build Ups
  3. Short Build Ups and Short Build Ups
  4. Significant Short Build Ups and Long Unwinding

I personally use these combinations. With a bit of observation, you might discover new combinations that work for you. Feel free to share in the comments if you find any new combinations that are effective.

This article is intended solely for educational purposes. Any discussion of stocks or sectors should not be interpreted as recommendations to buy or sell. It is advisable to seek guidance from your financial advisor before making any investment decisions.

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