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4 ways in which traders can sense market's direction by using participation data

Sensing fresh directional impulse or expected halt in on going directional move becomes easy and such directional impulses can be used, if not as principal argument yet as a supporting argument for creating or unwinding a trade

SHUBHAM AGARWAL | 07-Jul-19
Reading Time: 3 minutes

undefined Trade history has always been a guiding force in sensing the expectation of masses.

There have been multiple studies circling around historical trading elements that have proved capable of detecting and guiding future trading action.

Such trading history in the futures and options (F&O) market revolves around a couple of data points -- one being price differential and the being the open interest (OI).

While open interest gives an idea of how popular the instrument is among the participating traders, ‘Price differential’ lets us know how processed prices are navigating away from the scientific price calculations.

The price differential is a big science in itself and would require more than just a paper to analyze and make forecasting sense out of it. The Open Interest data, on the other hand, has always been quite straight forward.

We will discuss observations and inferences on widely traded Futures instrument. Futures Open Interest reading should be looked at with the help of three parameters viz. Price of the underlying, Premium/Discount on the future instrument and Open Interest data.

Four different kinds of readings with these parameters can be made with directional inferences.

1) Long:

When we have Open Interest increment of 5 percent or higher with increment in Underlying Price and Increment in Premium or Decrement in Discount.

Inference: The fact that there was an increment in the open interest means that there is a new set of entrants in the stock with an expectation of fresh directional quotient.

Secondly, the combination of increment in the underlying price and increment in the Premium indicates that there is some sense of urgency in creating the position among the buyers.

These observations could be concluded as Long reading in the futures. Such a build-up can be used as an argument for a bullish outlook on the underlying.

2. Short:

When we have Open Interest increment of 5% or higher with a decrement in Underlying Price and decrement in Premium or Increment in Discount.

Inference: Here the case is exactly opposite while the fresh directional quotient is still sensed via increment in open interest in futures. The price action in the underlying and the movement in the premium/discount is pointing downwards.

Such observations could be concluded as Short reading in the futures. Such built up can be used as an argument for the bearish outlook on the underlying.

3. Long Unwinding:

When we have all decrements open interest down, price down and Premium down as well.

Inference: Here there is a decrement in prices and decrement in OI indicates reduction in directional quotient.

Such observations could be labeled as Long Unwinding in futures. Such built up can be used as an argument for booking out of the buy position as this is a neutralizing factor and not a fresh directional impulse.

4. Short Covering:

When we have open interest down but Price Up and Premium Up.

Inference: Here there is an increment in prices and decrement in OI indicates a reduction in the downward directional quotient.

Such observation could be labeled as Short Covering in futures. Such open interest action can be used as an argument for booking out of short position.

Thus, sensing fresh directional impulse or expected halt in on going directional move becomes easy and such directional impulses can be used if not as principal argument yet as a supporting argument for creating or unwinding a trade.

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SHUBHAM AGARWAL is a CEO & Head of Research at Quantsapp Pvt. Ltd. He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages. Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.

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