Whether to carry forward position? Futures OI data has the answer

Traders are trend seekers. Moves in the market everyday gives us traders the stimulus to the trend in the making. However, it is always to be or not to be question. This is because while the current move may not necessarily continue tomorrow.

Variety of studies go into figuring out the life and more importantly continuance of the trend. This question can be answered in 2 parts. Fortunately, both of these parts use Futures Open Interest (OI) data. It becomes fairly simple to gauge with reasonable confidence that the current move has legs.

Before we get into that, let us revise 4 different inferences that we make using Futures OI associated with Price.

Futures OI Up + Price Up = Long = Bullish Bias

Futures OI UP + Price Down = Short = Bearish Bias

Futures OI Down + Price Down = Long Unwinding = Bullish to Neutral

Futures OI Down + Price Up = Short Covering = Bearish to Neutral

As can be seen from above equations only concentrating on Price movement may be misleading, strictly from the data reading perspective.

Step #1

It is not difficult to get these labeling across the symbols trading in Futures. Before we go ahead and try to check whether to carry forward today’s Price move led trade, it is always important to see whether the overall market is supporting the direction or not.

Most of us traders try to get into a bullish trade when the overall market trend is bullish. Logic is that overall trend could eventually support the stock that we have selected.

So, before our Bullish Trade:

Ensure 50%+ stocks are showing either Longs / Long Unwinding (Indicating overall Positive Futures OI Breadth)

For Bearish Trade:

Ensure 50%+ stocks are showing either Shorts / Shorts Short Covering (Indicating overall Negative Futures OI Breadth)

I will not say that if this does not validate you must not take a trade. In such case where Bullish trade is intended in Bearish Futures Breadth, on would review it thoroughly.

Step #2:

As indicated by 4 different signs of Price + OI reading of Futures all the up moves may not mean incremental bullish bias in to the stock.

Hence, it is very important that the Price move that we want to ride by taking a trade and carry forward it for the next day/s is coupled with rise in OI of the futures. Simple reason justifies this.

Trader always looks for fresh trading bias entering into the stock. That incremental participation resulting into Price move up/down is indicated by rise in OI.

Hence, One of the most crucial factors:

Ensure OI is Up along with Price Up / Down in the stock we intend to enter and carry forward.

Long Unwinding or Short Covering resulted by reduction in OI indicates that the existing traders are exiting. This means there is a “May Be” to whether this move will get any follow up or not. Hence, they are read as Neutralizing OI activity.

Thus, a simple OI filter gives us a fantastic tool to tell apart potential movers from one day wonders.