Price and Open interest – Do they ever lie?

Price and Open interest – Do they ever lie?

There is an old saying that life is like a game of chess. If we know our opponent’s game, our chances of winning are only 50% (because we do not know whether our opponent knows our game or not). This is true even in case of our favorite market – the stock market.

Many times we have observed that based on technical indicators we put a stop loss and the market rises just after the stop loss is triggered. Have we ever thought why it is so? There is always a fight between bulls and bears and both sides have read the books on technical analysis and they try to mislead each other.

Let us discuss an interesting trading strategy known to be adopted by institutions and big operators.

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The Strategy

As per most text books there is an established principle that if the price rises with rise in open interest the market is bullish. However, there is a lacuna in this information. In case of a calendar spread transaction i.e. buy near month future and sell far month future, usually the open interest of the both the position is counted. There will be an increase in the open interest but this could be misleading.

In the May 2013 expiry the same strategy was adopted by big players. Because of this reason there was 2.6% price rise in the week ending on 30th May 13 (5 days) but 3.4% fall in next three days of new expiry. It was because of this strategy adopted by big players.

Also Read : Markets from an Analyst’s eye

Devil is in the Detail

So if your trading decisions are based on price and open interest analysis, please be careful and study month wise open interest too.

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