Price action is one of the most popular technical analysis tools used by traders. It involves analyzing the historical price movements of a security to identify patterns that can be used to predict future price movements.
However, price action can be misleading, as it can be influenced by a variety of factors, including news events, investor sentiment, and market manipulation. Open interest is a more reliable indicator of market sentiment than price action. It measures the total number of open contracts in a futures or options market.
When open interest increases, it indicates that more traders are entering the market, which is a bullish signal. When open interest decreases, it indicates that traders are exiting the market, which is a bearish signal. Here are three reasons why open interest is more important than price action:
1. Open interest is a leading indicator
Price action is a lagging indicator, meaning that it reflects what has already happened in the market. Open interest, on the other hand, is a leading indicator, meaning that it can be used to predict future price movements. For example, if open interest starts to increase in a stock that has been trending down, it could be a sign that the trend is about to reverse. To understand this concept better, let's take a look at a simple example. Imagine a stock that has been trending down for the past few weeks. The price action has been very choppy, with a lot of ups and downs.
However, if you look at the open interest, you will see that it has been steadily increasing. This tells you that more and more traders are entering the market, even though the price action is still negative. This is a bullish signal, as it suggests that the trend is about to reverse.
2. Open interest is more reliable.
Price action can be influenced by a variety of factors, including news events, investor sentiment, and market manipulation. Open interest, on the other hand, is not as easily influenced by these factors. This makes open interest a more reliable indicator of market sentiment. For example, let's say there is a major news event that causes the price of a stock to go down. The price action will likely reflect this news event, and the stock price will likely go down. However, the open interest may not change much, or it may even increase. This is because open interest is not as easily influenced by news events.
In simple words, you can say that where price action is predicting future movement based on the past movement, Open Interest is telling us what is happening right now. Which is more important for us.
For example, a stock or an indices opened gap-up. When it's already gap-up, its past. We need to know whether this gap-up sustains or not? Here Open interest tells us what is actually happening in the market.
Like after a gap-up is you see long buildup in that script that means people are creating new long positions and we may expect further upside movement. And if there is long unwinding or short buildup that means this stock or indices will not sustain and we may expect some downside movement.
I hope now you have understood, why Open interest is more reliable compare to price action. Have question? Type in the comment box.
3. Open interest can be used to identify support and resistance levels.
Support and resistance levels are important technical analysis tools that can help traders identify potential entry and exit points.
Open interest can be used to identify support and resistance levels by looking for areas where there is a high concentration of open contracts. For example, if there is a large number of open contracts at a particular price level, it is likely that that price level will act as a support or resistance level. This is a very powerful tool, as it can help traders to identify potential trading opportunities. For example, if you see that open interest is increasing at a particular price level, it could be a sign that that price level is about to become a support level. This could be a good entry point for a long trade. In conclusion, open interest is a more reliable and informative indicator of market sentiment than price action. By tracking open interest, traders can gain a better understanding of where the market is headed and make more informed trading decisions.
I have written a detailed blog about how to find support and resistance using Open Interest and PCR.
Here are some additional tips for using open interest to your advantage:
Use open interest in conjunction with other technical analysis tools.
Open interest is most effective when used in conjunction with other technical analysis tools, such as price action, volume, and moving averages. By combining these tools, you can get a more comprehensive view of the market and make more informed trading decisions.
Pay attention to changes in open interest.
A sudden increase or decrease in open interest can be a sign of a major shift in market sentiment. If you see a large increase in open interest, it could be a sign that a trend is about to start or accelerate. A large decrease in open interest, on the other hand, could be a sign that a trend is about to end or reverse.
Use open interest to identify support and resistance levels.
As mentioned earlier, open interest can be used to identify support and resistance levels. This can be a helpful tool for identifying potential entry and exit points. By following these tips, you can use open interest to your advantage and improve your trading results.
If you are new to option trading, I recommend that you start by learning how to use open interest to find highly profitable traders. There are many resources available online and in libraries that can help you learn more about Open Interest.
Option Strategies: A Mentoring program is one such resource that teaches you the practice implementations of open interest for intraday and positional strategies via live mentoring. To enrol, click the button below.
Once you understand the basics of open interest, you can start to use it in your trading. However, it is important to remember that open interest are not a guarantee of profit. It's a simply tool that can be used to manage risk and to improve your chances of success in options trading.
I hope this article has helped you to understand the important of open interest. If you have any further questions, please feel free to ask me in the comment box.