What’s the story behind the OI patterns?
What’s the story behind the OI patterns?

Chapter 4

What’s the story behind the OI patterns?

In the prior chapter, the NSE Open Interest and Price relationship of an underlying were studied. But the financial markets have a mind of their own. It is an intermingling of several of these price-OI relationships which influence the price action and price expectations. We are aware that the ascent and descent of prices is hardly linear. The mathematicians and financial engineers call price movements of underlying assets like Nifty, or F&O stocks as fractal by nature, which are never ending patterns. Fractals are infinitely complex patterns that are self-similar across different scales.

So, inherently there is some sequence and not a linear performance.

The generic sequence has been highlighted ahead, based on NSE OI data.

Sequence of Open interest in the form of builtup and unwinding

Sequence #1:

In a bull cycle, we notice two price-oi combinations play out, namely, 

    • Long
    • Long unwinding

The prices rise up and open interest also increases, it suggests that new participants are entering the market despite rising prices, implying an upward or bullish bias. This is as discussed in earlier chapter, referred to as Long. After an impulsive move of prices of the underlying in the northward direction, a respite can be observed, where prices tend to come lower and there is also a shrinkage in OI, this is referred to as Long unwinding, a pause in the bullish move.

The above cycle is a bullish cycle, consisting of long build-up when price are heading higher and long unwinding, each time prices are drifting lower.

Sequence of Bullish cycle in terms of Open interest

Ahead is an example of Long- Long unwinding cycle of BANKNIFTY, based on NSE OI data, where there are some bars indicating short covering, but clearly, no shorts visible in the marked zone.

Example of how a bullish cycle can be observed in Quantsapp Builtup tool.

In a bear cycle, we notice two price-oi combinations play out, namely,

    • Short
    • Short Covering

The prices drop and open interest increases, it suggests that new participants are entering the market despite dropping prices, implying a downward or bearish bias. This is as discussed in earlier chapter, referred to as short. After an impulsive move of prices of the underlying in the southward direction, a pull-back can be observed, where prices tend to move higher and there is also a shrinkage in OI, this is referred to as short covering move, a pause in the bearish move.

The above cycle is a bear cycle, consisting of short build-up, when prices head lower and short covering; each time prices are drifting higher. The study/cycle is based on NSE OI data.

Sequence of Bearish cycle in terms of Open interest

Ahead is an example of Short- Short Covering cycle of INFOSYS, where there are very few bars indicating long unwinding, but clearly, only one long visible in the marked zone. These studies can be carried out with Quantsapp, one of the leading option analytics platform, using the Built-up tool.

Example of how a bearish cycle can be observed in Quantsapp Builtup tool.

FAQs

What is a fractal?

Fractals are infinitely complex patterns which are similar on different time scales.

What is a bull cycle?

Bull cycle is a sequence of specific price – OI combination namely, long and long unwinding. Long position occurs when prices of the futures increase with an increase in OI. Long unwinding occurs when prices of the futures decrease with a decrease in OI.

What is a bear cycle?

Bear cycle is a sequence of specific price – OI combination namely, short and short covering. Short position occurs when prices of the futures decrease with an increase in OI. Short covering occurs when prices of the futures increase with a decrease in OI.

Do futures prices move linearly?

No, the movement of futures prices are fractal by nature.