In the ‘Change in OI and market positioning’ table of the ‘Do the Derivatives’ page, there is a column for indication. Explain how to conclude whether it is a long build-up or short build-up etc.
In derivatives, we can assess the expectations of the participants. This will let us know how strong the existing trend is or whether the prevailing trend is losing momentum. For this, we use the Open Interest (OI) data along with the price of that security. Below are the four scenarios.
Long build-up: If the price of the security and OI increase simultaneously, traders are adding fresh positions as the price goes up. That is, they are bidding the price up. As they add fresh longs, OI goes up. This scenario is called long build-up. Participants continue to buy even though the price goes up because they are considerably bullish on that security. Here, the probability of the price going up further is high.
Long unwinding: The price and OI of the security decrease at the same time. Here, traders, who have bought earlier, have started to offload their longs. Once they start exiting (essentially selling), the price drops. Since they are exiting the trades, the OI also drops. This is called long unwinding, which indicates that the rally is weakening or a bearish trend reversal is on the cards.
Short build-up: Similar to long build-up, only the direction is different. As the price of the security falls, traders open more short positions. They do this because of their bearish expectations. So, as participants sell more, the OI goes up and the price falls as well. This scenario is short build-up. As the name suggests, short positions are being built up — increased, indicating strong bear trend.
Short covering: This is like long unwinding, but the direction of price movement differs. Traders who have been selling the security had started to reverse their positions — exit the shorts that were opened earlier. Exiting shorts essentially means buying back, resulting in an increase in price. Because they are exiting the positions that are already open, OI will start declining. So here, the price increases and OI decreases, called short covering. This is an indication that the downtrend is losing momentum or a bullish reversal is around the corner.
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