The stock market is such a complex place where millions of different types of transactions take place every second. In such a highly complex market, there are chances of mistakes and errors that can be happened to anyone, anytime anywhere while executing transactions.
Similarly, sometimes traders mistakenly put the sell order instead of the buy order or vice versa because of complex or large trades. And when such mistakes occur, corrections are made to fix such mistakes. Unwinding is part of such trade error correction that we will discuss today.
Long Unwinding in Stock Market
Before we discuss other things about Unwinding, do you know what is long unwinding in the share market? Let’s make it clear long unwinding meaning in the stock market. “Unwinding is the process of closing a trading position in the stock market, which means when a selling position is made to correct the transaction error, like sold stocks bought again.
The unwinding is a process where participating in a compensating transaction reverses or closes a trade. And a long unwinding in the cash market means exiting the long positions or squaring them off. And unwinding can be done either trader earned the targeted profit or now there is no movement in the stock that has been bought with the speculation to rise in the near term.
What is Long Unwinding in Stocks?
A long position in stocks means traders have created a long position in any stock and then exited from the same stock. Suppose a trader has mistakenly sold the stock instead of buying, then to fix this error he has to unwind that transaction by buying the sold shares and then buying the shares that were initially supposed to be bought.
In indices, traders create long or short positions in future and options. And to unwind the position in indices they have to make the relevant position in the underlying index. While in stocks, traders can create a position in F&O and the cash market as well.
Long Unwinding in Option Chain
In option chain traders writing the call option means there is an agreement between two parties to buy or sell the underlying assets at a specific price on the specific date of expiry in the future. In the option chain Call and Put are the two options traders use to trade. And there are different options like buying or selling options of different strike prices for trade.
In the option trading when any option is bought to unwind the long position it is called the unwinding of the option chain. And when the traders consider the security is overrated and looking to cover further loss or the call option has achieved the target. The unwinding takes place, and the process of call unwinding can be done in limit orders or market orders.
How Does Unwinding Work?
Unwinding is the process of closing out trades that needs multiple transactions, trades or steps that took time to complete the procedure. To understand better let's take an example, suppose you have taken a long position in a stock while at the same time also sold the Put of the same stock, then at a certain point in time you have unwind all trades.
Here the entire process involves examining the options available and then selling the original stocks and the same process is also followed by the brokers, who follow this usually to correct the buying or selling errors done by mistake or system issues. In brief, unwinding is the process of closing or reversing the trade by offsetting all such transactions.
How to Identify Long Unwinding?
Identifying the long unwinding in the stock market is possible in the derivatives market (F&O segment). Because in future and options, the contract of the underlying security is bought and sold in lot size containing the number of shares. And when their contracts are signed or ended the number of underlying security is counted as open interest.
Hence, to identify long unwinding you can use the open interest, and here if you have long unwinding in stock and if it’s open interest is falling along with its price it indicates that the current downtrend of the market is weakening.
What Does Long Unwinding Indicate?
Long unwinding is the result of stock mistakenly sold, but when traders take long positions they wait for the profit, and when they earn some profits they exit from such positions. Long and short positions are usually created in the future and options, and when a buyer who was earlier bullish on the market or towards particular stocks or underlying security is now exiting from their positions and it indicates the market is no longer going to move further.
Long Unwinding is Good or Bad
Long unwinding is usually done to correct mistakenly unwanted transactions. It cannot affect the stock market sentiment, as it is not done at a large scale if there is no huge volume of trades under the unwinding transactions.
However, unlike short-selling, if any particular stock broker has done the long position by mistake and later unwound the position, they are existing from the position, it might affect the stock price movement especially if the volume of trade is high. Hence, unwinding is neither good nor bad for the market but individually it is not good for the traders.
In case your broker has accidentally performed a wrong transaction while managing the investor's funds, then the broker has to unwind the position. Suppose, instead of selling the stocks, the broker has bought the stocks, then to fix this error, the broker has to resell the stocks that were accidentally bought.
Here broker makes the original selling transaction and if during this unwinding process to correct the error, then the broker would be responsible for such losses. Investors have nothing to do with such mistakes, they will not bear such losses.
Why Long Unwinding is Good?
If you have thorough knowledge and experience about such trading or how to unwind and have the idea of a market crash that has the potential to give profits from the stock market, then unwinding could be a profitable trading strategy for you.
While on the other hand, when brokers are not sure about the market risk, and looking to recover the loss, they use the long unwinding process, to deal with unexpected losses and stabilize their trades.
However, the traders, who hold a long position in the stock will realize that the future of the stock is not promising, in such situations, they use the long unwinding when the stock's value seems high and if shortly, the stock goes down during the intraday trading, they will purchase the stock again at a lower price, resulting a huge gain in the profit.
Why Long Unwinding is Bad?
Short-positioned traders, using the long unwinding strategy may suffer a huge loss in long-positioned trading in the stocks. Here a broker will face an unexpected loss, especially when a false operation is performed in the stock by traders.
In the stock market if the unwinding positions are taking place in huge quantities due to scams or illegal transactions, then the market might crash which can cause insecurity among the investors. And in such panic investors start withdrawing the money from stocks resulting market going down further.
And finally, the market crash has an impact on the entire economy of the country, and it also affects the growth of the economy. In the Harshad Mehta scam, the entire market crashed when investors started withdrawing money from the market which resulted in millions of losses to retail investors.
Long Unwinding Stocks
Long unwinding stocks are mostly included in the F&O segment. Mainly stocks having high volatility or high beta are included in the derivatives segment also chosen during the unwinding process. And when there is a change in open interest, and the price of the stock also charges, it means there is an unwinding process going on in the stock.
Though, in the cash market, unwinding means exiting from the long positions and squaring the same. In stocks when there is unwinding process happens, you can see the stock price starts falling and open interest also changes due to the fall. And traders can choose any stock from the F&O segment for unwinding or depending on the transaction errors.
Unwinding is the process of exiting the long positions in stocks or underlying security or indices and that is because of mistakes in doing the transactions. To cover the long poison, traders sell the stocks and exit from such trades.
To identify the unwinding of the long positions you can check the change in open interest with the change in price of stocks. Unwinding indicates market or stock is not going to move further, that's why traders are exiting from their positions.
And finally, unwinding is good for the traders giving them an option or an opportunity to correct their trading mistakes. Though, the huge quantity of unwinding traders in the market can create chaos among the investors resulting in panic in the market.
Also Read: Golden Rules of investing in Stock Market
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