stevespray
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Interpretation of Put / Call Ratio’s and other related indicators.
Take an un-biased approach.
The first point that I want to make about this subject is an important one. IT IS NOT 100% CORRECT 100% OF THE TIME. Like any system or indicator it is open to a degree of error and that error can, through interpretation, become either ignored or amplified. Where ever there is human interpretation there is a likelihood that many different people will interpret the same set of data figures in several different ways. This can be for many reasons. People who are bulls will look for positive factors to reassure themselves that they are correct, likewise, the bears may act in a similar fashion.
With all of the above in mind I have found that you need to try and place your mind in some kind of un-biased state before observing anything that you feel may point you towards forming an opinion of general market direction. This can be quite hard but over time is possible. It’s all about how easily YOU except that sometimes you are WRONG!
Interpretation of indicators vs. timeframe trading.
I feel that one of the most common errors made by people who trade on a regular basis is one of failing to establish a suitable level of timeframe based on the indicators which they are using. This appears often when analysing indicators such as Put / Call and also Elliot Wave Theories. I will endeavour to elaborate further. I have observed that people tend to apply indicators to too smaller time frames and because of this the indicators are of little technical use because, by the time their effect is evident, the trade has long been stopped out. Someone famous once said “The market can remain irrational far longer than I can stay solvent”…….Folk should print this out in 12 inch high letters and hang it in the office in clear view.
The fact is that if the market was a rational place then most would make money on a consistent basis, implicitly people don’t make money that easily and, in fact, once you’ve tried to make money at it you find that it is certainly easier to lose money than to accumulate it. Ask yourself why this is so?
When you trade you need to be sure that the indicators which you are using suits your trading style. If you are someone who likes the thought of jumping in and out of the market several times on a daily basis then the chances are that EW and Put / Call Ratio’s are of little real direct use to you. Put simply, market noise (ie the more random movement of prices in the short term) negates any real advantages these indicators provide except perhaps a small insight into general market direction. If you are someone who likes to run trades over a period of several days (or longer) then indicators like Put / Call can almost certainly provide you with an invaluable insight into what the masses are doing and, more importantly, how the crowd are reacting to sharp changes in market prices.
Psychology of the masses.
Generally speaking, the market will reward the few and punish the many. At no time is this more true than when you trade over the short term. The markets ability to punish human nature is, in my opinion, unparalleled. The large volumes which appear at market tops and bottoms is the most graphic evidence of this fact. This is true over many time frames ranging from 5 minute to weekly. Volumes form an important part of my own personal interpretations of Put / Call Ratio. Put simply, I like to see how convinced people are about market direction. This is especially true when markets are in potential overbought and oversold areas. Traditionally, in my experience, people who are looking for ‘Changes In Trend’ (CIT) are the folk most likely to get caught out by extended breakouts of a market. This is because, generally, these folk don’t wait for price action conformation before taking positions which will profit through a CIT. These people are happy to sell a new high or buy a new low. They are also people who fail to apply a sensible stop loss and who are prepared to ‘cost average’ their position (and hence double their risk) if the position goes further against them. These are the folk who will be punished most by an irrational market. Put / Call helps us identify when such activity is taking place.
Some ‘classic’ examples based on analysis.
I use a number of indicators to form the basis of my Put / Call studies. These are as follows…..
$WPCVE – CBOE Put Call Ratio on Equities
$WPCVA – CBOE Put Call Ratio on All Products
$WPVA - CBOE Put Call Volume on All Products
I set these up on daily charts and apply a number of indicators. For the two basic Put Call Ratio charts (Equities and All Products) I like to have a 5 day cumulative indicator. For the Put Call Volume chart I like also to have a simple moving average of around a week or two (say 7 – 8 sessions). The aim of these indicators is to filter out noise and hence reveal a signal.
Essentially I look for a number of factors when analysing the data and the indicators. Firstly, sharp changes in sentiment which last more than a day or so interests me. Secondly, a steady change in sentiment which builds over a period of several sessions also interests me. When either of these two events occur I look at price action. I will expand on this further once I’ve laid out some further observations concerning the actual indicators. What I’m really looking to do is to analyse the psychology of the crowd through the interpretation of the available data. Generally speaking as the market moves upwards people become more bullish. Likewise, as the market falls folk become bearish. What we are looking to establish through our study is essentially a level of ‘acceptance’ of these ‘new’ prices. This is hard to do if we simply look at one particular day’s data. This is where our cumulative studies help us. Generally speaking we can see what the masses are doing over an extended period of time. We can detect weather the shorter time frame traders are fighting a potential move or are just going with the flow. Some clear examples of this are evident if you were to study the relevant charts and data from the last six months. There are several points where it is clear that many people where ‘buying the market top’ and also that they then ‘sold the market bottom’. These are classic bull / bear traps which occur at tops and bottoms and these are very expensive experiences for the pre-emptive CIT boys because it is generally the point where they are 180 degrees out of sink with the market. With this in mind we are looking for points where the majority of these folk suddenly change their minds and decide that, on reflection, they have been wrong and the trend isn’t going to change (or at least they cant afford to speculate on a CIT any long). This is generally evidenced by the indicators showing us that a large percentage of folk are now in agreement with the direction that the market is moving. This is often then the point where we do actually reverse. I personally don’t pre-empt this reversal. I like to see at least a day of solid strength / weakness which backs up our predicted CIT. After that I like to see a further pre market + opening supporting our CIT. It is only then that my bias will generally change.
Essentially we are looking for suckers (and I mean that in a nice way) who are fighting a market which is clearly in a trend. If the market is moving higher in a steady fashion and Put / Call is generally rising then you can almost be certain (baring a bad news event) that we will continue to see higher prices in the short term. Likewise, if we get a steady run up followed by a small down day which sees a large jump in Put activity you can often be sure that the top is not in. Remember, the market does not reward the many, it rewards the few. Hence, the market is unlikely to reward the majority of people who start buying Puts at the moment weakness is seen after a nice run up (again, these people are predicting a top and use the first sign or weakness as a trigger to ‘swing short’). The flip side of that is obviously a situation were the market continues running up to point where Put activity gets extremely low (hence Call activity percentage wise is much higher). This often means that bears are rolling over and the majority are now bullish. This is when tops occur. Again this is a point where, if the market carried on going up, the majority would get rewarded and therefore higher prices are unlikely. Put simply, In order for a market to carry on moving in its current direction you are generally going to require a large number of people to be acting in a manner which is apposing the move. If you think about it logically, a market which moves higher despite the fact that so many are bearish is clearly a powerful one.
To conclude
Obviously, as I have already pointed out already, you can not simply take one indicator and apply it in such a manner as to continually make money. Having said that I believe that the studies of the Put Call Ratio’s which I have looked into are one of the most powerful indicators which I personally have. When you combine the Put Call studies with an entry criteria which is based on price conformation then you will surely have a method which can offer some fantastic rewards whilst drastically limiting your risk exposure because you will be betting on potential new trends almost from their moment of inception.
I hope this, my own personal insight, will be of help to others who like, from time to time, to try and interpret Put Call ratio’s.
Wishes,
Stevie.
Take an un-biased approach.
The first point that I want to make about this subject is an important one. IT IS NOT 100% CORRECT 100% OF THE TIME. Like any system or indicator it is open to a degree of error and that error can, through interpretation, become either ignored or amplified. Where ever there is human interpretation there is a likelihood that many different people will interpret the same set of data figures in several different ways. This can be for many reasons. People who are bulls will look for positive factors to reassure themselves that they are correct, likewise, the bears may act in a similar fashion.
With all of the above in mind I have found that you need to try and place your mind in some kind of un-biased state before observing anything that you feel may point you towards forming an opinion of general market direction. This can be quite hard but over time is possible. It’s all about how easily YOU except that sometimes you are WRONG!
Interpretation of indicators vs. timeframe trading.
I feel that one of the most common errors made by people who trade on a regular basis is one of failing to establish a suitable level of timeframe based on the indicators which they are using. This appears often when analysing indicators such as Put / Call and also Elliot Wave Theories. I will endeavour to elaborate further. I have observed that people tend to apply indicators to too smaller time frames and because of this the indicators are of little technical use because, by the time their effect is evident, the trade has long been stopped out. Someone famous once said “The market can remain irrational far longer than I can stay solvent”…….Folk should print this out in 12 inch high letters and hang it in the office in clear view.
The fact is that if the market was a rational place then most would make money on a consistent basis, implicitly people don’t make money that easily and, in fact, once you’ve tried to make money at it you find that it is certainly easier to lose money than to accumulate it. Ask yourself why this is so?
When you trade you need to be sure that the indicators which you are using suits your trading style. If you are someone who likes the thought of jumping in and out of the market several times on a daily basis then the chances are that EW and Put / Call Ratio’s are of little real direct use to you. Put simply, market noise (ie the more random movement of prices in the short term) negates any real advantages these indicators provide except perhaps a small insight into general market direction. If you are someone who likes to run trades over a period of several days (or longer) then indicators like Put / Call can almost certainly provide you with an invaluable insight into what the masses are doing and, more importantly, how the crowd are reacting to sharp changes in market prices.
Psychology of the masses.
Generally speaking, the market will reward the few and punish the many. At no time is this more true than when you trade over the short term. The markets ability to punish human nature is, in my opinion, unparalleled. The large volumes which appear at market tops and bottoms is the most graphic evidence of this fact. This is true over many time frames ranging from 5 minute to weekly. Volumes form an important part of my own personal interpretations of Put / Call Ratio. Put simply, I like to see how convinced people are about market direction. This is especially true when markets are in potential overbought and oversold areas. Traditionally, in my experience, people who are looking for ‘Changes In Trend’ (CIT) are the folk most likely to get caught out by extended breakouts of a market. This is because, generally, these folk don’t wait for price action conformation before taking positions which will profit through a CIT. These people are happy to sell a new high or buy a new low. They are also people who fail to apply a sensible stop loss and who are prepared to ‘cost average’ their position (and hence double their risk) if the position goes further against them. These are the folk who will be punished most by an irrational market. Put / Call helps us identify when such activity is taking place.
Some ‘classic’ examples based on analysis.
I use a number of indicators to form the basis of my Put / Call studies. These are as follows…..
$WPCVE – CBOE Put Call Ratio on Equities
$WPCVA – CBOE Put Call Ratio on All Products
$WPVA - CBOE Put Call Volume on All Products
I set these up on daily charts and apply a number of indicators. For the two basic Put Call Ratio charts (Equities and All Products) I like to have a 5 day cumulative indicator. For the Put Call Volume chart I like also to have a simple moving average of around a week or two (say 7 – 8 sessions). The aim of these indicators is to filter out noise and hence reveal a signal.
Essentially I look for a number of factors when analysing the data and the indicators. Firstly, sharp changes in sentiment which last more than a day or so interests me. Secondly, a steady change in sentiment which builds over a period of several sessions also interests me. When either of these two events occur I look at price action. I will expand on this further once I’ve laid out some further observations concerning the actual indicators. What I’m really looking to do is to analyse the psychology of the crowd through the interpretation of the available data. Generally speaking as the market moves upwards people become more bullish. Likewise, as the market falls folk become bearish. What we are looking to establish through our study is essentially a level of ‘acceptance’ of these ‘new’ prices. This is hard to do if we simply look at one particular day’s data. This is where our cumulative studies help us. Generally speaking we can see what the masses are doing over an extended period of time. We can detect weather the shorter time frame traders are fighting a potential move or are just going with the flow. Some clear examples of this are evident if you were to study the relevant charts and data from the last six months. There are several points where it is clear that many people where ‘buying the market top’ and also that they then ‘sold the market bottom’. These are classic bull / bear traps which occur at tops and bottoms and these are very expensive experiences for the pre-emptive CIT boys because it is generally the point where they are 180 degrees out of sink with the market. With this in mind we are looking for points where the majority of these folk suddenly change their minds and decide that, on reflection, they have been wrong and the trend isn’t going to change (or at least they cant afford to speculate on a CIT any long). This is generally evidenced by the indicators showing us that a large percentage of folk are now in agreement with the direction that the market is moving. This is often then the point where we do actually reverse. I personally don’t pre-empt this reversal. I like to see at least a day of solid strength / weakness which backs up our predicted CIT. After that I like to see a further pre market + opening supporting our CIT. It is only then that my bias will generally change.
Essentially we are looking for suckers (and I mean that in a nice way) who are fighting a market which is clearly in a trend. If the market is moving higher in a steady fashion and Put / Call is generally rising then you can almost be certain (baring a bad news event) that we will continue to see higher prices in the short term. Likewise, if we get a steady run up followed by a small down day which sees a large jump in Put activity you can often be sure that the top is not in. Remember, the market does not reward the many, it rewards the few. Hence, the market is unlikely to reward the majority of people who start buying Puts at the moment weakness is seen after a nice run up (again, these people are predicting a top and use the first sign or weakness as a trigger to ‘swing short’). The flip side of that is obviously a situation were the market continues running up to point where Put activity gets extremely low (hence Call activity percentage wise is much higher). This often means that bears are rolling over and the majority are now bullish. This is when tops occur. Again this is a point where, if the market carried on going up, the majority would get rewarded and therefore higher prices are unlikely. Put simply, In order for a market to carry on moving in its current direction you are generally going to require a large number of people to be acting in a manner which is apposing the move. If you think about it logically, a market which moves higher despite the fact that so many are bearish is clearly a powerful one.
To conclude
Obviously, as I have already pointed out already, you can not simply take one indicator and apply it in such a manner as to continually make money. Having said that I believe that the studies of the Put Call Ratio’s which I have looked into are one of the most powerful indicators which I personally have. When you combine the Put Call studies with an entry criteria which is based on price conformation then you will surely have a method which can offer some fantastic rewards whilst drastically limiting your risk exposure because you will be betting on potential new trends almost from their moment of inception.
I hope this, my own personal insight, will be of help to others who like, from time to time, to try and interpret Put Call ratio’s.
Wishes,
Stevie.
