TECHNICAL TOOLS: Against the Grain
Email This Article
Print This Article
SubscribeMOST POPULAR ARTICLES
- Kaeppel's Corner: Twisted VIXter
- Closing Wrap-Up, July 29
- Morning Watch, July 30
- Market Trends: Platinum Probability Bands
- Economic Watchdog, July 29
- Midday Action: July 29
- Morning Watch, July 29
- Growth Stock Swing Option: July 28, 2010
- Closing Wrap-Up, July 30
- Real-World Trading: Using Calendar Spreads in Sideways Markets, VII
- Real-World Trading: Using Calendar Spreads in Sideways Markets, VII
- Kaeppel's Corner: Twisted VIXter
- Real-World Trading: Using Calendar Spreads in Sideways Markets, Part VI
- Real-World Trading: Using Calendar Spreads in Sideways Markets, Part V
- Fundamental Focus: Insuring Your Portfolio
- Trading Calendar Spreads with Options
- REAL-WORLD TRADING: Five-Minute Success Formula
- Midday Action: July 30
- AU Editorial: Money and Holidays
- Hot Shots, July 30: Straddling a Breakout Performance from Within
- Economic Watchdog, July 29
- Market Trends: Platinum Probability Bands
- Midday Action: July 29
- Growth Stock Swing Option: July 28, 2010
- AU Market Review: Market Action
- Midday Action: July 28
- Real-World Trading: Using Calendar Spreads in Sideways Markets, VII
SPONSORED LINKS
July 27, 2007
Taking a contrarian view is often what trading (and investing) is all about. Contrarian is defined by the Merriam-Webster Online dictionary as a person who takes a contrary position or attitude. For our purposes, a secondary definition an investor who buys shares of stock when most others are selling and sells when others are buying is more to the point.
This approach is based on the idea that, at any given time, the majority of participants have an incorrect view of the markets in which they are involved. The adage buy when there is blood in the streets in another way to express this approach.
Contrarian analysis can take many forms, from buying in retracements to watching for overly bullish or bearish front page news then taking the opposite view.
Another very popular method is what is known as the Put/Call Ratio. This indicator divides the total Puts purchased on a stock by the number of Calls. The idea is that when more people are bearish on a stock and buying Puts its probably oversold; and when more people are bullish on a stock and buying Calls its probably overbought.
A Put/Call ratio of 1.00 indicates that there are an equal number of Puts and Calls on the stock. A reading greater than 1 means there are more Puts than Calls, while a reading of less than 1 means there are more Calls than Puts.
It would be reasonable to assume that a reading of 1 is a neutral level or balance point for this indicator. However in most markets there are typically more Calls than Puts purchased. For this reason, the typical neutral level for this indicator is 0.75. Anything above 1 is regarded as potentially oversold and anything below 0.50 as overbought.
Chart 1 CBOE All Equity Put/Call Ratio
In a similar fashion, the ratio moving below 0.5 in early May warned that stocks were overbought and not long after that the recent sideways trading pattern followed.
As shown above this certainly isnt an indicator that can be used for direct entry and exit signals, however there are traders who have modified it to do so! Instead, we are looking at a very straightforward method of determining the probability of coming trend direction.
When the Put/Call ratio is close to or above 1.00, its time to look at tightening stops on bearish trades and/or search for bullish ones. When the Put/Call ratio is close to or below 0.50, its time to tighten stops on bullish trades and look for bearish ones. Thats as complicated as it needs to be!
Until next time
Happy Trading
Jordan Craw
Trading Tutors
© Copyright 1995-2010 Optionetics. All rights reserved. This material is for personal use only. Republication and re-dissemination, including posting to newsgroups, is expressly prohibited without the prior written consent of Optionetics. Optionetics is a registered trademark of Optionetics, Inc.