Tuesday, June 03, 2014

Finding Trades When Sentiment is Stretched

One of the things I'm noticing in the recent stock market is the importance of sentiment.  When put/call ratios are high, the market is much more likely to rise/bounce than when those ratios are low.

For example, since 2012, suppose you combine the equity put/call ratio with the put/call ratio for stock indexes.  When that measure has been below .80 on a one-day basis, the next five days in SPY have averaged a gain of .05%.  When the measure has been above .80, the next five days in SPY have averaged a gain of .51%.  Indeed, when the equity put/call ratio by itself has been above 1.0, the next five days in SPY have averaged a solid gain of .90%. 

If you can figure out which way the herd is leaning, you can often find a good trade by identifying occasions in which committed traders will need to run for exits when their positions retrace.  I find Market Delta especially helpful in that regard, as the persistent lifting of offers or hitting of bids provides clues to the bullish or bearish execution behavior of traders.  What makes such trades unique is that you are not so much trading a particular stock or market as trading the behaviors of traders themselves.    

A number of other indicators I follow are summarized in this archive post.  When I return from my overseas work with traders, I will post some of the indicators I've found most useful recently.