Put/Call Ratio Tracks Trader ‘Panic’ In Stock Market
Consumer spending is flat, bank earnings are mixed, and stock market volatility isn’t subsiding.
Where do traders look to find direction in this volatility?
Put/call ratio tool tracks ‘panic’ in stock market
Simpler’s traders have been on the front lines of trading this market even on days like Thursday and Friday when the market shifted in ways that caught many traders off guard.
Henry Gambell, Senior Managing Director of Options Trading at Simpler Trading, tracked the sudden drop and then faster rally higher on Thursday using the put/call ratio.
The put/call ratio divides the total traded put options by the number of total traded call options for an index or individual stock. The put/call ratio helps measure market sentiment, i.e. whether traders are buying more call options in a bullish trend or buying more put calls in a bearish trend.
Market sentiment exhibited both sides of the put/call ratio Thursday and then bearish sentiment took over throughout the open session Friday.
While Henry targets stock market internal signals using Fibonacci levels and Voodoo Lines®, he layers in the put/call ratio to ascertain market sentiment – how retail traders are feeling and acting. This helps pattern market movement even in volatile conditions.
This can signal a “panicked” move in the market. Panic sentiment – from traders piling into a selling or buying scenario – is what to watch.
“Follow the put/call ratio, and when you see a move that looks a little euphoric, then the market is probably ready for a move,” Henry said. “You’ll have a lot of your retail traders react with panic and buy or sell against the market move.”
Here are some put/call ratio general guides:
- Below .45 indicates severely negative
- Between .45 and .65 indicates negative, yet not extremely negative
- Between .65 and .75 indicates slightly negative
- Between .70 and .85 is considered neutral, indicating market action and price on the Dow and S&P can go up or down equally as easy
- Between .85 and .95 indicates bullish, but moderate
- Above 1.0 indicates extremely bullish and a point where traders look for trades on the long side
Traders can find the put/call ratio through settings in online trading platforms or separate subscription services.
Learning the “ebb and flow” of the put/call ratio is the key to building skill with how this internal indicator reveals market moves. Extreme values – very low or very high – are what to watch when working to identify “panic” in the market.
This indicator adds another proficient tool to the trading arsenal to help identify bullish and bearish sentiment in the market. However, traders should keep in mind that the put/call ratio is a stock chart analysis tool, but it is not the all-in-one indicator for all market conditions.
There is still no substitute for analytical research and developing technical skills, and then layering in stock chart indicators to make informed trading decisions.
Even then – as the market so resoundingly proved Thursday and Friday – traders face the reality of unexpected risk in the stock market.