Signals generated by the Put/Call ratio have been very accurate this last year. It doesn't speak often, maybe a few times a year, but when it does, it pays to pay attention to it. A few days ago I wrote that several indicators of market sentiment had gotten quite high, including the 5 day average of the put/call ratio. Calls are leveraged bullish bets (strong belief market will go up) and puts are leveraged bearish bets (strong belief markets will decline). When the 5 or 10 day moving average reaches one standard deviation from the mean, the signal is highly contrarian; in the short term speculators are so convinced they are using leverage. In my experience this is almost exactly a turning point in the previous trend.
My personal put/call setup is a long term mean of one day closes of the put/call ratio. Then I calculate 1, and 1.5 standard deviations from the long term mean. Signals are generated when either the 5 or 10 day moving average crosses beyond the 1 or 1.5 standard deviation lines, then cross back, indicating a turn in sentiment is occurring or is imminent. That being said, lets look at the put/call ratio and where it stands today.
Chart 1: Total Put Call Ratio $CPC
In November the 5 day moving average indeed crossed the signal line then back, indicating short term sentiment was indeed running high. The broad market did pull back, but the previous signal in mid-November seems to have failed. But now the 5 day average is back in the signal area, indicating that in the near term, the market is saturated with Bulls. I will be watching to see if this signal get even more extreme, possibly enough to drag even the 10 day moving average below the signal line, which would be a very bearish setup.
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