Kesava Kumar A Kesava Kumar A, is Charted Market Technician, founder of SCube Analytics, specializes in the algorithmic trading, use of proprietary blend of sentiment & technical systems. Worked extensively in IT with work experience in USA and Middle East. Also completed "strategic management" program from IIMK. twitter: @KKumarCMT

Crowd Sentiment & Trading against them

2 min read

Crowd Sentiment & Trading against –

The word “Crowd” here is referring to emotionally driven investors/traders with less sophistication, who became uniform in their view of the market.

Why crowd goes together – humans nature is such that most people need to be emotionally secure in their decisions, which is precisely why they get pulled along with herd, and they chose to ignore the history , even their own trade setups/plans and thus capitulate to the herd mentality.

Who else are part of the crowd – today with market dominated by mutual fund managers & chartists who are considered as professional , but how many times these so called experts succeeded. They keep saying “Buy On Dips”, but none of these professionals knows which of their Buy on Dips is saying “Bye Bye”.

There is another argument that charts shows everything so chartists should be excluded to this broader term of Crowd. As Constance Brown says the most of the chartists use their default setting of their charting platform and they never bother to change and they get into same trap of unifom view on the markets. Just check how many times there is consensus with your fellow group on particular stock/market and trades got succeeded? So concluding the argument here is that chartists who use the default settings will be part of this broad term “Crowd”

Hope you now you got the meaning of “Crowd” and their uniform view on the market. So its time we gauge this sentiment, and one of the best indicator to gauge the sentiment is PCR (put call ratio)

Before getting into main topic, just basics on “what is puts/calls”?
Call option – buy in the anticipation of rise in prices
Put option – buy in the anticipation of fall in prices

1971 Marty Zweing invented the Put/Call volume ratio as an indicator to determine whether option crowd is on call-buying or put-buying. When too much buying has been identified with the options crowd titled one-way in their sentiment, you can usually bank on near buy market reversal (short/medium/long term based on the view of the sentiment range)

Which PCR is the right?
Since Marty Zweing first introduced the PCR ratio, there were too many attempts made to refine the orignal method.

 
1. PCR OI – more open interest in puts suggests bearishness, and more interest in calls says bullishness. There were too many methods on how to interpret OI

2. PCR OI (near the money strikes) – the issue is you are eliminating main crowd here where they normally use to buy Out of money calls (or near out of money calls).

3. PCR Volume – comparative to the OI, volume is the near best indicator. where you add all the volumes traded in the Put and divide with volumes traded in the calls. The issue here is equal weightage for all the strike prices. Suppose you take example of NIFTY trading to 8300, volume of PUTS is 100,000, and CALLS is 50,000. PCR is 2 here, which suggests bearishness. In the above scenario someone bought 70000 extreme out of option strike price at 9500. So just for calculation we remove this 9500 strike price then the PCR will now becomes extreme bullish.

4. PCR Dollar weighted – McMillan refine with value. Instead of PCR volume, this approach creates the ratio of value rather than volume. the calculation goes like this – you calculate each strike price value multiplied with volume traded in that strike price individually and then add all call value and put value and take the ratio of it.

Dollar Value = option price * option Volume
Ratio = Sum of dollar value of Puts/ sum of dollar value of calls;

Some mentioned this indicator failed to create topping at the Oct 1987, as compared to traditional PCR volume. Anyway its difficult to convince all what method is right, everyone has their own opinion. At the end of we need to see which is better to our market and how it is able to give maximum favourable signals. With my research goes on all these, I found PCR Dollar weighted was mostly giving favourable signals in Indian markets.

Based on my experience i have found when the PCR weighted goes extreme to greater than 1.75 (better >2) is considered bearish sentiment and expect market to be reversed and vice versa when it falls below 0.3 considered bullish sentiment and expect market to fall.

Since start of the year here is the different stats –

ABCharts

There is one exception in the reading of extremes, i have found during the expiry week (same day or prev day) market expected to carry the same momentum.

References:
1. Original Author for some of the content is John F. Summa (extracted from the book “Trading against to the crowd”)
2. PCR Dollar weighted Approach was defined by McMillan in one of the MTA video library

Kesava Kumar A Kesava Kumar A, is Charted Market Technician, founder of SCube Analytics, specializes in the algorithmic trading, use of proprietary blend of sentiment & technical systems. Worked extensively in IT with work experience in USA and Middle East. Also completed "strategic management" program from IIMK. twitter: @KKumarCMT

Ultimate Guide to Momentum Trading

This a brief video guide for the momentum traders which explains right from what is momentum trading ,how momentum trading is related to diffusion...
Rajandran R
18 sec read

What We Can Learn from the Sideways Market –…

What is more required during a sideways market is frequent evaluation of your strategy, keeping your emotional balance in check, and not getting into...
Rajandran R
1 min read

What We Can Learn from the Sideways Market –…

The sideways market occurs when markets are not dominated by the large players and instead traders attempt to dominate the market and keeps the...
Rajandran R
57 sec read

6 Replies to “Crowd Sentiment & Trading against them”

  1. Hi Kesava,
    I have been employing this techik for long. It gives the direction of the underlying current. However there is a upper current which causes swing in to the extent of 2 % which is difficult to read. However new indicators have to be built on the concept of pcr crossovers based on various timelines which possibly can give a better signal trend reversal even when pcr is very high.
    Challenge is time sample to get the OI and volume data to build the indicators.

    Hope I am explaining enough. If there is a share I can share my excel sheet.

    1. The extremes itself is the indication of the sentiment, there is no point in adding extra cross-over. Whatever i explained is for the what will be next 1/2/5 days max based on the sentiment. I will be keep tweeting these extreme reading in my twitter timeline (at @KKumarCMT)I. Tested OI and Volume to find the extremes they are not good reversal based on my 1yr long study on these.

      Yes agree getting the data is difficult, I also have 1 year data only. I am okay to share this data of OI, Volume of PCR

  2. It means the same thing right ? That option writers are proficient and higher put-call ratio means to expect market to rise ???

  3. I HAD TRADING IN THE SHARE MARKET FOR LAST 4YEARS.. I AM DEALING IN STOCKS, FUTURE AND OPTIONS. NORMALLY I AM USING PCR TO CHECK THE MARKET HEALTH. TILL THE LAST MARCH 2014. ITS WORKING GREAT AND I MAKE THE MONEY BUT FOR THEN ITS NOT WORKING. KINDLY GUIDE. I AM NORMALLY USE PCR OPEN INTREST TO ANALYSE.

    1. PCR to be used where is extreme liquidity available. Unfortunately in India other than NIFTY we dont have much options volume, so i strongly suggest limit of using PCR only to NIFTY, probably can be extended to BankNifty. Use Open Interest for stock futures. Hope i answered your question.

Leave a Reply

Get Notifications, Alerts on Market Updates, Trading Tools, Automation & More