Monday, January 2, 2012

Anticipating Shifts in Investor Sentiment Using the Put Call Ratio

by David P James

It is commonly believed that the equity markets are motivated by investor mood. You can regularly hear Wall Street analysts cite trader mood and sentiment as the main factor powering the markets. Some traders, therefore, examine charts and ratios in an effort to predict future shifts in investor sentiment.

Probably the most widely used barometer utilized to evaluate trader mood is the Put Call Ratio. The Ratio uses exchange volume of options contracts as a measurement for trader mood. An options contract provides the owner the choice, but not the requirement, to purchase or sell a stipulated quantity of shares at a fixed price level and defined time frame.

An investor who is expecting a stock to slide may invest in put contracts (the legal right to sell at a later date) whilst a trader who is expecting the stock to go up may invest in call contracts (the legal right to buy at a later date).

The most popular way of computing the put call ratio employs the trading activity of calls and puts. It's determined by dividing the quantity of puts exchanged by the amount of calls. For example, if 30,000 puts had been exchanged throughout a trading session but just 15,000 calls, the put call ratio would be 2.

Whilst utilizing trading volume to determine the put call ratio is the most common technique, some investors choose to use the actual dollar amount traded or the quantity of "open interest" for a stock. Open Interest describes the total quantity of contracts that have not yet been closed or expired. The Open Interest Put Call Ratio divides the total quantity of put contracts outstanding by the total quantity of call contracts. For instance, if there were 150,000 puts in the marketplace and 200,000 calls, the Open Interest Put Call Ratio would equal 0.75.

The ratio is usually fairly volatile day-to-day, which makes it tough to identify general trends. Because of this, most investors will look at weekly data or compute a moving average in order to smooth out the variances, therefore exposing longer-term trends and extreme situations.

The put call ratio is frequently utilized as a contrarian signal. If the ratio is very high, i.e. there's a lot of investors expecting a drop in prices, contrarian investors will seek out an opportunity to buy the stock. On the other hand, whenever the ratio is very low and many investors are forecasting a rally, they'll consider selling the market.

It ought to be noted that the put call ratio is frequently utilized in conjunction with additional sentiment indicators rather than as a stand-alone method. Additional sentiment indicators include the Volatility Index (VIX) as well as the Advance Decline Ratio.

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Trend Trading Using Advance Decline Index


By Dan Pipitone

Trading the trends is one of the most followed stock trading strategies. Long traders buy stocks at the start of an uptrend and sell them when the trend diminishes. Similarly short traders take short positions at the start of a downtrend and close there positions when the trend ends. Sounds like a very good strategy! But the problem is "how can we know a trend is starting or ending" and "is the trend has enough strength to bring prices to new highs or lows". A simple but effective tool to solve this problem is the "Advance - Decline Index or A-D Index"

Advance - Decline index measures the strength of a market movement. It is one of the most widely used trend analyzing tools by short-term and long-term traders trading all types of financial instruments - stocks, bonds, currencies, futures, etc. AD index is defined as the 'difference between total number of bullish or advancing stocks and total number of bearish or declining stocks'. The value can be a positive or negative integer. But with this single value analyzing trend strengths is difficult. So traders plot this value on a chart as an 'Advanced-Decline line', connecting points of each time periods. One point of the line can be derived from a simple formula.

A-D point = A-D value of the period + A-D value of previous period.

The period can be of any time frame; day traders can use short time periods like 15 or 30 minutes or 1 hour, other traders can use daily, weekly or monthly periods. Most trading systems today have AD index as a standard indicator.

Interpreting advance-decline indicator is easy.

1. Market up and AD down - Strong uptrend.

2. Market up and AD up - Weak uptrend.

3. Market down and AD down - Strong downtrend.

4. Market down and AD up - Weak downtrend.

The major advantages of AD indicator are its simplicity and scalability. It can indicate trend weakening and possible trend changes. But AD index cannot be used as a main tool to predict trend reversals. Traders should use other indicators like volume indicators, Fibonacci tools together with AD index to predict trend changes.

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Top Ten Systematic Trading Methods


By Michael R Bryant

Systematic trading methods are the basis for trading systems and automated trading strategies. They consist of technical indicators or other mathematical methods that are used to generate objective buy and sell signals in the financial markets. Some of the most popular methods have been in use since before the advent of computers, while other methods are more recent. This article lists ten of the most popular systematic methods found in trading systems.


  1. Moving average crossovers. Trading systems based on the crossover of two moving averages of different lengths is perhaps the most common systematic trading method. This method also includes triple moving average crossovers, as well as the moving average convergence divergence (MACD) indicator, which is the difference between two exponential moving averages. The moving averages themselves can be calculated in a variety of ways, such as simple, exponential, weighted, etc.

  2. Channel breakouts. In this method, a price channel is defined by the highest high and lowest low over some past number of bars. A trade is signaled when the market breaks out above or below the channel. This is also known as a Donchian channel, which traditionally uses a look-back length of 20 days. The famed "turtle" system was purportedly based on channel breakouts.

  3. Volatility breakouts. These are similar in some respects to channel breakouts except that instead of using the highest high and lowest low, the breakout is based on the so-called volatility. Volatility is typically represented by the average true range (ATR), which is essentially an average of the bars' ranges, adjusted for opening gaps, over some past number of bars. The ATR is added to or subtracted from the current bar's price to determine the breakout price.

  4. Support/resistance. This method is based on the idea that if the market is below a resistance level, it will have difficulty crossing above that price, whereas if it's above a support level, it will have difficulty falling below that price. It's considered significant when the market breaks through a support or resistance level. Also, when the market breaks through a resistance level, that price becomes the new support level. Likewise, when the market drops through a support level, that price becomes the new resistance level. The support and resistance levels are typically based on recent, significant prices, such as recent highs and lows or reversal points.

  5. Oscillators and cycles. Oscillators are technical indicators that move within a set range, such as zero to 100, and represent the extent to which the market is overbought or oversold. Typical oscillators include stochastics, Williams %R, Rate of Change (ROC), and the Relative Strength Indicator (RSI). Oscillators also reveal the cyclical nature of the markets. More direct methods of cycle analysis are also possible, such as calculating the dominant cycle length. The cycle length can be used as an input to other indicators or as part of a price prediction method.

  6. Price patterns. A price pattern can be as simple as a higher closing price or as complicated as a head-and-shoulders pattern. Numerous books have been written on the use of price patterns in trading. The topic of Japanese candle sticks is essentially a way of categorizing different price patterns and linking them to market behavior.

  7. Price envelopes. In this method, bands are constructed above and below the market such that the market normally stays within the bands. Bollinger bands, which calculate the width of the envelope from the standard deviation of price, are probably the most commonly used type of price envelope. Trading signals are typically generated when the market touches or passes through either the upper or lower band.

  8. Time-of-day/day-of-week. Time-based trading methods, based either on the time of day or the day of week, are quite common. A well known trading system for the S&P 500 futures bought on the open on Mondays and exited on the close. It took advantage of a tendency the market had at that time to trade up on Mondays. Other systematic approaches restrict trades to certain times of day that tend to favor certain patterns, such as trends, reversals, or high liquidity.

  9. Volume. Many systematic trading methods are based solely on prices (open, high, low and close). However, volume is one of the basic components of market data. As such, methods based on volume, while less common than price-based methods, are worthy of note. Oftentimes, traders use volume to confirm or validate a market move. Some of the most common systematic methods based on volume are the volume-based indicators, such as on-balance volume (OBV), the accumulation/distribution line, and the Chaiken oscillator.

  10. Forecasting. Market forecasting uses mathematical methods to predict the price of the market at some time in the future. Forecasting is qualitatively different than the methods listed above, which are designed to identify tradable market tendencies or patterns. In contrast, a trading system based on forecasting might, for example, buy the market today if the forecast is for the market to be higher a week from today.

Please keep in mind that this list is based on popularity, which is not necessarily the same as profitability. Successful trading systems often employ a combination of methods and often in unconventional ways. Also, it's possible that other, less popular methods may be more profitable in some cases.

About the Author:

Michael Bryant has a PhD degree in mechanical engineering with a minor in computer science and has been trading and studying the financial markets since 1994. To learn how to build profitable trading strategies for almost any market and time frame, please visit Adaptrade Software (http://www.adaptrade.com/Builder/).

(c) Copyright - Adaptrade Software. All rights reserved.




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For more information on technical indicators such as Accumulation Distribution Line and Chaikin Oscillator visit the StockMarketStudent Encyclopedia.

Day Trading Forex With Technical Indicators


By Paul Bryan

Day trading technical indicators are the representation of mathematical formulae a day trader can use to decide when to do the trading. Forex day trading involves buying and selling of various currencies with the goal of making a profit from the difference between the buying price and the selling price within a day.

The day traders employ different strategies like short term scalping where positions are only held for a few seconds or minutes or longer term swing and position trading, when they hold the position for the whole trading day. For their trades they follow one or more day trading technical indicators or develop a strategy based on a combination of many such indicators.

A day trading technical indicator is a series of data points that can be derived by applying a formula to the price data. Price data includes any combination of the open, high, low, or close over a period of time.

Some technical indicators may use only the closing prices while others incorporate volume and open interest into their formulas. The price data is entered into the formula and a data point is produced, which in turn creates the indicator.

The list of day trading technical indicators is practically endless. There are Absolute Breadth Index, Bollinger Bands, Bull/Bear Ratio, Candlestick Charts, indicators based on Dow Theory or Elliot Wave Theory, Envelopes, Fibonacci Levels, MACD, Moving Averages, TRIX, Weighted Close, and many more. All these can be used as a day trading technical indicators with slight or no modifications.

For example, the absolute breadth index or ABI is a market momentum indicator which shows the activity, volatility, and change taking place in the market without paying attention to the direction of the prices. High readings implicate active markets. As a day trading technical indicator, it can predict future direction if combined with other indicators.

Bollinger Bands on the other hand are a kind of moving average envelope. It exist at standard deviation levels above and below the moving average and generally stay within the upper and lower bands. As a day trading technical indicators, it predicts the future market movements. Fibonacci numbers with 4 theories - arcs, fans, retracements, and time zones, which highlight reversals in trends.

Day trading technical indicators has three functions-to alert, to confirm and to predict. So a trader can never miss a trading opportunity or run into loss if he or she can use the indicators judiciously.

The best approach will be to develop a strategy based on more than one indicator. Learning how to use these indicators is more of an art than a science. Through careful study and analysis, a day trading technical indicator can be developed over time, but they can never be full proof.

To find out more about trading Forex more accurately visit Day Trading Technical Indicators




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Why Above the Market Orders Don't Work Investing in Stocks

The above the market orders happen when you place an order with your broker, with the intention of buying a stock as it is going up, usually through a resistance line that an investor has chosen. Some investors believe in technical analysis and they look at resistance, which is the point where a stock stats leveling out after moving up or down. At the supposed resistance level, it is believed that many times the stock will break its fall or uptrend and start going up or down until it meets resistance again. If an investor places an order like this, he or she can try to catch the upward trend of a security or investment supposedly after resistance is met and the trend starts upward. In an above the market order, you want the stock to be going UP breaking through some level before a buy order is placed and hopeful profit will be made.

Comments:

I don't think that this strategy works very well because it's based on technical analysis which doesn't always work. Warren Buffet himself said that he realized technical analysis didn't work when he could turn the charts upside down and get the same answers for his investing. It's assuming that when a stock meets resistance - or any investment that it will then turn around and keep going up. I think this is very unsound because many times instead of going up it will just fall down again. Experts have never been able to find any pattern in the stock market, and trying to rely on resistance for consistent returns is foolish for the stated reasons.

Many times however some investors simply can't resist the temptation of using technical tools like this to buy stocks because their friends, family, or supposed experts tell them it is a good idea. If you have to use this type of analysis for your stocks, than make sure that you cut your losses SMALL. If they stock does go down at least the losses can remain small if you use a stop limit order, however if you hold onto the security for more than one day market makers can make the price LARGELY lower than what you bought it for proving this philosophy foolish.

Investing With The Bad Economy And High Current Unemployment Rates

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Klinger Oscillator and Percentage Volume Oscillator

In the world of technical analysis there are an endless variety of technical indicators. In fact, there are so many indicators that it is often difficult to distinguish between one and another. Many are variations of the same theme using the same input parameters and producing similar results.

Before developing a trading strategy it is important to wade through the raft of available technical indicators and determine what they actually do, then choose those that are unique, combine well with other indicators and most importantly, provide a trading advantage.

As an example, if a trader is intent on using Chaikin Money Flow then it probably doesn't make any sense to also choose the Klinger Volume Oscillator as part of the same stock trading strategy. Both of these indicators are based on accumulation and distribution of shares and both use price and volume as inputs.

Another example would be to select both the Stochastics Oscillator and Relative Strength Index (RSI) for use as overbought/oversold indicators. Both indicators deal with short-term price extremes and capitalize on a tendency for mean reversion.

One easy way to avoid overlap of functionality is to first determine the most important input parameters, then choose one technical indicator for each parameter. One could arguably say that the two most significant trading factors are the security's price and volume (in that order). Price is an obvious choice but stock volume is often ignored. Volume is important because it provides a clue to whether the security is in demand, or alternatively whether the stock is being dumped. With both directions of price movement, the greater the volume the more significant the price action is.

Selection of a price-only trading signal is a relatively easy thing to do. For example, a trader could use an RSI, Stochastics, Simple or Exponential Moving Average (EMA), or a multitude of others. However, it is not so easy to find a volume-only technical indicator. There are plenty of combined price/volume indicators such as the Klinger Oscillator and Chaikin Money Flow, both mentioned above. But they do not provide the price-independence that is being sought for the second indicator.

There is one volume-only indicator called the Percentage Volume Oscillator (PVO). There may be others out there but they are likely based on a similar formula. The PVO is calculated by subtracting the fast EMA from the slow EMA of volume as a percentage. Increasing volume is detected when the Percentage Volume Oscillator fluctuates around the zero line with increasing oscillator values. Decreasing volume is determined when the PVO fluctuates around the zero line with decreasing oscillator values.

An important use of the Percentage Volume Oscillator is when a stock breakout occurs. Such breakouts do not always succeed and instead of reaching new highs they often drop back to less lofty heights. You can generally judge the quality of the breakout based on the PVO. If a stock breaks out on significantly higher volume then the breakout will likely succeed. Conversely if the volume is below average then the stock price will probably fall back after a few days.

Steve Auger is a freelance writer and the administrator of the website stockmarketstudent.com. Stock Market Student includes an encyclopedia of stock market terminology, providing additional information on the technical indicators Percentage Volume Oscillator and Klinger Oscillator.