One of the arrows in a trader’s quiver is the sentiment approach to markets and individual equities. Learning the crowd’s psychology can be very helpful in determining not only when to take a position but also how to do so. It is a reversion to the mean approach where the trader is looking for extreme bullishness or bearishness on a stock or an index. There are good services available that can help in this path but some traders prefer to do their homework and construct their own data sets. In that regard, 1) the data must be reliable and 2) it must be for a reasonable time period. The more data- the more meaningful the analysis will be. One measure of sentiment is Put/Call ratios. It is suggested that at least 6 months of data should be accessible for analysis. Studied over time, Put/Call ratios can be helpful and focus the trader’s attention to potentially profitable opportunity & inflection points where going against the crowd might be rewarding. Focusing on a handful of stocks, one can easily construct a spreadsheet to handle daily data downloads. Then a moving average of a reasonable time period to smooth out spikes (outliers). A 20-day moving average in conjunction with a 5-day moving average graphed over time alongside a bar chart can help a trader be more discernable on trades. As one gets to know the data, one can also pick up on unusual and persistent trading over short periods that may be indicative of smart money positioning ahead of an event. These techniques are not for everyone, but to the well-informed trader can be rewarding. As always, be nimble, be flexible, and use stop orders to protect capital.
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