What sentiment says about this week’s action
I have begun
investigating the equity put/call ratio and
whether it makes a difference to short-term traders. I found, for
example, that rises in the equity index markets that are accompanied by high
put/call ratios are more likely to spill over to the next day than rises with
low ratios. It appears that when traders don’t turn bullish during a rise, the
rise–on average–has further to go. This occurred after Wednesday’s gain on a
relatively high put/call ratio. The rise spilled over to Thursday morning, but
with a much lower ratio. This preceded the Thursday selloff.
As I examined the equity option data, I noticed
that high option volume tended to occur to market turning points. That made me
wonder if the total equity option volume might be a nice measure of speculative
sentiment in the market.Â
On Thursday’s reversal, we dropped about .40% on
the S&P 500 Index
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PowerRating) from open to close. My analysis on the research
site found that such reversals tended to be followed by strength early in the
bull market (March, 2003 – April, 2004), but not from May, 2004 to the present.Â
This is but one of several patterns that I find to be breaking down in the
recent market, suggesting to me that the bull is aging.
In any case, of the 733 trading days in
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since March, 2003, I found 62 occasions in which the market dropped between .30
and .50%. In general, expectations were positive over the next three days, with
an average gain of .27% (38 up, 24 down). This is only modestly better than the
average three-day gain of .18% (432 up, 301 down) for the sample overall. When
speculative sentiment was high, however (N = 31), the next three days averaged a
loss of -.11% (14 up, 17 down). When speculative sentiment was low (N = 31),
the next three days averaged a gain of .65% (24 up, 7 down). Clearly, modest
declines in SPY had more bullish outcomes in the near term when the declines
were on light speculative volume. When option speculators were active, modest
drops in SPY tended to continue over the short run.
What does that mean for us now? Thursday’s drop
was on high speculative sentiment. That, and the subnormal recent returns
following reversal days, lead me to be cautious over the near term.
The total equity option volume findings support
the results I obtained with a totally different measure of sentiment, the NYSE
TICK. When you obtain similar findings from different measures of the same
underlying concept, you start taking notice. Sentiment seems to matter in the
equity ETF and index futures markets. Please note that these findings made use
of volume in equity options only–not the index options, which are more heavily
tied to arb trades rather than purely speculative ones.  Â
Brett Steenbarger
Brett N. Steenbarger,
Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at
SUNY Upstate Medical University in Syracuse, NY and author of
The Psychology of Trading (Wiley, 2003). As
Director of Trader Development for Kingstree Trading, LLC in Chicago, he has
mentored numerous professional traders and coordinated a training program for
traders. An active trader of the stock indexes, Brett utilizes
statistically-based pattern recognition for intraday trading. Brett does not
offer commercial services to traders, but maintains an archive of articles and a
trading blog at
www.brettsteenbarger.com and a blog of market
analytics at
www.traderfeed.blogspot.com. He is currently writing
a book on the topics of trader development and the enhancement of trader
performance.
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