Saturday, April 15, 2006

A Psychological Index of Stock Market

A Little Secret

The psychological power in the stock market is bigger than we think. Any action in the stock market has to go though peoples’ mind one way or another. If most people believe a stock will go up, then it probably will. If you know other people’s thought, your chance to win will be enlarged.

The option trader is more experienced then regular stock trader in general. Their judgment of a stock’s future movement would be a good reference. The question is --- How can we get such information?

The easiest way is to check the call/put ratio. For a particular stock, if its volume of call is significant higher then the volume of put at the same expiration date, you can know that a numbers of people think the stock will go up; otherwise go down.

You could watch the number change of the open instruction and the volume change of both call and put option for a few days. If you recorded the changing numbers, you can sense the change of expectations. The dynamic changed information can draw a clear line about the market speculation. It is reliable and helpful.

The option price supposed to be in synch with its stock price change. If you see an abnormal situation without a reasoning explanation, then it is a very useful hind. For example, if the stock is down a little, but its call option is stable or little bit up, then you can assume it is a positive sigh for that stock.

In many cases, not always, the option market acts earlier than its stock market. If you can trace the changes, you can catch the pause of the stock market.

Please note:
1. This theory would work for stocks that have bigger option market. Please do not apply it to any stock that has limited option available.
2. Some hedge funds are using the option to hedge their stock investment. There is a possibility that a large volume of option indicates an opposite direction.

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