Should You Use the PC Ratio?
In this article, we’ll review some of the major pros and cons of using the put call ratio to help anticipate market turns and trends. Let’s start with the pros.
Probably the most obvious advantage of using the Put Call Ratio is that it reports something that is often considered one of the primary market drivers, i.e. market sentiment.
Secondly, the data used to calculate the put call ratio is widely available to all investors with access to the internet.
The third supporting point is that, because historical data is rather abundant, the ratio can be charted easily using most major trading platforms or charting packages.
The fourth point in support of the put call ratio is that it is an easy concept to grasp for even the beginner trader or investor.
And the last pro of using the put call ratio is that it helps investors identify oversold and overbought conditions early enough to anticipate and act on new trends.
And now, for balance, the cons.
One of the major cons of using the p/c ratio is its simplicity. The simple calculation doesn’t always reflect a such a complex dynamic as investor psychology.
A second con of using the standard method of calculating the put call ratio is that it only accounts for the volume activity of options traded and not the dollar amount.
Thirdly, the p/c ratio is not a stand-alone indicator and, to be useful, must be applied with other indicators of market sentiment.
Fourthly, to calculate the p/c ratio for an individual stock, there must be options offered on the issue. So, the ratio cannot be calculated for smaller stocks.
The fifth con is that the options must have enough volume to reveal meaningful trends in investor sentiment.
So, those are some of the advantages of using the put call ratio.
So, should you incorporate the put call ratio into your analysis?
The put call ratio is a handy indicator for many investors and traders. But it should always be applied with full the knowledge of its limitations.
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