Forecasting Market Turns with the Put/Call Ratio

09/08/2009 10:07 am EST

Focus: OPTIONS

S. Wade Hansen

Co-Founder, Profiting with Forex (PFX) and Learning Markets

The put/call ratio is a market breadth indicator that compares the number of put options investors have purchased to the number of call options investors have purchased.

What the Put/Call Ratio Tells Us

The put/call ratio tells us one basic thing: Whether bullish or bearish momentum is pushing the option market, and in turn, the stock market.

One thing you do have to remember with the put/call ratio, however, is that it has an inverse relationship to the stock market.

Because the number of puts is the numerator and the number of calls is the denominator, when the ratio is above one, it means option traders have purchased more put options than call options. When the ratio is below one, it means option traders have purchased more call options than put options.

When option traders are buying more call options than put options, the put/call ratio moves lower. And when the put/call ratio is moving lower, you know that bullish momentum in the market is increasing.

When option traders are buying more put options than call options, the put/call ratio moves higher. And when the put/call ratio is moving higher, you know that bearish momentum in the market is increasing.

Watch the video for more details:

 

By S. Wade Hansen of LearningMarkets.com

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