Sentimental indicators, a key to trading decisions in critical times

##Shubham Agarwal##

We all work with our own trading systems, which are more or less rule-driven. Some are perfected by past experience and some by the power of analytics on top of the underlying’s price. On a day-to-day basis this works well, but during critical times you would need that extra bit of confirmation, or at least a supporting argument, before taking that brave-heart trade. That is where Sentimental Indicators come into play.

First, let us understand what these sentimental indicators are. We know that it is our aggregated opinions that drive prices in the market. Now, knowingly or unknowingly, our act of trading translates into a statistic that holds all our opinions into it. Let me explain with an example.

Let us say, the total positions in the market with all futures and options (F&O) accounted for is 100. Now suddenly, the Total Positions go up from 100 to 200, and 200 to 300. These are newer highs, or at least, highs for the year (for example).

Alongside, the price has also risen by 50-60 percent. Now, when we are trying to take a trade with our system, this Total Positions number can act as a sentimental indicator. That means, it will clearly tell us that we are in a very aggressive state in the current market.

##How does this indicator help?##

Well, you will not Bet Big, given such a scenario. Chances are we may miss out partially on some profit-making opportunities. But, a similar situation happened in 2008, and had we looked at this Sentimental Indicator of Total Positions, we would not have lost out on a lot, for sure.

There are a few such Sentimental Indicators that help us guide or support our trading decisions in crucial times.

#1 Total Positions:## We just saw this example. Calculating total positions on a regular basis may be a bit too much, but one more sub-indicator of this sentimental indicator can help. Look at the List of Securities in Ban (it’s a list of stocks published by the exchange that have hit a limit beyond which no new positions can be created). The Ban List, as it is popularly known, also indicates when we, as traders, have overdone it. Typically, when we see more than 10 stocks in the Ban List, it is time to go on the alert and reduce the aggression. Resort more to hedged trades. There could be a pull-back.

#2 Option Implied Volatility:## For given Option Premiums, the volatility figure that is back calculated is called Implied Volatility. How to calculate this is a different subject. But for now, we need to know that higher this Implied Volatility, higher the expected risk in the market — risk mostly of falling. Using most option analytics applications (apps), it’s easy to calculate the implied volatility on historical basis. But, if we need a sentimental indicator of that we have India VIX (Index of Implied Volatility of Nifty Options).

Now, if the market is falling, and India VIX also starts falling, it implies that during the course of this fall, the risk is reducing. This means there could be a halt, if not a reversal, in the fall.

Similarly, when the market is rising and India VIX also starts rising, it implies that traders are getting frightened at the top and the risk of a fall is rising. There could be a pull-back, if not a reversal from the top.

#3 Open Interest Put Call Ratio (OIPCR):## This is the Total Put Options Open Interest divided by Total Call Options Open Interest. Historical reading of this data is also available on a number of option analytics apps. One can also spend a few minutes every day maintaining this data for each symbol from the trade data provided by the NSE, called the Bhavcopy.

Rising underlying means more put sellers (whose view is that the market will not go down much), and more put sellers means more Put Open Interest (put positions). But if the OIPCR in rising and the underlying reaches a newer high, it makes sense to take a step back from participating in the ongoing upmove. Make all hedged bets.

Similarly, if the underlying is falling, there will be more Call Sellers (betting on underlying not going up). This will keep bringing the OIPCR down. But if the OIPCR makes newer low, step back from participating in the ongoing fall. Make all hedged bets.

Historically, such newer highs and newer lows in OICPR have brought halts, if not reversals, in underlying.

These are just three cases of Sentimental Indicators. There are many more. The idea here is to draw your attention to this wonderful world of Sentimental Indicators. Believe me, they will be saviours in difficult times.

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