Applying The Put/Call Ratio Indicator
In this third part of the series, you will find a trading method based on using the three put/call ratio indicators introduced in part 2.
Can the put/call ratio and open interest be used to build a leading indicator? Yes, it can. In part 1, I defined the put/call ratio. In the second part of this three-part series, I discussed how you can create the put/call ratio indicator (Pcri). Now, here’s how you can apply the three put/call ratio indicators.
Figure 1 shows my charting template for trading based on the put/call ratio indicators. The window at the top holds the Standard & Poor’s 500 daily data with three simple moving averages: 50 days (blue), 100 days (red dashed), and 200 days (red). These are typical averages useful as dynamic support and resistance levels. For the shorter-term dynamic support and resistance, I am using standard 20-period Bollinger Bands. Finally, I will be using support and resistance levels and trendlines in this window to look for line breaks.
The second and third windows display the fast and slow put/call ratio indicator and the inverse Fisher transform of the slow Pcri. These were discussed in the first and second parts of this series. In the fourth window, I use a standard stochastic 30-period oscillator with a five-day slowdown. In the same window you can see a smoothed inverse Fisher transform stochastic. This will help you stay in a trade or ultimately get you out of one if other signals fail.
THE SMOOTHED INVERSE FISHER TRANSFORM STOCHASTIC OSCILLATOR
You can find out all about the put/call ratio indicators in the second article of this series. But before starting on the trading examples, I have to discuss the inverse Fisher transform stochastic oscillator (SVE_Stoch_IFT) used in the lower window of the template. Basic information about the inverse Fisher transform can be found in my article about the relative strength index (Rsi) inverse Fisher transform published in the October 2010 issue of Stocks & Commodities.