A recurring theme has been presented here over the past several years: the performance of certain simple option strategies quite often gives an accurate picture of the mood of the stock market. The mood of traders – the emotion – does not determine the future of stock prices, but it surely determines how traders are likely to react to future news.
As with any indicator, be it a Simple Moving Average (SMA), a Relative Strength Index (RSI), an Elliott Wave or a Fibonacci Retracement, the use of options as an indicator is not useful at predicting the future. But, one does not need to know the future in order to be a successful trader. To be successful requires a trader to be cognizant of the emotions present in the market, thus allowing the trader to observe changes in the stock market in their proper context, and react accordingly.
A trader needs to know when other traders are optimistic, because a dip in stock prices makes optimistic traders likely to buy stocks. On the other hand, pessimism makes traders look for the nearest exit. A dip in stock prices in an optimistic market is not the same as a dip in a pessimistic one. The context is important.
Last week saw the first major shift away from optimism in several months. It is still an optimistic market, but not nearly as optimistic as it was just a few short weeks ago. The shift in optimism has been clearly outlined in three recent articles, available here:
This post was published at ZenTrader on September 28, 2014.
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