In the fast-paced world of crypto trading, understanding market sentiment and trends is essential before putting your funds in the markets. One crucial but often misunderstood trading indicator is the put call ratio.
This trading indicator, which started out from the traditional financial markets, has made its way into the realm of crypto trading and offers traders valuable insights into the sentiments and expectations of participants in the crypto markets. Read on to find out how you can use the put call ratio in your crypto trading.
What Is A Put Call Ratio (PCR) In Crypto
The put call ratio is a ratio derived from taking the total number of outstanding put options divided by the total number of outstanding call options in that period.
A put option gives the holder the right but not the obligation to sell an asset at a predetermined price. Traders who buy put options typically believe that the price of the asset is likely to fall in the future.
A call option gives the holder the right but not the obligation to buy an asset at a predetermined price. Traders who buy call options typically believe that the price of the asset is likely to rise in the future.
The put call ratio is widely used by traders to determine the overall sentiment of the market. If more put options are being bought compared to call options, this indicates bearish sentiments in the markets. On the other hand, if more call options are being bought compared to put options, this indicates bullish sentiments in the markets.
Put Call Ratio Formula
The put call ratio can be calculated by dividing the total number of outstanding put options by the total number of outstanding call options.
- Put Call Ratio = Total number of put options / Total number of call options
What Is A Good Put Call Ratio In Crypto
A put call ratio of 1 indicates that the total number of outstanding put options is the same as the total number of outstanding call options. As the majority of traders have a long bias in the markets, a ratio of 1 is not a good starting point to measure the sentiment of the market. Instead, a 0.7 put call ratio is generally considered a more accurate starting point.
A put call ratio exceeding 0.7 suggests that bearish sentiments are more prevalent than bullish sentiments.
A put call ratio that falls below the 0.7 level means that more call options are being bought relative to put options. This suggests bullish sentiments are more dominant.
Bob, a trader, is deciding whether to go long or go short in Bitcoin. He decides to analyze the prevailing sentiment in BTC. The total number of outstanding put options in BTC is 1800 and the total number of outstanding call options is 3000.
Put call ratio = Total number of put options / Total number of call options
= 1800 / 3000
The put call ratio of 0.6 is less than 0.7 and 1 which indicates that traders are bullish. The bullish sentiments suggest that the price of BTC might rise and Bob can look to go long on BTC.
Uses Of The Put Call Ratio
In addition to determining the overall sentiment of the market, the put call ratio can also be used as a contrarian indicator. When the put call ratio reaches extreme levels, it means that traders in the market are either overly bullish or bearish. Contrarians can use this as a signal that there is excessive optimism or fear in the crypto market and position their trades accordingly.
For example, an extremely high put call ratio may indicate that the crypto market is excessively bearish, which can be a bullish signal and buying opportunity for contrarian traders. While an extremely low put call ratio may indicate that the crypto market is overly bullish. Contrarian traders might take this as a bearish signal and selling opportunity.
While the put call ratio can allow traders to have a gauge of the prevailing sentiments in the particular cryptocurrency or the overall crypto market, it is worth noting that the put call ratio, or any other trading ratio or indicator for that matter, is not a magic indicator that can predict prices.
Profitable traders know that trading in the crypto markets is all about probabilities and having probabilities skewed in their favour. The effective use of the put call ratio alongside other trading indicators and proper risk management strategies can help traders move probabilities in their favour.
Now that you have a better understanding of the put call ratio, add it to your trading arsenal and take your crypto trading to the next level. Trade over 180+ tokens with low trading fees on the Flipster app today!
Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service.
Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.