Nifty PCR: A Sharp Tool for Analysing Market Sentiment
In trading and investing, market psychology can be as important as analysing charts and financial statements. For instance, the Nifty PCR or Put Call Ratio of Nifty provides insight into market mood.
Understanding Nifty PCR and trading in the stock market or following the Nifty 50 Index on a regular basis can be a healthy supplement to one's analysis.
I will explain this concept in simple Indian English so even novice readers of finance can follow.
What is Nifty PCR?
Put Call Ratio stands for PCR. Nifty PCR in this case denotes the ratio of the total value of put options to the total value of call options relating to a particular Nifty index. This indicator tracks the mood of the trader in the market.
In other terms:
Put options are contracts that provide the holder the right to sell. Traders generally purchase puts when they expect the market to dip.
A call option provides the right to purchase which explains why investors buy calls when there is an expectation of a bullish market.
Likewise, Nifty PCR provides information about general market sentiment based on the volume of Nifty options traded. It tells if a trader is feeling bullish or bearish about the market.
What is the process to calculate Nifty PCR?
The Nifty PCR calculation does not need overly complicated instructions. It simply takes the total open interest of put options and divides it by the total open interest of call options for Nifty.
Open interest indicates the number of currently available active option contracts at a specific moment.
Assuming the total open interest in put options for Nifty is 80 Lakh and the total open interest in call options is 60 Lakh, we get a Nifty PCR of Total open interest of Put options/Total open interest of Call options=80/60 = PCR 1.33.
This suggests the Nifty PCR is greater than 1 meaning an oversupply of puts relative to calls which signals that traders anticipate a market downturn or want to hedge their risks.
What does the Nifty PCR imply?
The Nifty PCR serves as a gauge of market sentiment. It assists in determining what most market participants are doing in the options segment of the market.
A high Nifty PCR tends to signify larger trades on put options, indicating that the market is likely bullish or has already increased, and traders are securing profits or preparing for a decline.
A low value of the Nifty PCR is associated with increased activity on call options, signaling that traders are extremely optimistic about a rally. Alternatively, the market is bearish, and participants are positioning themselves to capitalise on an upturn.
Numerous professional traders have adopted the strategy of trading opposite of the Nifty PCR indicator. This means in case everyone becomes extremely bullish or bearish, a reversal is most likely to occur soon. The reasoning is straightforward – when people overspeculate in one way, the market tends to react by taking a sudden turn in the opposite direction.
Nifty PCR and Market Sentiment
Let us analyse this using simple examples:
If the Nifty PCR value is greater than one, it indicates that there is a higher volume of put options being traded than call options. This may indicate either a bullish sentiment or that the market is already at its peak and participants are hedging their positions.
If the value is less than one, it means that there is a greater volume of calls being traded. This could indicate a bearish sentiment or that the market is in the oversold territory and participants are anticipating some sort of a rally.
An example of very high Nifty PCR could be above 1.5, which typically suggests the market is overbought and a correction is likely to follow soon. On the contrary, a very low Nifty PCR like below 0.7 could suggest that the market is in oversold territory and likely to bounce back.
These values should not be considered in isolation, however. The Nifty PCR should be analysed in conjunction with the overall market trend, news, and global cues.
Nifty PCR for Intraday and Short Term Trading
Nifty PCR is frequently used among those who engage in intraday or short-term trading. It helps them grasp market sentiment.
As an example, consider the situation when both the Nifty and PCR are increasing. In this case, it suggests strong bullish momentum. In contrast, if both of them are declining, it confirms a bearish trend as well.
Nifty moving up and PCR moving down should arouse some suspicion regarding bullish strength, prompting traders towards a more cautious stance. Just like the opposite side, if Nifty is declining and there is a PCR increase, it may suggest that a bearish resurgence could be probable.
Therefore, combining Nifty PCR with price action, other indicators such as RSI or MACD, as well as decisive levels like support and resistance, enables one to benefit from multiple perspectives.
Incorporating Nifty PCR into Trading Strategy
Nifty PCR can be used in various practical manners and here are some which apply best to trading systems:
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Trend Confirmation
Consecutive increases in both the PCR and Nifty Index are said to strengthen the confirmation of the trend.
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Reversal Indicator
Such high readings, for example above 1.6 or 1.7, imply that the Nifty PCR may be overly high, signalling most traders have aligned in one direction. This is an indicative marker the market could reverse shortly. In the same manner, a PCR that is extremely low might indicate a potential upward reversal.
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Risk Management
Moreover, the Nifty PCR can determine how aggressive your stop losses should be or the size of your position depending on the prevailing sentiment in the market. For example, with extreme PCR readings, it may make sense to ease on the risk or wait for more evidence before taking a position in the market.
Nifty PCR and Option Strategies
Traders that operate with options tend to leverage the Nifty PCR to determine which strategy to adopt.
They might use bullish strategies such as bull call spreads, long calls, or selling puts if the PCR sentiment is bullish.
On the other hand, the same traders would rely on bear put spreads, short calls, or buying put options in case the PCR sentiment is bearish.
Neutral sentiment on the PCR tends to result in preference for range-bound strategies such as iron condors or straddles.
Shortcomings of Nifty PCR
Despite the benefits of the Nifty PCR, it is crucial to note that it should not be relied upon singularly. Some of its limitations are as follows:
PCR provides sentiment for a particular market, and does not specify exact levels for positions.
During important occurrences such as RBI announcements, elections, or news from other countries, PCR values may change rapidly.
As with other indicators, using PCR without considering the bigger picture can prove to be detrimental.
PCR results should be looked at in conjunction with other technical indicators, news flow, and significant support/resistance levels.
Thus, Nifty PCR should always be used with other tools to obtain the best accuracy.
Where Can You View Nifty PCR?
Check live Nifty PCR from a variety of sites and apps. Nifty PCR is updated regularly on the NSE India website and on trading apps such as Zerodha Kite, Angel One, Sensibull, and Opstra and can also be found on other platforms. These tools enable traders to track the rate at which sentiment shifts.
Recording Nifty PCR on a daily basis will enable one to learn how the market behaves during a multitude of events. Over time, these patterns begin to emerge aiding in informing trading strategies.
Nifty's PCR and Sentiments
Nifty Put Call Ratio, or Nifty PCR, is not merely a digit. It gauges the sentiment of the market players and assists traders in determining if the market is dipping towards panic or has a firm footing on optimism. When incorporated properly, it can strengthen your analysis and enhance your chances of winning in trading.
Like Nifty PCR, it doesn't come without faults, however. As with all indicators, it needs to be applied alongside put-verifiable discipline, risk management and corroboration from other indicators.
Thus, whenever you decide to analyse the Nifty market, bear in mind the Nifty PCR as it can portray a brilliant direction throughout your trading journey.
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