Option Trading Analytics

Thanks to the internet there is almost more stock market analysis information available than there are stocks to analyze.  Most brokerage firms provide online trading software and with the software comes charts and analytics.  There is a plethora of books written on the subject, please see my resource list for some of my favorites.  I am a strong believer in keeping things simple, and since I only trade index options, and stick to the same 2 – 4, I don’t have a need for complex analytics.  If you are analytical by nature or have the desire to explore, google stock option analysis – you’ll find more information than you could ever want.  If you’re like me and want a simple yet effective indicator for where the market is headed, check out the Relative Strength Index (RSI).  The RSI measures the strength of any trading vehicle by monitoring changes in its closing prices and is included in most software packages.  It is a leading indicator, not a laggard.  The RSI ranges between 0 and 100.  When the RSI reaches a peak and turns up or down, it indicates a top or bottom.  Horizontal reference lines cut across the highest peaks and the lowest valleys.  They usually are drawn at 30 and 70.  Horizontal reference lines are sometimes effected by bull or bear markets.  In a bull market, often the lines are drawn at 40 and 80, in a bear market, between 20 and 60.  The RSI uses closing prices because they reflect the most important consensus of price for the day primarily because the settlement of traders’ accounts depend on it.  Most traders look to the closing price as opposed to the price at any other time during the trading day.

The RSI is an indicator, it is not a predictor of market performance.  I use the RSI as just another tool in my arsenal.  It helps me make trading decisions, but it is not the only tool I use.

I also look at volume and open interest.  There are three ways to measure volume, the actual number of shares or contracts traded, the number of trades, or the tick volume which is the number of price changes during a selected time frame.  Some interesting things about volume.

• A trend that moves on steady volume is likely to continue
• Falling volume shows the supply of losers is drying up and a trend is ready to reverse
• A breakout on low volume shows little commitment to a new trend and indicates prices are likely to return to their trading range.

Open interest is the number of contracts help by buyers or owned by short sellers in a given market on a given day.  It reflects the number of existing contracts.  Open interest rises or falls depending on whether new traders enter the market or existing traders exit the market.