The term contrarian indicators applies to certain measures that are in opposition to a trend. They are used to identify extremes in investor psychology for the purpose of identifying a change in the trend. 

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                    When investors are most bearish or pessimistic, the stock market is at, or close to, the bottom.                            Conversely, when the herd is most bullish or optimistic, the market may be at the top. 

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The challenge is in the determination.

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Herd psychology

Intuitively the following makes sense. If the stock market has been falling for a prolonged period of time, investors are becoming increasingly pessimistic which drives them to selling. Those who have been selling may sell more and eventually everybody who is going to sell has done so. At that point in time, the trend changes as the balance between sellers and buyers shifts. 

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• When a historical extreme is registered in a reliable contrarian indicator it may be used for timing. 

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But not all contrarian indicators are useful. In fact, very few are and none have been found to identify a long term peak in the stock market. Let's explore the ones the research has identified as reliable.

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Market Lows

The put-call ratio is remarkably accurate for spotting the low in a major stock market decline. What happens is investors reduce their purchase of calls while the demand for puts spikes sharply higher. The balance, or imbalance, is usually more than 1 meaning more puts are purchased than calls. And they get it wrong right at the bottom!

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$CPCE is the symbol for the put-call ratio on stockcharts.com.

Intraday put-call ratio statistics from the CBOE. 

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Related: How does your mindset fit in with using contrarian indicators?

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More is coming. Fear not as "he who waits, reaps a full harvest". - Grasshopper

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