The best traders appear to turn profits in any type of market condition.
What is the essential element all of them have?
Are they better at timing the market than the rest of us?
Or is it something deeper that we just can’t put our finger on?
Despite being Mensa certified, nothing came easy to me when it came to mastering the stock market.
To improve my trading. I began relying on analytical tools and stopped trading on hunches and other people’s ideas.
This discovery felt like unearthing a hidden treasure lost to the ravages of time.
However, traders treat these tools as a panacea for market tops.
That’s where they go awry. These tools only tell you where potential turns are likely. There’s no guarantee they will happen.
However, the more evidence we gather that a turn is due, the higher the chances of one occurring.
We’ve all heard the parable from Warren Buffett – Be fearful when others are greedy and greedy when others are fearful. No truer words were spoken that remain applicable to trading throughout the years.
Sentiment indicators help traders identify when general opinion has become too bullish or bearish. There are a few different ones out there, so I’ll just cover their basics.
Social media sentiment indicators look at mentions and trends on social media that indicate bias. They use algorithms to comb through data and label them to each category. A sentiment indicator is presented based on some calculations using the data.
The problem with these indicators is they don’t represent actual trades. They look at social media feeds, which may or may not correlate to actual market moves. I only consider these at the periphery.
Instead, I focus on the consumer sentiment index published by the University of Michigan. They conduct a rigorous survey to approximate consumer attitudes towards the economy. I like the history behind this, which gives a lot of context to the data. When sentiment hits overly bullish records, I start to question things
My favorite metric is the simple price to earnings ratio of the S&P 500. While this can stretch pretty far, it tends to trade within a range.
The last 20 years really changed the dynamic of what was acceptable. Prior to 2000, stocks generally traded in a range of 10x-20x earnings. Now we’re at an estimated 24.28x earnings.
Not everyone wants to play the long game. That’s why we have some indicators I use intraday and daily to time my market approach.
The NYSE Tick chart helps me look at market breadth. It compares all the stocks declining to all those advancing. That gives me a sense of whether the market rallies or declines are broad-based or focused on a few stocks.
NYSE hourly TICK chart
This only really works intraday. It’s not something that works between days.
My other favorite indicator – because I’m an options trader – is the put/call ratio. The main one I look at focuses on the volume of calls to puts on a basket of stocks. You can also look at ones on the S&P 500 as well.
When I see the index rising, it’s an indication that we’re nearing a capitulation point. Traders are piling into protection, leaving a lot of risk for a snapback. Conversely, a low ratio indicates complacency among investors. They aren’t preparing themselves for a potential downdraft.
The #1 Indicator – The VIX
Up high on Mount Olympus sits the VIX. No other indicator tells me more about market turns than the VIX. Because of its mean-reversion tendencies, anytime the VIX hits extreme levels for too long peaks my interest.
Here’s the trick – you want relative extremes in the VIX. Back in 2017, we had excessively low levels in the VIX for the entire year.
VIX weekly chart
However, there were still opportunities to find turns when the VIX hit new lows or highs…places it hadn’t visited for quite a while. I couple that with the VVIX, which measures volatility on the VIX, to give me a sense of when the VIX will turn.
VVIX weekly chart
You can see how even though the VIX itself didn’t move much, the VVIX highlighted the changes loud and clear. That’s why I look at both of these, in tandem, to give me the clearest sense of the market turns.
The most money is made when the market crashes
Some of the wealthiest traders made money off market crashes. They timed their entries and pressed their advantage. I plan to do the same thing.
You can see exactly how I do this by joining Total Alpha.
All my trades will be streamed live for you to see.