My apologies for not writing to you sooner… I had a bad death in the family.
While it’s a bit painful, I have a job to do. And I’m going to do it well. Life happens. He had a great life so I can’t be too down.
I wish I could say I am shocked by recent market behavior…
But I’m not. I’ve warned of impending doom for quite some time. It’s the reason we’ve asked that you not risk the house, or more than you can afford to lose at any given time.
The market has been nothing short of a mess.
We were well aware of the market deficiencies and what was likely the whole time. The only thing we’re shocked by is the amount of bulls that rushed in as toppy conditions told us to run for cover.
We knew Greece was in trouble. We knew things wouldn’t work out. And we didn’t need a crystal ball to tell us. The writing was on the wall.
Now we have to hope that Puerto Rico doesn’t default… Or, we’re in a heap of trouble there, too. It’s a wait-and-see, though.
Along the way, we’ve broken through significant support levels, most notably the 200-day moving average that we’ve spoken about, too.
Having just broken through the 200-day moving average, we’ve also just moved below prior May 2015 support. Unless something miraculous happens, the S&P 500 could move to 2000 — a 3% decline. It’s a wait-and-see at this point.
For the time being, hold all open positions. And consider selling to close half of the MU October 20 put for gains of up to 59%. Hold the call side of the hedge.
Before we part ways today, I wanted to share some educational tools with you, too, for use on your own moving forward.
If you pull a rubber band too far, too tight, what happens?
It snaps back.
Well… the same thing happens with stocks driven by two of the most powerful forces on Wall Street – fear and greed.
If traders get too greedy, they send stocks too high, too fast. And it becomes an unsustainable move. Eventually, a stock will pull back, allowing us to profit.
If traders get too fearful, they send stocks down too much, too fast. And again, it becomes an unsustainable move. Eventually, the stock bottoms out, allowing us to profit.
Sounds simple, right?
So how can the average trader – you – spot these excessive moves?
That’s the easy part. You can find them just about anywhere, especially after news has been released.
Opportunities like these happen all the time.
One of the best ways to catch them is by watching for massive volume spikes, anticipatory momentum, news dissemination and the death of news, to name a few.
For example, when the Ebola story hit, panic sent related stocks – like Tekmira (TKMR) – up 333% in no time at all.
No one knew how high it was headed…
But we did.
After that sizable run, look at what momentum indicator, Relative Strength (RSI) was telling us. It was screaming, “Sell me.”
Once RSI topped out above that 70-line, we knew the stock would reverse, as it did.
Historically, an RSI read above the 70-line tells us it’s overbought. A read at or below the 30-line tells us it’s oversold.
But we can’t just rely on a sole indicator for directional change. That’s not safe.
So we move to confirm what RSI is telling us by looking at another popular momentum indicator known as moving average convergence divergence (MACD).
All we’re looking for here are obscene moves from the mean.
Massive spikes in either direction give us an indication that a reversal is likely on a mean reversion in MACD, as you can see here. Look at the spikes in MACD above 2.0. Each time that happened here – with confirmation from RSI – the stock reversed.
We can strengthen our argument a bit more by looking at the momentum of money flowing in and out of the name with the Money Flow Index (MFI).
Notice what happens when MFI moves above its 80-line or below its 20-line. It reverses.
While these three indicators work well in determining the death and rebirth of momentum, we can confirm a bit more by seeing just how far we can pull the rubber band.
To do so, we identify the Bollinger Bands, which let us know how far we can “pull” the stock. As we can see in this example, about 80% of the time, the lower and upper Bollinger Bands told us exactly how far we could pull the stock.
Coupled with the above-mentioned indicators, our chances for success increase substantially.
We can confirm even more, though, with the ultimate momentum indictor, Williams % Range (W%R). Here, look at what happens when Williams % Range reaches zero, considered overbought.
It reverses.
Now look at what happens when Williams % Range reaches -100, considered oversold.
It reverses.
Granted, there are hundreds of indicators and patterns to watch when identifying reversal patterns. But when used together, these indicators alone are some of the most powerful because they look at the momentum generated by the crowd.
They allowed us to exploit crowd mentality, driven by two of the most psychologically powerful tools of the market – fear and greed,
All stocks, indexes, ETFs – are all driven by fear and greed.
If we can identify where and when those reach an extreme, we increase our chances of success.
Using these tools, traders had an opportunity to make 186% gains in just 14 trading days.
Watch this. In early June 2015, shares of Zumiez, Inc. (ZUMZ) were sent down $6 in a day on a sales report. It was an unnecessary overreaction.
Once MFI fell under its 20-line…
Once MACD pulled back to -2…
Once RSI fell under its 30-line… I knew the stock was greatly oversold and ready to bounce. So, I recommended a buy on the ZUMZ August 25 calls at $1.05.
By June 22, 2015, the stock gapped to just under $28 a share, sending my option to $3 a contract for 186% profits in 14 trading days.
What did my Bollinger Bands (2,20) and Williams % Range indicators tell me at the same time? That this stock was insanely oversold…
Take a look.
I’m not tempted to buy a near-term put option on ZUMZ as W%R reaches overbought reads coupled with over-extensions on my Money Flow indicator.
Good Investing,
Ian L. Cooper
Forgotten Profits