Trading the Hot Market
Stockscores.com Perspectives for the week ending November 21, 2011
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In this week's issue:
Charting updates are nearly complete, it is now possible to change your default settings, view intraday charts on any time interval and add many different technical analysis studies. There are a few more upgrades coming and the Interactive charts will be added back to the charting controls. If you find that the charts do not work at all for you, please email me at tylerb@stockscores.com so I can have the issue solved.
There is a very simple way to do well in the stock market or any investment you make. While many investors are seeking that powerful indicator or great trading strategy, applying simple rules to a market, stock, ETF, commodity, industry or asset class that has an abnormally strong trend is the easiest way to succeed in the market.
Consider where people have made fortunes over the past 20 years. In the mid 1990's, junior mining stocks were unbelievably strong, led by the eventual fraud Bre-X. A lot of people made a lot of money trading that stock and other related plays from 1995 to 1997.
Once Bre-X was revealed as a fraud those stocks collapsed and Canadian listed mining stocks were a terrible place to be for many years. However, the hot money could be found elsewhere, the late 1990's brought us what is likely the greatest speculative stock market boom in history, the great technology run that lasted in to March of 2000. I made a lot of money trading companies with poor fundamentals but which attracted stock speculators in a way that I had never seen before. It was easy.
What next? The bursting of the Internet bubble hurt stock market investors and many turned their backs on stocks and invested in residential real estate. Low interest rates and demand from Baby Boomers seeking multiple residences to park their accumulated wealth motivated a parabolic upward trend in home prices.
This lead to yet another speculative bubble which burst in 2007 and lead to the worst loss of wealth we will likely ever see. Previously uncorrelated assets all moved in the same direction - down. While it may not have felt like a hot market, this downward move was intense and strong trending. Investors like John Paulson who played it from the short side made billions of dollars.
The near collapse of the global financial system necessitated the printing of money by central banks motivating yet another great speculative trend, this time in Gold. It has seemed that Gold bugs have been bullish on the commodity since the dawn of time but the past few years has finally shown them to be right. Trading in Gold and Silver over the past few years has been lucrative, allowing small investors to leverage a small amount of capital in to millions of dollars.
Where is the action now? It resides in a very odd place because the easy money in the past few months has not been in an asset but instead in the most powerful emotion that investors battle - fear.
The uncertainty that exists in the future of the global economic system causes investors to act with very little conviction. They are confused and lack direction, creating an opportunity for those able to trade price volatility.
The Chicago Board Options Exchange's VIX index is often referred to as the Fear Index because it rises with uncertainty. Based on implied volatility in Option prices, it tends to go up with stock price volatility, particularly in downward trends. Investors hedge risk with Options so we see the VIX move higher when investors perceive risk in their stock market investments. It is easily traded by retail investors through a number of Exchange Traded Funds, most notably the VXX and T.VXX.
Many investors shy away from hot markets because they almost always end badly. Bubbles throughout history, from the Tulip Bulb craze to Railroad stocks to Munitions stocks to Gold Mining stocks to Internet stocks to Housing have all made fortunes for those who rode the trend and got out before the bubble burst. Trade the hot market with enthusiasm but with the knowledge that human history is littered with stories of those who lost everything because they believed in the trend more than they should.
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The environment for stock investment continues to be challenging as there is a lack of trend. Individual stocks continue to have a strong correlation to the overall market index, making it difficult to find stocks that are able to outperform the overall market and move without its influence.
Where is the action in this market? Rather than focus on a strategy to pick stocks, this week I will outline some characteristics of hot markets. With these characteristics in mind, we can use the Stockscores Market Scan tool to find those hot stocks and ETFs that put the odds for success in your favor. It is a lot easier to make money in a hot market, how can we find one?
To answer this question, we have to define the characteristics of a money maker's market and what Stockscores Market Scan Filters will find these characteristics:
Near new highs - Today's Price is > 90% of the 150 day high
Near new lows - Today's Price is < 110% of the 150 day low
Highly liquid - Number of Trades > 25,000 (3000 for Canadian Markets)
Trending Up - Sentiment Stockscore > 60
Trending Down - Sentiment Stockscore < 40
Trading Abnormal Volume - Abnormal Volume = Abnormal Volume
Trading Abnormal Price Activity - Abnormal Activity - Abnormal Day Up or Abnormal Day Down
High Price Volatility - Volatility Index Today = High
Breaking Through Resistance - 5, 15 or 80 Day Resistance = Breakout
Breaking Through Support - 5, 15 or 80 Day Support = Breakdown
You can then combine these indicators in complimentary ways. For example, we could look for stocks making an 80 day breakout, trading abnormal volume, trading at least 25000 times a day with Volatility Index Today = High. This would highlight stocks that may be at the start of upward trends.
To find hot stocks that are well in to up trends already, look for those with a Sentiment Stockscore of > 60 with Today's Price > 90% of the 150 day high and with a number of trades > 25,000.
The charts below show examples of recently hot markets; see how they demonstrate the characteristics highlighted above.
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1. VXX
VXX became hot recently when the European debt crisis took center stage again in early August. At that time, it made an abnormal break to the upside with abnormal volume, breaking through 80 day resistance. As the trend developed, its Sentiment Stockscore moved above 60 and stayed above until its collapse in October. At that point, it remained a hot market to trade but on the short side.
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2. GLD
Gold has been in a long term upward trend for some time but it really heated up over the summer when volume increased and it ran away from its trend line. The Sentiment Stockscore was above 60 and it was hitting new, all-time highs. During that time, it was hard to listen to any financial news and not hear about Gold.
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3. NFLX
NFLX was a hot stock to the upside until August when it broke its long term upward trend line and became an even hotter stock to the downside. Short sellers who saw the Sentiment Stockscore drop fast as it traded high volume and move to new lows day after day were rewarded for taking a position in this bungee jump. Remember that hot stocks do not have to just go up, those that fall fast can be even more profitable.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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