Tuesday, October 7, 2014
The stock market collapsed last week.
The S&P 500 started the week above 1,980. Shortly after the market opened on Thursday, the index was at 1,930. That's a 2.5% loss in just four trading days.
It was enough of a move to send traders running for cover. Financial-television talking heads quickly turned bearish. And many said the correction we've all been waiting for was finally here.
So I surprised a lot of my S&A Short Report subscribers on Thursday when I told them it was time to buy...
No, I haven't turned wildly bullish on stocks. There are still plenty of reasons to be cautious right now.
But as we've told you in these pages before, if you want to be a successful trader, you have to become a "connoisseur of extremes." This means monitoring the market for extreme situations where valuations, technical readings, or sentiment are badly out of whack. These extreme, "out of whack" situations often precede big price moves.
And on Wednesday, we had another one.
Take a look at this chart of the NYSE McClellan Oscillator (the "NYMO")...
The NYMO is a measure of overbought and oversold conditions in the stock market. It has a terrific track record of signaling short-term reversals in stocks.
Readings above 60 signal overbought conditions and warn of an impending decline in the market. Readings below -60 point to oversold conditions and signal the potential for stocks to move higher.
Wednesday's reading of -70 is only the sixth "buy" signal we've gotten from the NYMO over the past two years. The previous five signals were profitable. So there was good reason to expect this buy signal to work out as well.
And this chart of the Chicago Board of Options Exchange (CBOE) put/call ratio sealed the deal...
This Chicago Board of Options Exchange put/call ratio is the number of puts traded on the CBOE divided by the number of calls traded. It's another measure of overbought and oversold conditions.
Readings below 0.65 signal overbought conditions and warn of an impending decline in stock prices. Readings above 1.15 are oversold and signal the potential for a bounce in the market.
On Wednesday, the CBOE put/call ratio closed at 1.28. That's the second-highest level of the year.
The extreme oversold readings from the NYMO and the CBOE put/call ratio were a sign that traders should be looking for a bounce in the stock market. And that's exactly what happened.
By the time the stock market closed on Friday, the S&P 500 had recovered nearly all of its losses of the week. And I was able to pocket a solid gain from the trade I made on Thursday morning.
In short, if you want to be a successful trader in just about any market, pay attention to extremes – like overbought and oversold conditions in the NYMO and the CBOE put/call ratio.
It's a simple strategy you can use again and again to make consistent profits.
Best regards and good trading,
P.S. On Thursday, I also told my Twitter followers I was buying stocks. If you want to receive more up-to-date market commentary from me, follow me on Twitter @JeffClarktrader.
Jeff uses several indicators to gauge where the market is headed next... including Bollinger Bands, the MACD indicator, bullish percent indexes, and the "empty restaurant" indicator.
Editor in Chief Brian Hunt has reviewed just about every type of technical analysis out there. And he has distilled this complex subject into a few important ideas that belong in every investor's toolkit. Learn how to time your trades – and ensure the biggest profits – right here.
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