Reinforce the Warren Buffet “Fear and Greed” mantra with three more reliable indicators to increase your chances of trading success.
“Be afraid when others are greedy and greedy when others are afraid” is a well-known stock market saying by the famous investor Warren Buffet. The CNN Fear and Greed Index certainly embodies that idea. The chart below shows how greed and fear tend to swing from one extreme to the other.
Following in Mr. Buffet’s footsteps is never a bad decision in my opinion. Getting greedy when others are scared and getting scared when others are greedy has worked well in 2022. Adding a few other proven methods to that philosophy can make it even more robust. Here are three more ways to increase the chance of success in trading.
The chart below shows the one-year price action for the S&P 500 (SPX). It is clear that the SPX continues to be in a well-defined downtrend, with a series of lower highs and lower lows. Indeed, the recent strong rally we saw from the lows ended right on the trendline before starting to reverse course.
How far the current pullback will go is anyone’s best guess. However, if history is any guide, then $3400 would be a good bet.
I drew the numbers from the previous three times the SPX fell off the down trendline before bottoming out and moving back up as shown in the table below.
The average of the three declines so far this year has been just over 16% and lasted about a little over two months. That would equate to a drop that lands about $3,400 in the S&P 500 by about the February option’s expiration date of 2/17/2023, if the averages are correct.
Sure, many are still waiting for the so-called “Santa Claus Rally” to get stocks up on a seasonal basis until Christmas. Given the red-hot rally since October, Santa may have hit the market early. But seasonality is a double-edged sword. Once Kris Kringle leaves town, stocks tend to suffer.
January has been the worst performing month for stocks in the past two decades. The S&P 500 has averaged a 0.5% loss in that time frame and has fallen 55% of the time. February was also a laggard.
Stocks may struggle to find their way until spring if seasonality is any guide.
The VIX is a measure of the 30-day implied volatility in the S&P 500 options. It is also referred to as the fear meter because it tends to rise when stocks fall and fall when stocks rise. I recently wrote an article that showed how to use the VIX to time the market.
The chart below shows how pops and drops in the VIX matched almost exactly with similar drops and pops in the S&P 500. Also note how the VIX extremes match the CNN Fear and Greed Index extremes listed at the beginning of this article. were listed.
The latest drop in the VIX from highs at 34 to recent lows below 20, followed by a subsequent rally to near 23, provided another VIX-based sell signal for stocks. Each of the previous moves from the lows in the VIX eventually ended in the 34 area. If history holds, the VIX has much more to rise and the stock will fall much further.
As you can see in the chart, each new VIX-based buy signal corresponded to a new low in the SPY, the S&P 500 ETF.
All things being equal, stocks may not bottom out and be a buy until they hit new year lows.
Trading is all about probability, not certainty. By using these three metrics discussed in your decision making, you can put probabilities – and therefore the odds – in your favor.
What to do now?
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All the best!
SPY shares closed Friday at $393.28, down $2.96 (-0.75%). Year-to-date, SPY is down -16.24%, versus a percentage increase in the benchmark S&P 500 index over the same period.
About the author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His main passion is to make the complex world of options more understandable and therefore more useful for the everyday trader. Tim is the editor of the POWR options newsletter. Read more about Tim’s background, along with links to his most recent articles.
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