Investors are motivated by two things and two things only: fear and greed.
It may be as cliché as it gets, but it's just that simple.
More often than not, they turn quite bullish when they think a stock is headed higher and quite bearish when they fear that all is lost.
The trouble with this strategy is that, for most retail investors, it is exactly at these extremes in sentiment when they lose their shirts...
While conventional financial theory does suggest the idea that markets behave rationally, not accounting for the emotional aspect of the trade, this often leads to all of the wrong entry and exit points.
And believe me when I tell you this: It's hard to make any money on the Street when you're constantly getting either one or both of them wrong.
That's why successful technical analysts often rely on the VIX indicator to assess whether or not the current market sentiment is either excessively bullish or bearish in order to plot their next move.
Make Better Trades Using the Fear Gauge :
The VIX is one of the so-called contrarian indicators.
It is incredibly useful in determining whether the markets have reached an extreme position one way or the other. When that happens, it tends to be a sure sign that the markets are about to stage a reversal.
When a wide majority believes that one bet is such a sure thing, they pile on and chase after gains. Unfortunately for them, the market is usually ready to turn the other way by the time they jump into a position.
If "the crowd" is feeling very bullish, in other words, it is definitely time to think about getting bearish.
Smart investors simply use the VIX indicator to determine when to bet against them all. It's counter-intuitive for sure, but it works nearly all of the time — especially in volatile markets. And that's why the VIX indicator is a trader's best friend these days.
After all, in today's market there are definitely a lot of people chasing gains that already happened. There are also plenty of skittish investors fearing the end of quantitative easing and a market correction.
What Is the VIX Indicator?
Developed by the Chicago Board Options Exchange in 1993, the CBOE Volatility Index (Chicago Options: ^VIX) is one of the most widely accepted methods to gauge stock market volatility.
Using short-term, near-the-money call and put options, the index measures the implied volatility of S&P 500 Index options over the next 30-day period.
It is basically a derivative of a derivative. Because of that, it acts more like a market thermometer more than anything else. And just like a thermometer, there are specific numbers that tell the market's story.
A level below 20 is generally considered to be bearish, indicating that investors have become overly complacent. Meanwhile, with a reading of greater than 30, a high level of investor fear is implied, which is bullish from a contrarian point of view.
The smart thing to do then is to wait for peaks in the VIX above 30 and wait for the VIX to start to decline before placing your buy. As the volatility declines, stocks in general will rise and you can make big profits.
You see it time and time again. In fact, the old saying with the VIX is, "When the VIX is high, it's time to buy."
That's because when volatility is high and rising, that means the crowd is panicked. It leads to selling based on fear and quickly falling stock prices. That creates a short window where there are bargains in the market for moneymaking traders.
Here's a couple examples of how it works in the real world...
First up is a series of three classic reversals in the S&P 500 back in 2008. Each one of them successfully predicted by the VIX using its 200-day moving average (DMA) as the basis of each move.
At times, the VIX will break through the 200-day moving average and stay there, making the system invert. When this happens, the VIX will spike up to the 200-day moving average and then drop.
A perfect example of a crossover can be found back in 2010:
The inverted scenario was in full effect in the first half of 2013 as well. Every time the VIX breached the 200 day moving average, it quickly fell. The spikes were tied to drops in the S&P 500, which became attractive entry points as the market rebounded:
Note that the pattern may invert, but the VIX spikes represent a good time to jump into the market regardless of the pattern in play.
For smart and disciplined traders, each occasion was the equivalent of taking candy from a baby, simply by betting against the "wisdom" of the crowd.
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The keys to making the one-trade-per-day strategy work for you are being disciplined and patient
By preparing your trading strategy and trading plan before you begin trading with real money you will put the odds of success in your favor while diminishing the chances of becoming an emotional trader who loses money
So, let’s say 8 winners and 12 losers over the course of a month.
8 x $450 = $3600 profit
12 x 150 = $1800 loss
----------------------------------------------------- Total profit = $1,800 (60% return)!
So, we can see in the above example that if you only traded 20 times in a month ,This is a 60% return on your investment over a one month period, a very acceptable return by any professional’s standards