Secret 11MAVERICK INVESTING

To truly predict what the markets will do in the future, you

need to look at the field of psychology and group behavior.

Since the start of the NYSE, it is well known that specialists

who make a market in listed stocks make a lot of money each

year. Why? Because they are forced to buy stock when prices are

falling and sell stocks when prices are rising. Their job is to make

a market in a stock, which means they must buy stock when

everyone wants to sell and sell stock when everyone wants to buy.

This forces them to be on the other side of the crowd. Emotionally

they prefer not to be in that position. In fact, when the market

is falling, they would prefer to be also sellers. The specialists

in a sense have been forced to be contrary investors in the very

short term. Consequently, in the end they are the winners.

Markets at times tend to move to extremes. When they do,

you have a chance to stack the odds in your favor and improve

your odds of predicting future price moves. The problem is that

when markets move to extremes, you, like everyone else, emotionally

don’t want to take an opposing position. Despite this

aversion, ironically, the best time to buy stocks is when there is

blood in the streets and when in the pit of your stomach, you feel

the world is about to end.

Markets tend to overshoot and undershoot their true value

and at times become irrational as we saw in the internet crash in

2000. Here it is easy to predict the future, if you have the guts to

go against the psychology of the crowd.

However, to be a successful contrary investor or maverick

investor, you must be patient and wait for the real extremes. Buy

when there is a lot of fear in the market and sell when there is a

lot of euphoria and greed in the market. You also must control

your greed in the midst of a bull market and control your fear at

the bottom of the market.

One indication of whether the stock market is near a bottom

is the CBOE Market Volatility Index (VIX). This index measures

the implied volatility of the S&P 100 Index Options and, as a result,

is a good measure of the fear in the market.

When implied volatility is high, options are expensive. This

is because when there is a lot of fear in the market, investors buy

put options, forcing put prices up, making options more expensive,

and the VIX measures how expensive options are. The

higher the VIX, the more fear there is in the market.

The index moving above 35% suggests that we are near a

market bottom. (There is one exception to this rule. If the market

is really volatile, the VIX should be high to reflect that volatility.

Then the VIX will not be as predictive.)

Knowing how fear and euphoria work in the market and

using it for you rather than against you is a self-discipline you

have to acquire. Emotionally as well as intellectually, you have to

prepare yourself for the game.

To truly predict what the markets will do in the future, you

need to look at the field of psychology and group behavior.

Since the start of the NYSE, it is well known that specialists

who make a market in listed stocks make a lot of money each

year. Why? Because they are forced to buy stock when prices are

falling and sell stocks when prices are rising. Their job is to make

a market in a stock, which means they must buy stock when

everyone wants to sell and sell stock when everyone wants to buy.

This forces them to be on the other side of the crowd. Emotionally

they prefer not to be in that position. In fact, when the market

is falling, they would prefer to be also sellers. The specialists

in a sense have been forced to be contrary investors in the very

short term. Consequently, in the end they are the winners.

Markets at times tend to move to extremes. When they do,

you have a chance to stack the odds in your favor and improve

your odds of predicting future price moves. The problem is that

when markets move to extremes, you, like everyone else, emotionally

don’t want to take an opposing position. Despite this

aversion, ironically, the best time to buy stocks is when there is

blood in the streets and when in the pit of your stomach, you feel

the world is about to end.

Markets tend to overshoot and undershoot their true value

and at times become irrational as we saw in the internet crash in

2000. Here it is easy to predict the future, if you have the guts to

go against the psychology of the crowd.

However, to be a successful contrary investor or maverick

investor, you must be patient and wait for the real extremes. Buy

when there is a lot of fear in the market and sell when there is a

lot of euphoria and greed in the market. You also must control

your greed in the midst of a bull market and control your fear at

the bottom of the market.

One indication of whether the stock market is near a bottom

is the CBOE Market Volatility Index (VIX). This index measures

the implied volatility of the S&P 100 Index Options and, as a result,

is a good measure of the fear in the market.

When implied volatility is high, options are expensive. This

is because when there is a lot of fear in the market, investors buy

put options, forcing put prices up, making options more expensive,

and the VIX measures how expensive options are. The

higher the VIX, the more fear there is in the market.

The index moving above 35% suggests that we are near a

market bottom. (There is one exception to this rule. If the market

is really volatile, the VIX should be high to reflect that volatility.

Then the VIX will not be as predictive.)

Knowing how fear and euphoria work in the market and

using it for you rather than against you is a self-discipline you

have to acquire. Emotionally as well as intellectually, you have to

prepare yourself for the game.