Secret 16PREDICTING STOCK TOPS AND MARKET BOTTOMS
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The technical charts can also provide clues for when a stock
is near or about to make a top. The secret, here, is the stock’s volume.
When a stock price has been in a strong uptrend and then
suddenly shows extremely high volume—yet the stock’s price
shows no upward progress—there is a good probability the stock
is making a top or is near a top. If you own the stock or calls on
the stock, it is time to take profits.
My rule of thumb is that the volume must be extremely high
for two or three days in a row. Corinthian Colleges (COCO) is a
stock where I recommended a put option in the summer of 2001,
based on this phenomenon. Over the next month, COCO dropped
from 51 to 25.
The secret to determining when the market hits bottom or a
temporary bottom is to measure the amount of panic in the market.
One classic line is “only buy when there is blood in the
streets” or when in the pit of the stomach, you feel the world is
coming to an end. This is, indeed, the time to buy.
One easy way to measure such panic is to look at two indexes,
the CBOE Volatility Index (VIX) and the Nasdaq Volatility
Index (VNX). The CBOE Volatility Index measures the implied
volatility of the puts and calls of the S&P 100 Index (OEX). The
Nasdaq Volatility Index measures the implied volatility of puts
and calls of the Nasdaq 100 Index. The higher the implied volatility,
the more expensive the options.
During market declines, investors buy more put options,
driving up the price of options and, therefore, their implied
volatility. The implied volatility getting extremely high is a sign
of panic in the market. Sometimes it takes a few weeks to reach
that bottom, but when the VIX and VNX are extremely high, it is
time to start entering bullish strategies.
One warning, however, the VIX and VNX must be at extremes.
For example, after the tragic World Trade Center events
of September 11, 2001, the VIX hit a high of over 57%
One final comment here. Bottoms are made when the sellers
are exhausted. This occurs when a stock stops dropping in price
on very high volume. For example, when WorldCom collapsed,
the stock price dropped to 7-cents and stopped moving down on
huge volume. Knowing that even bankrupt stocks will hold a
small premium, and that 7-cents was the bottom of that market
where the sellers would be exhausted, I bought the stock at 7-
cents and sold it the next day for 24-cents a share.
The technical charts can also provide clues for when a stock
is near or about to make a top. The secret, here, is the stock’s volume.
When a stock price has been in a strong uptrend and then
suddenly shows extremely high volume—yet the stock’s price
shows no upward progress—there is a good probability the stock
is making a top or is near a top. If you own the stock or calls on
the stock, it is time to take profits.
My rule of thumb is that the volume must be extremely high
for two or three days in a row. Corinthian Colleges (COCO) is a
stock where I recommended a put option in the summer of 2001,
based on this phenomenon. Over the next month, COCO dropped
from 51 to 25.
The secret to determining when the market hits bottom or a
temporary bottom is to measure the amount of panic in the market.
One classic line is “only buy when there is blood in the
streets” or when in the pit of the stomach, you feel the world is
coming to an end. This is, indeed, the time to buy.
One easy way to measure such panic is to look at two indexes,
the CBOE Volatility Index (VIX) and the Nasdaq Volatility
Index (VNX). The CBOE Volatility Index measures the implied
volatility of the puts and calls of the S&P 100 Index (OEX). The
Nasdaq Volatility Index measures the implied volatility of puts
and calls of the Nasdaq 100 Index. The higher the implied volatility,
the more expensive the options.
During market declines, investors buy more put options,
driving up the price of options and, therefore, their implied
volatility. The implied volatility getting extremely high is a sign
of panic in the market. Sometimes it takes a few weeks to reach
that bottom, but when the VIX and VNX are extremely high, it is
time to start entering bullish strategies.
One warning, however, the VIX and VNX must be at extremes.
For example, after the tragic World Trade Center events
of September 11, 2001, the VIX hit a high of over 57%
One final comment here. Bottoms are made when the sellers
are exhausted. This occurs when a stock stops dropping in price
on very high volume. For example, when WorldCom collapsed,
the stock price dropped to 7-cents and stopped moving down on
huge volume. Knowing that even bankrupt stocks will hold a
small premium, and that 7-cents was the bottom of that market
where the sellers would be exhausted, I bought the stock at 7-
cents and sold it the next day for 24-cents a share.