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Wednesday, November 23, 2011

Tips to Trade Using Market Sentiment and the Holiday Season 2011

Tips to Trade Using Market Sentiment and the Holiday Season 2011 : The months of November and December are the second strongest back-to-back months for the financial markets. Many traders and investors use this time of the year to reap big gains as they close the year out. The fact that most traders and investors are sitting in cash and underweight stocks in their portfolios leads me to believe a Santa Clause rally is just around the corner: everyone has cash on hand to buy stocks because they are selling their positions in this pullback we're in right now. I know traders well enough; they will buy back into the market trying to catch the holiday rally in the coming weeks.

I have been short the S&P 500 for a couple of weeks after watching the broad market become overbought and sentiment levels became overly bullish with greedy people thinking they could buy stocks after a massive month-long rally that had not pulled back. Once the selling started you would either get you head handed to you or you made a killing buying leveraged inverse ETFs.

Those who arrived late to the rally are the ones selling out of their positions this week. The interesting thing about this week’s market condition is that I have not seeing any real panic selling in stocks, and I’m not seeing the volatility index spike in value yet.

What does this mean? Well, it means we could actually see another big dip in the market which should last one to two days, and then we get a sharp reversal to the upside.

Take a look at the S&P 500 and Volatility Index below.

This chart allows us to get a feel for fear in the market. Being a contrarian trader, I focus on market sentiment extremes. When the masses are losing money hand over fist, I’m generally on the other side of that trade with open arms. Trading off fear is one of the easiest ways to trade the market. That's because fear is much more powerful than greed and it shows up better on the charts. You can successfully trade panic sell-off bottoms if you know what to look for and how to do it.

On the chart you can see the pullbacks in the S&P 500 that triggered a panic-selling spike in my green indicator. What I look for is a pullback in the S&P 500 and for my panic-selling indicator to spike over 20. When that happens I start watching the Volatility Index for a spike also. The good news is that the Volatility Index typically rises the following day making my panic indicator more of a leading one.

I could write a 20-page report on this topic, but that’s not the point of this article. Just realize that the stock market is likely going to put in a bottom very soon and likely to end with a strong panic-selling washout this week or next.
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