How to End a Bear Market in the Green
Unlike many traders, I remember the 2000 dot-com bubble fondly.Because while most people were rushing to get into big names like AOL and Yahoo every morning, I was doing the opposite… Instead of following the crowd and “day trading,” I stepped back and analyzed the market action. I saw that day traders were driving large moves in stocks. But most of these big moves came early or late in the day. I thought about what it meant to day trade, and I realized the key thing was to not hold positions overnight. Day traders sold at the close and bought at the open. When traders rushed to buy every morning, they created gaps on the chart. When they sold at the close, they pushed prices down. I decided to profit from this behavior… by becoming a “night trader.”
Why Night Trading Worked Then, But Doesn’t Now
Being a night trader isn’t as dramatic as it sounds. It simply means buying the close and selling the open — the opposite of the dot-com day traders.This was a profitable, if risky strategy back then. Holding overnight carries the risk of markets opening lower off a bad headline. But the technical indicators I followed helped me avoid large losses. And when stocks are in a bubble, odds are good that stocks will open higher. This “night trading” strategy worked well until the crash… But it’s never worked again. See, there were unique rules in place for the internet bubble, including a special order type that pushed you to the front of the line for execution (SOES orders, a story for another time). When the exchanges saw that some people were taking advantage of this, they changed the rules. That was the first time I saw the value of understanding how markets work. But in my years of research following the dot-com crash, I discovered something even more important. The key to unlocking profits in the stock market is to measure how greedy investors are. As it so happens, I recently put the finishing touches on an indicator that does just that. If I’d had it back in 2000, I would’ve made money on bullish positions, a vast majority of the time, during the worst bear market in 70 years. Lucky for us, I do have it now. During the biggest stock downturn since the pandemic. And today, you’re going to learn how it works.
A 74% Win Rate in the Worst Bear Market in 70 Years
If you’ve been following along lately, you already know the indicator I’m talking about…Greed Gauge is an indicator I developed to measure the level of greed in the market. It’s based on how close a stock’s current price is to its 52-week high. The 52-week high represents the maximum level of greed in the past year. I smooth that calculation to show the values in a format similar to the commonly used MACD. The resulting “Greed Gauge” is at the bottom of the chart below. Green bars are bullish and red bars are bearish.The
This is a chart of the S&P 400 Midcap Index (MID) during the bear market that started in 2000.Midcaps were the strongest stocks at the time, relative to the rest of the market. While other indexes went almost straight down, MID made several attempts to reach new highs before bottoming in October 2002. At the bottom, midcaps were about 30% below their all-time high. For comparison, the tech stock-heavy Nasdaq 100 Index was down more than 80%. The blue-chip S&P 500 fell almost 45%. If I’d had my Greed Gauge back in 2000, midcaps would have been a clear target. I could’ve used it to trade the SPDR Midcap S&P 400 ETF (MDY), an index that tracks midcaps. But individual midcap stocks fared even better. Greed Gauge buy signals resulted in gains 73.6% of the time. The average signal resulted in a gain of 0.5% over the next week. That’s not a big enough gain to trade stocks. But it is enough to trade options. Simply buying calls on the buy signals would have been profitable during the dot-com crash. We don’t know which index will lead during the next bear market. But based on history, we do know the Greed Gauge should deliver profits as other investors panic. And it’s always nice to end a bear market with more money than you had at the start.
Regards,Michael Carr, CMT, CFTeEditor, True Options Masters
Chart of the Day:Learning Bonds, with Mike Carr’s Help
By Mike Merson, Managing Editor, True Options Masters
The biggest blind spot in my investing acumen is the bond market.Most new-ish investors can probably say the same. Bonds are a critical part of the world economy, but not as immediately grokkable as stocks. Thankfully, I have market maestro Mike Carr at my side to help me learn the ropes. Here goes something… 10-year Treasury Bond yields have nearly doubled in 2022. That’s about what we should expect as stocks have sold off gradually since the start of the year. But over the last couple weeks, bond yields have fallen along with stocks. That reflects more demand for T-bonds, as a flight to safety from stocks. It also could suggest traders are betting on a slower economy given last week’s underwhelming inflation data. If this continues, it’s likely that the yield curve will invert once again — meaning long-term Treasury yield rates will fall below short-term rates. All this is to say, we should all be watching the bond market carefully. It often serves as a leading indicator for both the stock market and the larger economic picture.
Regards,Mike Merson Managing Editor, True Options Masters