Reinforce the Warren Buffet mantra “Fear and Greed” with three more reliable indicators to increase your chances of success in trading.
“Be afraid when others are greedy and greedy when others are afraid” is a famous stock market adage by famed investor Warren Buffet. The CNN Fear and Greed Index certainly embodies this notion. The chart below shows how greed and fear tend to swing from one extreme to the other.
Following in Mr. Buffet’s footsteps is never a bad decision, in my opinion. Getting greedy when others are scared and being scared when others are greedy worked well in 2022. Adding a few other proven methodologies to this philosophy can make it even more robust. Here are three more ways to increase the odds of trading success.
The chart below shows the one-year price action for the S&P 500 (SPX). It is evident that the SPX continues to be in a well-defined downtrend with a series of lower highs and lower lows. Indeed, the recent strong rally we’ve seen from the lows ended right at the trendline before it began to reverse course.
How far the current pullback will go is anyone’s best guess. However, if previous history is any guide, then $3400 would be a good estimate.
I removed the numbers from the previous three times the SPX fell off the downtrend line before bottoming and rising again, as shown in the chart below.
The average of the three declines so far this year has been just over 16% and has taken about a little over two months. This would equate to a decline ending around $3,400 in the S&P 500 around February option expiration on 2/17/2023 – if averages hold.
Granted, many are still waiting for the so-called “Santa’s Gathering” to increase inventory seasonally until Christmas. Given the scorching rally since October, Santa may have already arrived early for the markets. But seasonality is a double-edged sword. Once Kris Kringle leaves town, stocks tend to suffer.
January was the worst performing month for equities over the past two decades. The S&P 500 posted an average loss of 0.5% during this period and fell 55% of the time. February also lagged.
Stocks may struggle to find their way into spring if seasonality is any guide.
The VIX is a measure of the 30-day implied volatility of S&P 500 options. It is also called the fear gauge because it tends to rise when stocks fall and fall when stocks rally. I recently wrote an article that showed how to use the VIX to time the market.
The chart below shows how the pops and dips in the VIX have matched almost precisely similar dips and pops in the S&P 500. Also note how the extremes of the VIX match the extremes of the CNN Fear and Greed Index noted at the beginning of this article.
The latest drop in the VIX from highs of 34 to recent lows of less than 20, followed by a subsequent rally to near 23, generated another VIX-based sell signal for stocks. Each of the previous moves from the VIX lows ended up stalling in the 34 area. If the story holds, the VIX still has a lot to do and stocks still have a lot to fall.
As you can see from the chart, each new buy signal based on the VIX corresponded to a new low in the SPY, which is the S&P 500 ETF.
All things being equal, stocks may not bottom out and be a buy until they hit new lows during the year.
Trading is about probability, not certainty. Using these three discussed metrics in your decision making will help put the odds – and therefore the odds – in your favor.
What to do next?
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All my wishes!
Editor, POWR Options Newsletter
SPY shares closed at $393.28 on Friday, down -$2.96 (-0.75%). Year-to-date, SPY is down -16.24%, versus a % rise in the benchmark S&P 500 over the same period.
About the Author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Chief Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade “Morning Trade Live” network. His primary passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR Options newsletter. Learn more about Tim’s journey, as well as links to his most recent articles.
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