In short, you must start looking at the market completely backwards. I focus on buying into heavy volume sell offs (panic) and selling position into heavy volume breakouts (greed). This was a very tough transition for me to make and its best to paper trade it for while until you are comfortable with buying into fear and selling into greed. It will feel completely wrong at the beginning but the profits speak for themselves!
The Four Charts I Follow Closely
The 4 main tools need to make money from trading against the herd. While this is only one of my trading strategies it is my favorite. I trade the ES futures contract and some sometimes the SDS and SSO exchange traded funds. This may seem basic at first glance but when you combine them you end up with a highly effective trading strategy.
SP500 - 5 Minute Chart
Here is a 5 minute chart of the SP500 showing where I went short. It is important to know that over the past 2 years the SP500 has provided a 1.25% profit on average each time one of these extreme sentiment readings occur on the charts.
The red indicator on the chart is a simple volume based indicator which measures fear and greed in the market and is very powerful for picking market tops and bottoms. It’s calculated by taking the NYSE up volume and dividing it by the down volume. In short, when you see this indicator start to rise it tells us the majority of traders (the herd) are buying and we should start to look at taking a short position.
Let me show you how to find the trade using the market sentiment....
The NYSE advance/ decline line
Is the most easy to understand. How I use this is simple, when there are 1500+ stocks trading up on the day then the market is getting overbought meaning too many stocks have moved up in a short period of time and traders will most likely start taking profits or exit their positions. I also look at the intraday chart for topping patterns or resistance levels then wait for the other two indicators to confirm Selling Volume on the chart above and the put/call ratio before going short the market.
The last indicator I follow is the put/call ratio
This indicator can be a little tougher to use at times because when the market is trending down the ratio tends to fluctuate near the top or bottom of its range during up or down trends. In a down trend is stays near the top which the chart below shows.
When the broad market bounces and we see the put/call ratio drop into the lower band it’s telling me the majority of traders have finally become bullish. This tends to happen once a previous high is broken as it triggers short covering and breakout traders start to buy.
Trading Market Sentiment Conclusion:
All you need to use these indicators, focus on the 15 minute charts, trade only with trend, and take profits at 1%, 2% and keep a small position open for much larger gains.
It is critical that once you take partial profits once you reach a 1% gain then you must start moving your protective stop into the money to lock in a profit for the balance of the position. All three indicators need to reach the extreme levels at the same time for a trade to be triggered. I have seen the market trend in the extreme levels for several weeks continuing to move up day after day and you will get stuck in that situation if you jump the gun entering a trade before each indicator signals an extreme level.
Final thoughts, his strategy works just as well in a bull market but there are some minor changes required on each of the indicators. Also I use inter market analysis following the US Dollar, Gold, Bonds and the Volatility Index for other trading strategies which I incorporate using the market sentiment.
If you would like to get Chris Vermeulen's ETF Trade Alerts for Low Risk Setups checkout his service at The Gold And Oil Guy.com
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