It has been said many times that the stock market is a function of fear and greed. Many investors are not rational. They are emotional and they act on what the crowd is saying instead of making an intelligent course of action for themselves by relying on fact and not hype. Unfortunately for most they do not have the intellect or emotional courage to follow their own path. They find security in herd mentality or “group think”. They cannot partake in what is known as contrarian investing.
Simply put, contrarian investing is going against the crowd. When everyone is getting into the market, that’s the time to get out or even sell short. When everyone is fearful and are not touching stocks with a ten -foot pole, that is the time to get in. There is a certain grain of truth to this approach. If everyone is getting in, then the markets are overbought and with the excess demand for stock, the price is artificially driven up. Stocks are overvalued and do not represent a bargain. On the flip side, when everyone is getting out, stocks are oversold and prices are depressed. This is the best time to get in. Remember, buy low.
A case can be made for contrarian investing this week. The Dow is clearly oversold. It has had four down days in a row. You can make all the excuses like the Iran War, the situation with the Strait of Hormuz, oil restrictions leading to increased gas prices, inflation up, impact on interest rates. You can listen to the negativity, but when pessimism is at its worst, opportunity is at its best. The question remains; how do you know when the market has bottomed?
At twopercentgoal.com, we are swing traders and not day traders. The difference between the two is the time horizon. A day trader acts intra-day while a swing trader buys and sells over a few days or a few weeks. But to answer the question about when the market has bottomed, we look at several indicators and wait for them to come out of oversold territory.
Both the Relative Strength Index and the stochastic oscillator measure momentum, velocity and sensitivity of a stock’s price action. When they come out of oversold territory, that is when we enter the market. We have bought low. Is it a perfect system? Absolutely not, that is why we use the MACD and on-balance volume to confirm the reversing price trend and we go with the overall trend of the 50-day and 200-day moving averages that coincides with the longer trend direction. When you have several technical indicators saying the same thing at the same time, you can make the trade with confidence.
There is an interesting barometer that has no scientific weight, but it still cannot be ignored. Every weekend we go through the stock chart of every company that make up the S&P 500 to identify potential buys for the week ahead. We have 67 stocks that almost meet all the criteria before pulling the trigger and making them buy recommendations. We must wait for their RSI’s and/or its stochastic oscillator to come out of oversold and pass its 20-line threshold. There are ZERO companies we are looking to short. There are very few if any short sells on the horizon. Shorting was profitable for the last two weeks but those opportunities have dried up. Milk the existing shorts for as much as you can, profit at the 2% level and get out.
Since there are so many buying opportunities and no shorting ones on the horizon, this gives further fuel to suggest the market is ready for a rebound. Not a matter of if, but when. Good luck with your investments.