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Maximum Fear
The Smart Profits Report: Issue #211
Tuesday, May 24, 2005
Maximum Fear: How to Turn “Maximum Fear” Into Maximum Profits
By Dean Albrecht
Fear and greed are timeless emotions. They’ve been around since caveman days, and they’ll be around for a long time to come. Particularly when it comes to buying and selling options… Fear and greed motivate us as traders and, to a slightly lesser degree, as investors.
When the market or a stock is headed up, people are getting “greedy”; when the market or a stock is going down, they’re feeling “fearful.” Considering that options tend to move with stocks, understanding and reading fear and greed can be to your advantage as an options trader.
For example, just by buying an option on a “maximum fear” day instead of a few days later when greed is kicking back in, you could easily wind up with a 20% gain versus a 20% loss…
Even better, there are ways of drastically improving your chances of buying on a maximum fear day.
Let me explain…
When a Stock Has Reached a Low - Strike!
As a quantitative analysis-based investor, I look at numbers to determine which direction a position is headed. But what I’m really tracking are fear and greed as they ripple through the markets.
As I look at the numbers, the trends, I’m using an algorithm that is seeking extreme levels of fear and greed within the normal oscillations of the market.
I’m looking for percentage moves up, percentage moves down, and the oscillation of price - and ultimately I’m looking to find direction.
On a monthly basis, for example, the markets move anywhere from 6% to 10%, up and down. Individual stocks tend to move between 10% to 20% each month.
So for short-term traders, the key is getting in when the stock’s headed up that 10-20%, instead of when it’s headed down.
In other words, you want to determine when maximum fear has hit - and the crowd has finished selling out of a position - and that’s when you want to buy. How do you do that? By identifying attractive stocks at the bottom of their normal trading range…
Maximum Fear: Look for Stocks at the Bottom of Their Range
When markets and sectors and stocks are down at the lower range of our expectation, we start taking notice. And of course, this is when I would tend to look to get into a long position.
(The opposite is true for stocks people are greedy for - their higher prices make them good shorting opportunities.)
On a very basic level, you can see when the market’s fearful about a particular stock by looking at its 52-week range… If the company’s trading on the low end of its 52-week range, it could be a sign that maximum fear is driving investors.
Here’s an example using IBM:
You can see that IBM hit a 52-week high of $99.10 in January… and today it’s trading around $76.59.
So should you rush out and buy IBM right now because it’s trading on the lower end of its 52-week range ($71.85 to $99.10) - because there’s fear in the market? No.
But considering the fear factor, you might consider IBM…(Of course, the quantitative analysis systems I use are taking in a number of factors, not just one.)
But be assured that learning all the different ways of reading fear and greed can help you:
- Take advantage of the markets rather than letting the markets take advantage of you
- Preserve capital by telling you when to stay on the sidelines
Indeed, when a stock is ebbing on maximum fear in the markets, it could be time to strike. And buy your options accordingly…
Good trading,
Dean Albrecht
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Today’s Smart Profits Cribsheet
- Check out our Smart Profits Glossary for definitions of option terms like “trend” or “daily range” along with related articles and other option terminology.
- For a deeper look into the mind of Dean Albrecht, check out Smart Profits #161, Quantitative Research: An Interview with Dean Albrecht.
Related Articles:
- Investing In The Fear Effect: How To Buy Bargain Stocks When There’s Blood In The Streets
- Greed & Fear: Gauge The Fear And Greed Factor To Boost Your Investment Success
- Option Prices: How to Get the Best Price on Your Options
