Strategy

As a chartered financial analyst and chartered market technician, I recognize the importance of both fundamental and technical analysis. But I also believe that the emotional reactions of most investors often generate the biggest opportunities. This fear-and-greed spectrum plays out repeatedly in the markets. Most investors time the market very badly, so those who do the opposite of the crowd at the major extremes tend to have a major advantage.

Sentiment indicators, including put/call ratios, the CBOE Volatility Index ($VIX.X) and Rydex mutual-fund flows all factor heavily into any analysis of the state of investors' fear or greed. I weigh these opinions against the strength or weakness of the prevailing technical trends in the market to figure out where the next major surprise is likely to occur.

My book "Big Trends in Trading"lays out the groundwork for my top-down approach to market timing and security selection, driven by quantitative measurements of crowd opinion.

I think that the market tends to frustrate the majority of investors the majority of the time. By the time most have become bullish, buying power is exhausted and more risk than reward lies ahead. In contrast, indications of worry or panic often generate contrarian buy signals once a selling climax is confirmed in the technical indicators. I then use my proprietary Acceleration Bands and other unique technical indicators to spot the stocks with the greatest potential to lead the market and experience persistent trends.

The level of noise in the markets today is much greater than when I started trading 17 years ago. As a result, I seek to filter out many of the moves that simply are not predictable and focus instead on the more meaningful breakouts. In addition to my Acceleration Bands and Momentum Divergence techniques, I more recently have focused on the importance of options charts in determining whether a stock's trend is moving more quickly than the time lost (because options lose value due to time decay if the stock is not moving favorably enough). This helps me focus on the best stocks and use options as a stock substitute where appropriate.

Relative strength

Most investors focus too absolutely on the particular stocks they own, without grading them on a relative scale versus the other available opportunities. I focus on relative strength as a measure of a stock's outperformance or underperformance versus other alternatives. I typically advocate the "closing stop" technique (as opposed to an intraday stop) to avoid the noise of short-term movements, while still having an "uncle" point to exit promptly should the trend break on a closing basis. I define the bigger trend first, even when trading on a short-term basis. As a result, I like to study monthly and weekly charts before analyzing shorter-term time frames.

I use computers to scan for acceleration or divergence patterns, among other methods I have found to create an edge for traders and investors over time. I also monitor important news reports, particularly earnings surprises, to see how a stock reacts to good or bad news. The biggest moves often happen once a stock reacts to news in the opposite direction of what the crowd had expected. Thus, the reactions are more important than the news itself in my work. The surprise reactions tell you where the next unexpected trend is likely to occur.

Big trends can occur over both the short term and longer term, and you can spot these trends as long as you possess a sound methodology and the discipline to follow a systematic plan, instead of reacting with emotion as most traders do.

In the breeding and racing of Thoroughbreds, there's a saying: "Sometimes it's better to be lucky than smart." But in trading and market timing, the lucky investors who trade based on hunches tend to be outlasted and outwitted by the smart investors who stick to a battle-tested trading plan.