Don’t Expect to Beat the Market Unless You’re Doing This
An old trader once told me, “Trading is the hardest easy money you’ll ever make.”
In theory, trading is easy enough — all you have to do is buy low and sell high, right? After all, there are thousands of books claiming to have all the information we’ll ever need.
In practice, however, trading is among the most difficult activities in the financial world. Despite the availability of a wealth of information, few do it well.
In fact, all that accessible information actually makes it harder to trade successfully. As an old trader once told me, “To know what everyone knows is to know nothing.” If everyone has the same tools, it’s difficult to use them to gain an advantage over everyone else.
Think about that for a moment.
If you could really win in the markets by simply buying stocks with low price-to-earnings (P/E) ratios, then we would all be successful. The secret to beating the market — and your fellow investors — is to use little-known indicators, which act like secret weapons for trading.
That’s why I developed my own indicator, which I call the Income Trader Volatility (ITV) indicator.
ITV is similar to the Volatility S&P 500 (VIX), which you’re probably familiar with. Also known as the “fear index,” the VIX measures the volatility of the broader market. A low VIX suggests investor complacency. When stocks fall, volatility/fear rises. Many analysts watch VIX spikes in a market sell-off to help determine where prices may find a bottom.
There are a couple problems with the VIX, though. First, it only applies to the broader market. The VIX won’t help us find individual stocks that are bottoming.
A bigger problem is that there’s really no way to know when the VIX is high enough to signal a bottom. In hindsight — days or weeks after the bottom is in place — it’s easy to spot the spike in the VIX that signaled the bottom. But we have to make trades in real time, so we need a real-time trade signal from volatility. And if we want to beat the market, we need to have signals for individual stocks.
ITV is my solution to both of those problems.
For the technically inclined, ITV is basically a stochastic indicator of lows and can be found for any stock or ETF. That solves the first problem with VIX, because ITV pinpoints individual buying opportunities.
Adding a moving average (MA) solves the second problem. High volatility indicates fear, and we expect fear to rise as prices fall. When ITV rises above its MA, fear is rising. The buy signal comes when ITV falls back below its MA. We won’t catch the exact bottom with this tool, but we should catch a large part of the uptrend while avoiding stocks that languish at low levels.
The chart below shows ITV applied to the Wilshire 5000 index, which is among the broadest measures of the stock market.
ITV is bearish when the volatility indicator (the grey line) is above its moving average (the green dashed line). Currently, volatility is higher than average, which is consistent with a declining market.
But, as I mentioned, ITV can also be applied to individual stocks. For instance, every Friday, I send my Income Trader readers three bonus trades based on stocks flashing ITV buy signals. Below are the stocks from May 12:
ITV is telling us each of these stocks is a “buy” right now, and you certainly could go out and do just that. However, that’s not what I told my Income Trader readers to do.
Instead, I recommended that they sell put options on these three stocks. If you’re not familiar with selling puts, I suggest you watch this free eight-minute training video. While I typically love to talk about the benefits of this strategy, they’re too numerous to fit in this issue.
What I do want to tell you is that using the ITV indicator with a put selling strategy is a powerful combination.
Two years ago, I submitted my research on ITV to the Market Technicians Association and ending up winning the 2015 Charles H. Dow Award, which highlights outstanding research in technical analysis, for my work.
In my paper, I showed the results of the bonus ITV trades I recommended to Income Trader readers between Sept. 20, 2013 and Sept. 26, 2014, the period covered in the research I submitted.
In just over a year, I recommended 183 trades, and almost 93% of the time, the trades were winners.
I’ve continued to use ITV successfully to time put selling opportunities for the bonus trades. I also use the indicator to help select my regular weekly Income Trader recommendations. Since 2013, of the weekly 140 trades I’ve recommended, 134 have been winners. That’s a 96% win rate.
If you’re interested in learning how you can generate a track record like this, I’ve put together a webinar explaining how to get started.