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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 tell us everything we need to know.
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.
To understand why it is so easy for investors to fail, I always remember the advice of another old trader who told me: "To know what everyone knows is to know nothing." In other words, investors who are using the tools everyone knows about shouldn't expect to be successful.
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.
Personally, I've been successful using tools you likely have not heard of, like the Income Trader Volatility (ITV) indicator.
ITV is similar to the Volatility S&P 500 (VIX), which you're no doubt 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.
Now there are a couple problems with the VIX. First of all, it only applies to a basket of stocks. The VIX won't help us find individual stocks that are bottoming.
A bigger problem is that there is 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 my broker makes me trade in real time and doesn't allow me to place orders to buy the S&P 500 last week. That means I need a real-time trade signal from volatility. And if I want to beat the market, I need to have signals for individual stocks.
ITV provides a solution to both of those problems.
For the technically inclined, ITV is basically a stochastic indicator of the 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 PowerShares QQQ (NASDAQ: QQQ), an ETF that tracks the market-leading Nasdaq 100 index. ITV is the gray, solid line at the bottom. The dashed line is the 20-week MA of ITV, and the green boxes show when ITV was on a buy signal.
This indicator would have captured most of the gains in QQQ in 2014 and avoided the downturns.
ITV gives a clear buy signal when volatility breaks below its MA. That's a buy signal that can only occur after volatility peaks. This buy signal quantifies what so many analysts are looking for, which is a way to use volatility to spot potential market bottoms.
The next chart shows Skechers USA (NYSE: SKX), which is currently on an ITV buy signal.
This is the 13th time we have had an ITV buy signal in SKX over the past two years. Nine of the previous 12 signals, or 75%, would have been winners, and SKX gained an average of 7.3% in the six weeks after the signal. That works out to an average annualized return of more than 60%.
The table below shows the date the buy signals were given and the amount traders would have made before ITV crossed back up through its 20-day MA, issuing a sell signal.
As you can tell from the number of buy signals, ITV is a short-term trading tool. I combine it with other indicators, including fundamental data, to identify the best trading opportunities.
I discovered this indicator in late 2012 and have been using it with great success in my Income Trader service. Each week, it helps alert me to the best opportunities available in the market. And it hasn't failed me yet.
Since February 2013, each of the 78 trades I've closed have been a winner. That's not the kind of track record you get by following the indicators that every else knows about.
If you'd like to learn more about how ITV works -- and my favorite strategy to use it with -- follow this link.
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