(Getting) Oversold

Well, after today’s nightmarish session on the stock exchange, all indications point to the market being close to oversold.  Nevertheless, the breadth of destruction that took place today is quite unique.

I don’t keep track of these things, but can’t recall seeing so many different stocks, across sectors and industries that have shown such ‘significant’ weakness all at once.  By ‘significant’, I mean stocks that closed beneath the lower Bollinger band [(x,y) = standard: (20,2)].

As many of you realize, Bollinger Bands provide a good reference in regard to volatility over the preceding “x” days, with the bands forming an envelope around price based on a normal distribution of prices at “y” std. dev.  from the mean.   When prices close outside of the Bollinger band range (at 2 std. dev. , based on a normal distribution [which is likely an erroneous assumption…but I’m looking to KISS here], prices should fall inside of the bands 95% of the time), that tends to signify a significant development in the price of a stock.

As an interesting aside related to prices closing outside of the (20,2) BB’s…when stock prices are rising, stocks that exhibit significant ‘upward’ momentum and close outside of the upper BB have been observed to continue climbing.  Again, this is just an observation, and hasn’t been tested or traded.  Something for future exploration.

What I’m wondering is if a similar phenomenon can/will occur with the lower BB?  I think the natural inclination of people is to want stock prices to go up…thus oversold markets tend to snap back quickly, even if for a brief period.  Therefore I feel like oversold markets provide a fantastic risk/reward setup.  Oversold markets rarely get “more oversold” (unlike their overbought brethren, which I have been burned by on numerous occasions).

The farther the band stretches, the greater the likelihood of a snapback.  I just don’t think the band is going to break.  Sure… if it does break, I’m going to lose a sum of money, but certainly not to the extent that it would ruin me.

Singles and doubles can make for a fantastic career, but sometimes you need to let it rip when you get that hanging slider.  You can get lucky and knock one out (i.e. a buyout), or you can sit on your pitch and crush it if you get it.  After today, the band is really starting to stretch.

From my observations, it’s getting close, but still has more room to maneuver…look at the $QQQ.

7/27/11 $QQQ

 

With the exception of today’s session, that chart looks ok.  Hell, in a couple of days this has the makings of a fantastic setup.  More (lighter volume) selling tomorrow, throw in a doji on Friday around the 3 month MA with the lower band constricting right up under the MA for support, that is one of my favorite setups.  Behold!  I have returned from the future and procured this chart:

 

7/29/11 $QQQ

Anyway, I’m liking our chances for a bounce Friday or Monday…in fact I’m hoping for that scenario.  I need more calm (in stock prices) to comfortably trade this market.  If we bounce strong tomorrow, my head might explode.  There is a lot of volatility out there and it’s taking place right at the top of the trading range, as it has been since mid February.  I don’t know if that’s a good or bad sign…I think I’ll let the market let me know.

So what do I like right now?  I’m looking at call options in $IWM.  This small-cap ETF is very liquid, and the underlying was trading over 82 yesterday.  Today, Aug 82 calls finished up at 1.20…losing nearly 50% of their value in a single day…ouch.  Here is where I’m seeing an opportunity to exploit the expanding the rubber-band.  I’m heading to the plate looking for that slider…and I think he might slip up and throw it.  I’m going to start building a position tomorrow…if things progress to my liking I will take on a heavier risk profile over time with this trade…making multiple purchases at 1% risk…I’m willing to take it up to 5-7%…and try to crush one.

 

7/27/11 $IWM

I will be posting my buys on Stocktwits…so stay tuned.

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This entry was posted in General, Options, potential trades, Psychology and tagged , , , . Bookmark the permalink.

2 Responses to (Getting) Oversold

  1. Dino says:

    Glad to see you’re back posting.

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