Volume and Bollinger Bands

The way to make money in the stock market is in knowing when to buy a stock before it takes off. This situation can be understood by three factors: (1) knowing which stocks are really strong and news driven, (2) narrow Bollinger bands, and (3) low volume.

Low volume means there is not much current interest in a stock, and this is really the best time to buy it as long as you are buying a strong news sensitive stock. The volume will eventually pick up with a strong stock whereas volume may always be low on a poor stock.

Narrow Bollinger bands mean a stock will soon break out either in the up direction or down. Again, if you are looking at a strong stock, that is the time to buy it for whatever direction you anticipate it will go.

For example, TVIX, the double VIX volatility ETF, was selling for around $20 per share in the first part of June 2011. It also had narrow Bollinger bands at the time along with low volume. It was the perfect setup for a strong stock. It took almost two months before TVIX really started rising significantly, but it began making a moon shot around the first part of August when Congress was so indecisive about raising the debt ceiling. This was a very powerful volatile news driven situation. TVIX made it all the way to $100 per share by the first trading day of October.

Since it is difficult to pick an exact top, the best thing to do is to take profits when you have made three or four times your money and while the stock price is still high. TVIX spent several days in the $80 and $90 range. That would have been a great time to sell. You would have made 400% on your money in four months. A lot of people won't make 400% on their money in a lifetime. It is well worth the patience to wait for the right time to buy and then sell while you still have a great profit. If you can make 200% or more for your money in just a few months out of each year, you could sit on your hands the rest of the time and enjoy life!

Never Go All In

Most people agree that you should never put all your eggs in one basket on just one stock. Diversification is not enough, though. If you own five stocks, and you want to buy one more with $10,000 in cash, you should not buy the new stock all at once with the whole 10K. You should buy it in three or four segments. One thing that I have seen happen many times is your new stock immediately drops in price as soon as you buy it. This could be for a number of reasons.

First, you might not have done your homework. It might be a bad stock. If you only spent $2,500 on your first buy instead of the whole 10K, your losses will probably be minimal.

Secondly, the whole stock market could be going down, and it is taking your stock with it even when it is okay. One example of this is ERX, the 3X energy ETF comprised of major oil companies and other stocks. It looked like it had formed a bottom around $40 per share during August of 2011 and the first half of September. Then, suddenly, it dropped to the low 30s and even below 30 during the last part of September and the first trading day of October. If you had just spent $2,500 on your first purchase of ERX, you could have bought the rest of your position after it went down 25%. Then, you would have made a lot more money with ERX when it came back along with the rest of the stock market in the next month.

Stock Market Instability

The world is waiting to see how the Europeans will handle their financial issues during the week of October 24. It is my guess that we will see more promises rather than definite action. The EU is about as divided as the U.S. Congress. It is difficult to get anything done this way.

I am not planning to buy any additional stocks for the long term until there is more visibility on which way Europe is headed. The same thing could be said about the U.S. also. We have seen some good reports in October, but one month does not make a trend. I am long on the leveraged ETFs ERX and UDOW, but I would rate them as a hold rather than a buy at this level with the Dow at 11,800.

If anything goes wrong with the EU plans, the stock market could fall below 11,000 again. If the market rises on good news, that may be a good time to buy a volatility ETF because the good times will probably not last. If TVIX, the double VIX volatility ETF falls to 40, I will be a buyer. Sooner or later, bad news will reign again in the stock market. If you buy a few thousand dollars of TVIX at a low level, you could quickly double your money when extreme volatility sends TVIX past $80 per share again.

Low Volume Tops

The volume level is one of the best indicators for knowing when to sell a stock. For example, a three month chart of ERX, the 3X energy bull ETF, showed a relatively low volume of 2M shares in the middle of July 2011. ERX was selling for more than $80 per share then. When the August 2011 Congressional impasse began over the debt ceiling, ERX started dropping dramatically on much higher volume until it finally bottomed on the first trading day of October.

ERX was trading at around $30 per share when it had a buying volume surge of more than 8M shares on the second trading day of October 2011. As of October 14, the volume has dropped down to 4M shares. ERX may never reach its former high anytime soon. However, when the volume drops to 2M shares again, that may be the intermediate top for ERX. It so happens that the stock market in general is following the pattern of ERX, too. One reason for that is that ERX is an ETF stock which comprises some of the world's biggest oil companies. So, as oil goes, the market seems to follow, or vice versa. Anyway, it may be time to go short again whenever ERX falls to a low volume level of 2M shares of trading per day.

Paradigm Market Shift

In August of 2011, we experienced the beginning of a new paradigm in stock market investing. While Americans were appalled by the deadlock in Congress over increasing the debt limit, the stock market began to sink uncontrollably. The smart money suddenly realized how hopeless our economy was becoming. Then, in September and on the first trading day of October, the world started taking note of the Greek debt seriously. These events had a profound effect on the stock market. Fundamentals of individual stocks no longer matter that much. Most stocks now move in tandem with each other depending on the macro view of the world economy.

The best way to make money under the new stock market conditions is to buy leveraged ETFs as long as you can buy them near the bottom. The stock market had a tremendous rally during the first two weeks of October after the first bad trading day of the month. Now, we are technically overbought, and we are not near a bottom for either longs or shorts. TVIX, the double volatility VIX ETF, has fallen to $50 from $100 since the rally began. According to the ECRI and other sources, we still might see a recession. So, dark days are ahead again sometime in the future. When TVIX drops to $30 per share, I will be a buyer. Then, in the coming months when the bad news once more rules the stock market, I expect to make three times my investment as TVIX makes another run at $100 per share.

Managing Risk

In a volatile unpredictable stock market, an investor must ask himself or herself "what could go wrong" before every trade. As the old cliche goes, "the devil is in the details." If you enter a bad trade with a leveraged ETF or a speculative stock, the price of the stock could drop 25-50% in three days waiting time before the stock trade settles.

If you invested $10,000 in what you thought was a sure thing, and you lose 30% on the trade, you are down $3,000. What if this happens multiple times? You could lose $9,000 more or less on just three bad trades.

I also have real examples to prove this from the stock market of September-October 2011. ERX, the triple energy ETF, was selling in the $44 range around the middle of September. It was down almost 50% from its high of $85. It seemed like the bottom was somewhere in the low 40s. Then, believe it or not, the stock dropped to $30 per share by September 30. If you had bought it around $44, you would have lost over 30% of your money in two weeks.

Then, for a second example, I'll turn to TVIX, the double VIX volatility ETF. By the end of September, it looked like the whole world was heading into a recession. The respected ECRI even predicted a recession for the U.S. for certain around this time. TVIX jumped up to $100 per share on the first trading day of October. What if you had bought $10,000 worth when TVIX was selling for $100? The stock was selling for $75 per share just three days later. You would have lost $2,500 in less than a week on a trade that seemed like a sure thing at the end of September.

My advice is to limit trades to $2,000 unless you have money to burn. If you make 30%, that is $600, and you should take your profit while you have it. If you lose 30%, it is only $600 rather than thousands of dollars. Even the best traders may only be right 2/3 of the time. If you make 48 trades per year at a 66.7% win rate with $600 gained or lost on each trade, you will be able to keep the $600 on 16 of those trades. The other 32 trades will cancel each other out. $600 times the net 16 trades adds up to $9,600 per year that you could make with just $2,000 of investment money that you keep cycling throughout the year.

Volatility and Volume

Whenever you see increasing volume in a stock with a resulting chart upswing or downturn, that is the time to buy or sell depending on the chart direction. The volume increase I am talking about is five to ten times the normal volume. The volume peaks will sometimes be so high that it looks like a skyscraper rising in a desert.

A classic example of this occurred in August of 2011 when Congress was in a terrible debate over the debt ceiling limit. XIV, the inverse volatility index ETF signaled that tremendous volatility was on the way. The average volume was less than 5 million shares per day prior to its explosive sudden change. XIV first started jumping up around 20 million shares of volume and eventually hit around 30 million shares of volume a couple of times. During this high volume period, the stock price dropped over 50%. If you had sold when the volume first spiked high, you would have only lost a little money versus a lot of money later on.

Whether you owned XIV or not during the August-September 2011 bear market raid, this volatility situation affected nearly all stocks. Even if you don't want to own XIV, it will be very beneficial if you put it on your watch list because it can be a warning signal to sell your favorite stocks in other sectors before you lose a lot of money. For example, ERX, the 3X energy bull ETF lost over 50% in this volatile time also. So, you can save yourself a lot of grief and money if you pay attention to increasing volume in a volatility index like XIV.