Combine These 2 Techniques for Maximum Gains

Today's PowerRatings article will focus on Rule #2 of TradingMarkets 10 Rules For Trading.  Rule #2 states: Buy The Market After It's Dropped; Not After It's Risen.

We've all watched CNBC and seen how emotional the reporters and the analysts become after the market rises sharply for a few days or drops hard for a few days.

After the market has risen, everyone is jumping up and down telling you how good things are and why prices are likely going higher. After a hard drop, the doom-sayers come in repeating over and over again why the market dropped and why it will likely continue to drop.

As most of us have seen, these people are usually wrong. Why? because they are only repeating what the market already knows. And the market has already factored in much the good news (that's why it has risen) and it has already factored in much of the bad news (including the potential for future bad news).

This has been the way markets have worked for decades and in our opinion, they will likely work like this for decades to come.

How do you profit from this information? By not buying the market or a stock right after its risen a number of days in a row, and not selling (or shorting) a stock after it has dropped a number of days in a row.

Here are some statistics to guide you. Since 1989, after the S&P 500 index has dropped three days in a row, it has risen nearly 4 times it's average weekly gain over the next five trading days. And, after the S&P 500 has risen 3 days in a row, it has made nearly zero net gains over the next five trading days. And the same price behavior has been seen in the Nasdaq 100 index.

In conclusion, buy the market after it's dropped, not after it's risen!

Here is a chart of the S&P 500 Index from Monday's close:

Notice that it has closed positively for 4 straight sessions and is due for a pullback.  Lets take a look at some individual stocks from the S&P 500 that have PowerRatings of 3 or lower.  These stocks should be considered "stocks to avoid" or for more aggressive traders "stocks to short".

eBay (EBAY | Quote | Chart | News | PowerRating)

Sears Holdings (SHLD | Quote | Chart | News | PowerRating)

Whole Foods Market (WFMI | Quote | Chart | News | PowerRating)

From 1995-2005, stocks with a PowerRating of 8 have outperformed the S&P 500 index on average by an 8.3-to-1 margin, while a PowerRating of 10 doubles that performance to 16.3.

PowerRatings also help indicate a stock's downside as well as timely short-sale entry points; PowerRatings of 1 and 2 have on average lost money over the next week. A PowerRating of 1 typically underperformed the S&P 500 by a 5-1 margin. Obviously, you should ideally be looking to buy high PowerRating stocks and avoid (or short) low PowerRatings stocks.

You can attend a free class on how to use PowerRatings, presented by Steve Primo, our Director of Education.

Click here to try PowerRatings for yourself, risk free.

Darren Wong
Associate Editor
darrenw@tradingmarkets.com

Reminder: We are in no way recommending the purchase or short sale of these stocks. This article is intended for education purposes only. Trading should be based on your own understanding of market conditions, price patterns and risk; our information is designed to contribute to your understanding. Controlling risk through the use of protective stops is critical.