Spotting Price Reversals With The VIX by John Zachary
Crowds are often wrong, particularly in the market. Use the
CBOE Volatility Index to be on the right side.
The stock market can move in waves where its price action can trade into extreme price levels, resulting in waves of traders that enter or exit the market. However, it is exactly at these extreme levels that traders need to be cautious and consider short-term reversals, but crowd psychology takes over as one trader follows the next in fear of missing out on a potential move or taking a loss.
Studying market psychology is really about the study of human nature, as the marketís price action reveals to the intelligent speculator what the market is reflecting about the market participants. For example, when markets are trending upward, it reflects that they are optimistic about the future of an investment and begin accumulating it, which causes it to rise. Conversely, if the markets are reversing, then it reveals that the mass crowd of traders participating in the markets have a negative view of current prices and/or the future prospects of the market, which causes distribution, or selling, resulting in a downtrend.
At times, though, the market has moved too far, too fast in a given direction and reverses course. When large numbers of traders begin to enter the market and are driven by either fear or greed, taking the market to extremes, it sets the stage for a quick price reversal. These short-term reversals serve as both a warning and an opportunity to a trader who can spot the staging ground of such a move to occur.