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Generally, prices are going to bounce. The VIX, especially, would also increase dramatically. What happens when the VIX increases dramatically?
The prices of options go up as well. In fact, they’re probably at pretty high levels, in this area of prices right here. It’s a good time to sell vertical puts, and capture the premium on vertical puts. Generally, whenever you have a sell-off like that, you are also going to get a snap-back.
That’s exactly what happened. Now, if I was going to add to my positions, what I would do is maybe when it came back up into this resistance level here, it would be a good time to sell some calls, vertical call spreads – selling some vertical call spreads. Measuring these support and resistance points is an important technical tool in order to determine when you should be doing certain types of trading activities.
That’s just one way I use support and resistance points. Let’s talk about cycles for a second. Why do prices rise, and then fall? Why do they do that in the first place? Of course, the smart-aleck answer is that there are more buyers than sellers when it is going up, and there are more sellers than buyers when it is going down.
There is some truth in that. It also has to do with not just economic cycles, but cyclical cycles in sectors. What happens, generally, is that the large mutual funds and other professionals that manage money, on a professional basis, for investors, and 401k plans, and mutual funds, and all of the funds that invest on behalf of individual investors. They have to go out and buy stocks. Money isn’t flowing from investors into their funds, and they have to go out and buy stocks.
Generally, what happens is that there is a sector in which the majority of the mutual funds are going to be putting their money. Now, they have to put in money into thousands of companies. They have so much money that if they were to start buying a single stock, that stock would go into the stratosphere.
If all of the mutual funds decided one day, to go out and buy shares of Starbucks, Starbucks would go from their current level of about $17.50, to probably about $350, within a couple of weeks. There would be so much buying of Starbucks stock, that it would have absolutely no price resistance to the upside.
The mutual funds know that if they did that, they would never be able to get out of those positions. There would be no buyers left that they could sell to. Once prices got to a certain level, they would be the only people holding the bag, and prices would dramatically fall against them.
Instead of that, they spread and they buy sectors. They buy industries. For example, recently the big run-up over the last 9 months or so has been the oil stocks. The price of a barrel of oil has dramatically increased, from about $70 last August, to as high as $135 a barrel.
Along with that, a number of different stocks have gone up in price. They are all in the oil industry. Here’s one – RIG. HES. Let’s just take a look at the last 9 months, because that was the biggest run-up. OXY.NOV, National Oil Well. Now, this one looks like it has gone quite sideways, but it had a dramatic run before that, during 2007.
What else do we have? CNQ. On a weekly basis, these look even more dramatic. The big stocks have had the biggest run-ups. These stocks are absolutely incredible. You can even go back a couple of years, and you can see what a price run this has had. It’s absolutely incredible.
What always happens, after an exuberance of price like this? Let’s say mutual funds started getting involved in this, because they are far-seeing, and they have tremendous research. They knew the price of oil was eventually going to go up. They started buying their positions back here on the $40-$70 level, and now they find themselves with profits at the $155 level.
They don’t buy a single stock. They buy an industry. In other words, they have taken positions not only in RIG, but in HES, Noble Energy, Oxy-Petroleum, National Oil Well, Canadian Natural Resources, and Devon Energy. All of the stocks, all of the energy stocks, all of the oil stocks. They are not going to take a position on just one. They’re going to buy the whole industry. They’re going to buy the whole sector.
Now, they’re at a place where they have significant profits in these stocks. The question is, how do they get out of them? For a lot of mutual funds, and a lot of other companies that take investors’ money and invest it for them, the answer is simply to go out and sell it.
But they can’t sell it all in one day. Otherwise, they would have a tremendous drop in price, very similar to the drop in price that we had right here. In this one particular stock, you can see that prices went from 144, all the way down to 120, in a single month.
Let’s close in on that, a little bit. You can see the dramatic rise in price here. During January and February of 2008, we had a tremendous sell-off in prices, here. Pretty much the majority of mutual funds and those who manage 401ks and other investments funds, when they want to get out of a stock, they will get out of a stock. They will generally do it over the period of several months, because they have large positions.
Those sales turn up on the charts as these large sell-offs, here. They sold off. They got up to another price level, where they sold off. Who’s buying down at these price levels, anyway? If large mutual funds are starting to sell out of their positions, who’s buying here?
A lot of us.A lot of individual investors, who have seen this tremendous trend, and are taught to buy on the dips. It’s worked pretty well, so far. If you bought all of these dips, you would be making money. And it does. The trends do last for a lot longer than you might think. That is a good way to make money.
In general, however, when you see large price drops with correspondingly large volume, that is a sign that institutional investors are selling the stock. That is generally not a good sign for the future of that stock.
Over the period of this time here, you saw a couple of very large sell-offs, with some large volume on the down-side