Using Fear and Greed to Your Advantage

It has always been my philosophy that we are a fairly weak species, succumbing at a moment's notice to the lure of sex, money or power. In fact, if you look at the downfall of nearly every great leader or country, you'll normally see the roots of demise in one of those areas.

The good news? The market is all about the pursuit of money, and while fundamentalists would have you believe stock prices reflect rational behavior, my experience is that they reflect people either wanting more money (read: greed), or trying to save what money they have left (read: fear). My approach to charting takes advantage of these natural forces with one simple concept: I go long greed and short fear.

Let me explain with two simple charts, both taken from my recent newsletters.

The first is a long I noted a few weeks ago, Jupitermedia (JUPM Quote). What I look for in longs is simple: a dramatic, upward change in the direction of the stock, always on higher-than-normal volume.

My thinking, backed with data, is that everyone had been comfortable with the stock heading in one direction, and then for whatever reason, it was all of a sudden "OK" to pay dramatically more for the stock. That former direction may have been sideways or down, and the stock might have jumped for any number of reasons.

Those reasons don't concern me. What does concern me is buying the day after the stock breaks out, in hopes that greed will kick in and propel the price higher. It usually does, and I take profits quickly, moving on to the next breakout.

Of course, as I've mentioned previously, there is no guarantee the stock will move higher. Depending on what exit strategy you employ, a breakout might fail 30% of the time even in a bull market. But if it does fail, so what? I simply exit with a small loss.

Again, something like Jupitermedia is one of thousands of trades I'll make, as I explained Thursday. It should work, but if it doesn't, it doesn't. I'm not invested in being right but rather in making money.

The Search for Fear

On the flip side is the search for fear by going short. Here my approach is almost the exact opposite of my long strategy. I look for stocks that have made a sharp, downward change in direction on large volume. Those are the stocks in which holders normally panic -- they've just seen a dramatic loss in profits! -- and they usually sell as quickly as they can. I step in to take advantage of that fear, going short and covering later when the price drops.

Again, shorts don't always work. Sometimes bottom-fishers come in and bid the price up, thinking it's a great buying opportunity. I don't fight them or stay with my position insisting I'm right. I simply fold, acknowledging that their full house beat my pair of aces.

OK, that's as simple as I can outline my long and short approach. But why does it work, how does it ensure I can survive all types of market, and what are the nuances? Those I'll address next week!

Today, the Nasdaq Composite, Ameritrade (AMTD Quote), Teradyne (TER Quote), XM Satellite Radio (XMSR Quote), Coach (COH Quote), Dell (DELL Quote) and Overstock.com (OSTK Quote).

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Charts produced by TC2000, which is a registered trademark of Worden Brothers Inc.

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And that is the final word from Washington, D.C., where, Bush or Kerry fan, we have both of them to thank for a renewed interest in politics. And that interest is definitely a good thing!

And don't forget -- now is a great time to learn how to make bigger, faster profits with technical analysis and charting. Get a free trial of my newsletter, The Chartman's Top Stocks and follow along with me.