Market timing is everything in investing, but when you have an egg timer running constantly, it makes success that much more difficult to achieve. That is what we face as option traders.
Now, as option sellers, we have the luxury of time being on our side, preferring to let options decay and taking in the premium before expiration. Premium sellers are often content with a stock moving sideways. On the other hand, option buyers need robust action up or down. So how do we time the markets? We don’t. We analyze the charts and technicals to find established patterns that can move within the time frame we’re considering.
Market timing requires technical analysis
If you’re buying puts or calls, you must be aware of timing mechanisms, the current environment, and chart analytics to have a chance with a directional bet. The charts are a great place to start, but if there is risk in the markets and conditions are not favorable, then we may have to pass on a trade idea.
Market signals are important to follow from a macro viewpoint, and they may keep us out of harm’s way.
For instance, is it prudent to go long SPY index calls after a massive run higher and when overbought signals are apparent? Look at put/call ratio trends, breadth indicators, polls and mutual fund money flows along with the VIX to find the best reads on sentiment. Keep in mind that price and volume action are the most important, aka primary, indicators.
What this looks like in real life
Recently, I saw some secondary market signals flash buy alerts. The breadth indicators I follow clocked in with a confirmed buy signal. The VIX remains low (stocks can rally while the volatility index is lower, but when it trends up, that signals trouble). Put/call ratios have trended down from lower levels. Sentiment polls, which are contrarian in nature, have far too many in the bear camp. So, these all line up for a potential buy signal, yet the price of the markets (SPX 500, Dow Industrials and Russell 2K) have not confirmed with a breakout.
So, what to do? Do I follow the secondary signals, risk a potential rollover, and buy the market, or do I wait for price to be confirmed?
I prefer to err on the side of caution and wait for price action to side with other market signals, because it’s the truest and best signal we have. Watch the other signals, so you’re ready to make a move, but when it comes to market timing, the primary signals of price and volume trump everything else.
This article was updated on May 11, 2023.
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