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How to Technically Exploit Herd Mentality

March 18, 2018

When you pull a rubber band too far, what happens?

Eventually, it snaps back. Stocks do the same.

At times, extreme bouts of fear can send a stock tumbling to excessive unsustainable lows. Other times, extreme bouts of greed can send a stock up too much, too soon. And if we can spot those very extremes, therein lies opportunity.

Once these opportunities appear, 80% success isn’t out of the question.

To find such hot opportunities, we only need two indicators, which have a history of 80% success when used together.

The first is Williams’ %R (W%R).

What’s interesting about W%R is that it historically turns higher or lower before said stock turns higher or lower. In short, it’s the ultimate momentum indicator that signals oversold and overbought conditions. As it nears or penetrates its 20-line, the stock in question is considered overbought. As it nears or penetrates its 80-line, the stock in question is considered oversold.

Then again, we can’t just buy a stock based on a single indicator.

So, we begin to confirm with Bollinger Bands (2,20).

With Bollinger Bands (plotted at standard deviation levels above and below moving averages), stock prices tend to stay within the upper and lower bands. So when prices move to or above the upper Bollinger Band, it’s considered overbought. When prices move to or below the lower Bollinger Band, it’s considered oversold.

Let’s look at the two in action using AT&T (T).

Notice what happens when Williams’ %R dips to or below its 80-line, as the stock challenges the lower Bollinger Band. Shortly after, we see a bounce. Now, notice what happens when Williams’ %R runs to or above its 20-line, as the stock challenges its upper Band. Shortly after, the stock pivots and turns lower.

Then again, it never hurts to confirm even more with other indicators, such as relative strength (RSI), MACD and even Money Flow (MFI).

For practice, pull up your favorite charts using a 1-3 year range.

Overlay Bollinger Bands set at (2,20), or two standard deviations above and below the 20-day moving average, and see if similar trends appear.

Historically, these two indicators alone have had accuracy as high as 80%.

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