StreeTools - Part 1

In my opinion, one of the biggest mistakes that traders make regarding contrarianism is to confuse price action with market sentiment. Just because a stock has lost X-percent of its value does not make it a contrarian play. This has been a hard lesson that many learned as they bought stocks (or held positions) that continued their declines from lofty levels to the great abyss.

Don't get me wrong -- price action is important and you do need to put sentiment into the context of price action. If a stock is rallying, you would expect to see a level of optimism. The goal of the contrarian is to look at the price action and the sentiment, then try to determine if the optimism is getting extreme. One of my favorite situations is where a stock is strong and the sentiment shows pessimism, either through put activity, building short interest, or analysts continually bashing the shares in the media. This signals that there are potential buyers on the sidelines who have not yet come into the stock. Notice, I don't say that the stock is guaranteed to go up. There is no assurance that those on the sidelines will come in, but it does give that situation an opportunity to happen. Once everyone has nothing but bullish comments, it's a sign that everyone who wants to buy has done so and is now just waiting for a chance to sell. Supply and demand.

If a stock is testing support, I check the sentiment. If the sentiment is pessimistic, I would view the stock as a potential long candidate. If the sentiment is optimistic, I would not view the stock as a potential long candidate. In fact, I may watch the stock and see if the support breaks and then look to short the stock. (Remember - breaks of support and resistance can often be violent)! Reverse the above statements and you have my philosophy for short trades.

I wanted to reiterate these statements so that we have a common groundwork to start from as I attempt to detail what I look for in the indicators on the Stocks Tools page. The screen shot below is what you see when you click on the the Quotes & Tools tab.

In this first part of the series, we will go over the "Market Summary" section and explore the other sections parts two and three. For this feature, I think there's really only one link that needs explanation – "Sentiment Brief." The other links are fairly common tools and I'm making the assumption that most readers are beyond that point.

I've removed the name of the stock because I want to focus on theory and not a stock recommendation! I've highlighted what I view as the most important pieces of information here. Again, this is only one opinion. Another trader may focus on different aspects of this page and that is completely acceptable. To each his (or her) own.

The first highlighted item is the "One Year Percentile Ranking" field. This number tells you how today's reading compares with the last year's worth of readings on a scale of zero to one hundred. The higher the number, the higher today's reading relative to the past year. In the above example, the reading of 80 percent means that this stock's put/call open interest ratio is at the higher end of its yearly range. I use this in conjunction with the put/call ratio chart, which we will explore in future commentaries.

The next highlighted field is the "Current Short Interest Ratio (SIR)." This is a common metric that compares the current short interest level to the recent average daily volume. In theory, this tells you how many days it would take all the shorts to cover at the average daily volume. Short interest can be skewed by hedging strategies (as with large convertible offerings) – so I don't use this as a stand-alone indicator. As a rule of thumb, I would like to see a short interest ratio greater than 5 for a long trade. If I'm looking to short the stock, I would prefer to see the number lower. Again, this is only a supporting driver for me and not a primary driver.

That does it for this first section. In part two we'll explore the other sections in an attempt to show you how I use the tools on our website!