With respect to playing puts, I am interested if there are good signs to look for to see tops and movement down.
Individual stocks give signs that they are topping. When playing pre-split stocks, we keep a keen eye for telltale signs when a stock may have ended its momentum-based run into its split. These are useful for looking at any stock to determine if a top is approaching.
One thing to look for is a surge higher on very high volume after a stock has already made a great move. This represents the late comers coming into a stock trying to get a piece of that great move. They rush in while institutions and other smart money uses the opportunity to get out. That is a classic sign a possible top is on the way.
We also look for stocks that start trading in a wider trading range and closing off of their intraday highs, particularly if they are approaching an old resistance level. If they tap at the resistance level on their highs but cannot break it, that is a sign the move may be failing. Moreover, if the stock shows us doji’s after a move up, i.e., where the opening price and closing price are about equal, that is a sign that the sellers have caught up with the buyers and we could see a change in direction.
This is especially true if the move starts running out of volume as it approaches resistance. A stock can move up on lower volume for a couple of days or so, but we don’t like to see a prolonged move on low volume unless we are getting ready to short a stock. The stock is losing buyers, and without buyers, it is hard to support the move up. Some stocks are notorious for this (LXK, ISSX), but most do not behave this way.
In addition, a high volume reversal after a run is also a sign of a top. The Nasdaq gave us one of these on 3-10.
Another trend to watch is what we have been seeing the past four weeks. Stocks have started to correct and are forming downtrends. As they move down, they act just the opposite of stocks in uptrends: they tap the trendline, fall for a few days, mount a move back up, tap the trendline again, and then fall again, continually riding down the trendline. If the selling gets heavy, the trendline can increase in its angle. This gives us a great trend to play: buying the put when the stock fails to break its trendline, and riding it down. We can continue to ride it as long as the trend is not broken. As we will see from one of our plays tonight, even downtrends in a down market can be broken. The majority, however, are riding down their trendlines as the Nasdaq corrects. Take a look at the attached charts for examples. Note how the stocks move up to tap at the trendline but fail to break it over the past month.
