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How to Make New Investments in this Market

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At Patriot Advisory, we get calls every day, “Is it too late to invest? The market is so high.” At this point, I want investors to know the market may be high, but it’s also very strong. The best way to invest in a strong market is on pullbacks using “Implied Momentum”.

What is Implied Momentum?

To understand implied momentum you must first understand implied volatility. Typically, a stock’s volatility is calculated using historical prices to calculate a standard deviation. This, in turn, gives you an idea of the volatility of the stock. One disadvantage of using historical volatility though is that you’re looking back in the past to get an idea of future volatility. To remedy this it is possible to use the Black-Scholes option pricing equation to back solve for the standard deviation given the price of an option. This calculation is called implied volatility because it gives the volatility that the market believes the stock will have over the next year based on the price of the stock’s options. In turn, we use the implied volatility to place each stock in a particular zone. There are six zones which are comparable to different levels of the trading band. Zone 1 is the most oversold, whereas Zone 6 is the most overbought.

Implied Momentum

08/05/2013

pic for 8.6.13 blog

This is a snap shot of the S&P 100 that have options on them. When most of the stocks are in zones 5 and 6  the market is overbought and does not favor new investments . Buying on pullbacks just requires a little patience. Put another way; we just wait for the next sale on new investments . Pullbacks in the market are a normal occurrence, and usually result in declines of 3 to 5 percent. Of course, the media will likely send you into a panic with scary headlines, but for educated investors it simply provides a better entry point for new investments.


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