As you know,I'm not big on prediction. Yes, when a market is over bought, you know it will reverse. But when? As John Maynard Keynes said, "the market can stay irrational a lot longer than you or I can stay solvent".
So how do you trade it. There are a number of ways, many of which work depending upon your tolerances and available capital. Let's consider two. Both work for many people.
The first one I'll call the anti-Keynes method. In this strategy, when the market becomes overbought "enough", the trader goes short. One well known proponent of this is Tom Sosnoff,the founder of Think or Swim. If the market goes "enough" against him, the trader sells more short and averages. This doubling down can go on until the market reverses enough to make a profit. This works if the trader has enough resolve and enough money. Not a method for everybody. I do use this technique in a modified way quite often. My modification is that I backtest the "enough" over years and years of data and also backtest a drop dead stop loss so I know when to say uncle" and take a loss.This can work a very high percentage of the time on specific markets.
The other methodology is to trade the order flow. The issue here is being able to "see" the order flow.I remember seeing the film The Invisible Man when I was a kid. They,of course,couldn't show you the invisible man because he was invisible but the audience had to "see" him or there could be no movie. So the writers and directors used two main techniques so we could "see" the invisible man: they showed us his footsteps in the dust and dirt and they also sometimes showed us his outline by wrapping him in bandages. Trading order flow is looking for those footsteps and seeing the outline in the bandages.
I'll post more on this subject using Thursday's and Friday's down moves as an example.
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