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When traders panic, they become irrational.

Amid the panic all of that rational thought goes out the window.

“Oh no, my favorite stock is crashing. Everyone is selling. I have to sell too. Get out of my way. The sky is falling. I’m going to lose everything.”

And then we hit the sell button.  We’ve all been there.

But if you can spot the spot where fear is just beginning to rage out of control, you may have found an opportunity others are too afraid to touch – temporarily.  Even Warren Buffett will tell you to “Be greedy when others are fearful.”

If you know when fear or greed reaches that unsustainable extreme, you give yourself a greater chance of calling turning points.  Eventually, the fear subsides; at the point where fear tops, the stock becomes oversold. That's where turnaround signals appear, hiding at the bottom of trends, waving that it's time for a reversal.

The question then becomes how?

There are two ways.  One is technical-based using Bollinger Bands (2,20), Williams’ %R (W%R), relative strength (RSI), and MACD.  The other is option-based using a tool that actually pinpoints outrageous fear.

It’s called the PCR, or the put-call ratio. 

When a stock's PCR climbs above one, it indicates a stock is becoming oversold and reversal is nearing. When the PCR hits two or three, panic is climbing to unsustainable levels.   But we like to use PCRs well above four, which indicate fear is so great, a turnaround is inevitable. 

Look at Roku Inc. (ROKU) in April 2018 for example.

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The stock just plummeted from $51 to less than $30. Fear ran rampant. But at that time, its PCR was pushing an outrageous 3.5, meaning that with every one call-option, there was an average of 3.5 puts on the line, too.

That’s the first indication that fear was out of control.

Now look at the stock at its lower Bollinger Band (2,20). It’s oversold along with RSI at its 30-line, along with MACD at a historic low, and along with Williams’ %R stuck in deep oversold territory. Once all of these technical indicators aligned in oversold territory, and we knew fear had reached an epic high, buyers emerged.

By July 2018, the stock ran from just under $30 to just under $51.

In short, we are taking advantage of significant fear and irrational behaviors that force average traders into selling at the wrong time.

It may not work 100% of the time, but give it a shot with your trades.

It may just improve your overall trading results.

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