om its pinnacle in late 2004 and by 50 percent from its September 2005 peak。 And this。trough in volatility was。quickly followed by a 20 percent decline in crude oil prices。
The collapse of Amaranth Advisors。（which lost half its。asset value in September 2006 as。a result of trading blowups。in the natural gas。market） was。a tough lesson on the volatility of natural gas。prices。 But in yet another instance of the calm before the storm （see Figure 7。10）； by early September 2006 the 10…day historical volatility of natural gas。futures。（NG/） had declined to less。than half its。level of just a month earlier。 And natural gas。futures。then proceeded to tank to the tune of about 25 percent during the two weeks。that followed。
But major troughs。in volatility can also be followed by。moves。to the upside； such as that which occurred with the stock。market in 1995 at the inception of a multiyear bull market。 Note in Figure 7。11 how the 3…month volatility for the S&P 500 Index （SPX） hovered at very low levels。from 1993 to 1995； with most readings。below the 10 percent mark。 The powerful bull market that began in 1995 and ended in early 2000 was。characterized by steadily rising volatility。
Note as well that during the period from 2004 through late 2006； the market was characterized by low volatility readings。similar to those registered a decade earlier at the beginning of a multiyear bull market。 Yet what's。particularly interesting is。the nearly unanimously bearish conclusion by the investment munity regarding the implications。of these low volatility levels。 The low VIX has been professed to be an indicator of increasing investor placency； which isnsistent with a stock。market that is。fast approaching a major top。
Troughs。in volatility often indicate an uping acceleration in directional movement。 In the examples。from the crude oil （Figure 7。9） and natural gas。（Figure 7。10） markets； this acceleration was。to the downside。 In the case of the stock。market from 1993 to 1995 （Figure 7。11）； the acceleration was。to the upside。 It appears。that the odds。favor a similar resolution of the 2004…2000 low volatility
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that leaves。them vulnerable to failure when market environments。change or when some or all of their trading criteria lose effectiveness； often from overuse by peting traders。
One promise is。to use a screening process。to identify potentially tradable opportunities based on a set of objective criteria。 A trader then drills。down to extract much more detail on each name generated by the screen to determine which of these stocks might be tradable。 The operative concept here is。that it is。impossible to screen for all the criteria necessary to generate a trade； but without the screening process。one will fall prey to being 〃objectivity challenged” and insufficiently disciplined； and the breadth of ideas。suffers； as。well。
What follows。is。an illustration of a screening process that used criteria based on the principles。discussed in this。chapter。 The screen is for potential buy candidates。and is。based on the general principle that stocks。with strong price action bined with evidence of skeptical or bearish sentiment have a greater…than…average likelihood of posting additional gains。 This。approach bines。the best features。of 〃trading with the trend〃 and 〃avoiding the crowded trade；〃 that is； the trade that might look。good on the chart but is。dangerous because too many players。have already mitted too much money； causing the stock to be excessively vulnerable to a reversal。
Our screening criteria are as。follows：
。
Put/call open interest ratio （SOIR） is。in excess。of 1。00 （open put positions。exceed open call positions）
。
SOIR is。in the 75th percentile or greater of all SOIR readings。taken during the past year
。
The stock。has。outperformed the SPX by at least 10 percent during the past fifty trading days。
。
The short…interest ratio （short interest average daily trading volume） is。above 3。00
。
Less。than 50 percent of analysts。rate the pany a buy
This。screen returned 28 names； and Figure 7。12 displays。a subset of seven names。
Investors。often fear that focusing on strongly。performing stocks。on which expectations are modest or downright low might generate too few actionable trading ideas。 After all； they。argue； stocks。that have been clearly outperforming the market will very likely have attracted significant call buying； the shorts。will have covered their positions； and Wall Street analysts。will surely have fallen in love with them。 But； in fact； such low…expectation situations。are rather plentiful； as。negative opinions。often die hard despite being regularly invalidated in strong stock。performance。 And the bonus for buying such stocks。is。that the uptrend is。unlikely to end before there has。been at least some capitulation by these skeptics。
Just how persistent a negative sentiment backdrop can be despite powerful price action is。illustrated in Figures。7。13 and 7。14； which show the performance of DirecTV Group （DTV） and Gymboree （GYMB）； respectively； for year…to…date 2006。
As。of late 2006； DirecTV had gained 59。9 percent in 2006 and had reached an all…time high。 Yet only 13 percent of Wall Street analysts。had buy ratings。on the stock； short interest was。5。3 times。the stock's。average daily trading volume； and put open interest exceeded tall open interest by nearly。60 percent。
GYMB had posted an 83 percent year…to…date gain for 2006 and had also traded at all…time highs。 But there was。80 percent more put open interest than call open interest on GYMB； short interest exceeded three times daily volume； and just 40 percent of analysts。had buy ratings。on the stock。
According to Humphrey Neill—the market analyst for whom I have the greatest respect and from whom I've learned the most over the years—in his。classic。work； The Art of Contrary。Thinking； “No problem connected with the Theory of Contrary Opinion is。more difficult to solve than： （a） how to know what prevailing general opinions。are； and （b） how to measure their prevalence and intensity。〃
This。chapter on options…based indicators。in conjunction with other relevant sentiment indicators。will help traders。attack。Neill's。admittedly difficult problem and lead to more robust trading results。 Being a successful contrarian investor is。not about buying at low prices。and buying cheap stocks： the successful contrarian investor is。instead a buyer of low expectations on strong stocks。 In fact； as。Neill states。in The Art of Contrary。Thinking； “The ‘crowd’ is。most enthusiastic。and optimistic。when it should be cautious。and prudent； and is most fearful when it should be bold
CHAPTER。8
Point。and Figure Analysis： Modern Developments in an Old Technique
JEREMY DU PLESSIS
One can hardly describe the point and figure chart as。a 〃breakthrough in technical analysis”； but in its。130…year history； this measure of price changes。has。had many breakthroughs。 That's。because； unlike other chart types； point and figure analysis。has。not stood still； but has。adapted to the changing times。and technology。 Even its。name changed during its。early development。 This。chapter highlights。the changes。to point and figure charts。during their first one hundred years。and discusses。the new thinking and interpretation of this。veteran strategy。
Point and Figure Charts： One Hundred Years of Change
Point and figure analysis。started life on the trading floors。and bucket shops。of the late nineteenth and early twentieth centuries； where traders。needed a method of recording prices。 They simply wrote down the traded prices。in columns； a rising column of numbers。as。the price rose and a falling column as the price fell。 It served simply as。a price record and ignored any fractions。 Eventually traders。began to notice patterns in their price records； and the record became known as。a figure chart。
Writing down numbers。was。a tedious。business； so traders。began to use a vertical scale and inserted Xs。instead of numbers。 The resultant chart became known as。a point chart。 For thirty years； figure charts。and point chartsexisted； with chat lists。referring to their point charts。and their figure charts； or their point and figure charts； the name we use today。 Figure charts。were eventually。dispensed with in the 1930s； and in the late 1940s； a new method of plotting the charts。was。proposed； using Xs。for the rising columns and Os。for falling columns。 Figure 8。1 shows。this。evolution。
The plotting method has。not remained constant either。 As。markets。and data availability。have changed； so too point and figure construction has。adapted and changed。 Originally； point and figure charts。were constructed from the tape using every trade。 The Xs。were assigned a value—called the box size—of one point； and any price change less than one point was。ignored。 When the price reversed by one point； a new column was。started。 This became known as。a 1…box reversal chart。 Because these charts。were very sensitive； a more condensed version was。sought； and many traders。transferred the data from their 1…box charts。to their 3…box charts； where the column did not change unless。the price reversal had the value of three boxes。 Some even drew 5…box reversal charts。to show the longer…term view； although thes