Market Structure Expert Shares One Simple Trading Rule With An 83% Success Rate

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.
This special presentation from Market Structure EDGE comes from the Benzinga Options Boot Camp, which took place on August 28, 2020.

Any investor that’s attempted to dip their toes in the world of stock or options trading knows how complicated it can be. There are a multitude of methods, techniques and strategies that can be utilized.

For Founder & CEO of Market Structure EDGE Tim Quast, analyzing the stock market is as simple as looking at two different metrics, Market Structure Sentiment and Short Volume. 

Quast and his team analyze Market Structure Sentiment to utilize what they call “The 5/5 Rule.” This strategy makes trading stocks simple and is a great method for investors both at the beginner and expert level. 

And for options traders, building portfolios of stocks that are 10/10 Overbought and more than 50% short, for instance, increases the probability that you can keep the premium on call options you sell. Conversely, sell puts on stocks that are 1/10 Oversold with low short volume, because they are mathematically more likely to rise. 

Market Structure Sentiment & Short Volume

Market structure is an important factor in the decision-making process and understanding what it is can help in making strategic decisions and determining future profit. It is, essentially, the organization and characteristics of a market and how those characteristics affect competition and pricing.

“You can think of market structure to mean the behavior of money behind price and volume,” said Quast.

Short Volume is the percentage of trading volume driven by borrowed shares that can be used in tandem with market structure to better understand the sentiment. Stocks with high short volume show high statistical correlation to underperformance versus the broad market. Avoid them if you can.

Still, as a general rule, Quast believes that “sentiment trumps everything.”

The 5/5 Rule

For day traders who do not have the time or desire to spend hours watching stocks, analyzing sentiment can be an easy solution. 

Market Structure Sentiment uses a 10-point scale system metering how stocks move from oversold to overbought. 

“Market Structure Sentiment is not mass psychology, it’s not analyst ratings, it’s not whether there are more people buying it or selling it, it’s not relative strength, it is purely a measure of key market behaviors and their effects on supply and demand,” said Quast.

The 5/5 Rule says the entry point for a stock is when its Market Structure Sentiment rises past 5.0 on the 10-point scale, and the exit is when it falls back below 5.0. Quast used Pfizer Inc. PFE to show how the rule works, noting consistent returns that exceeded the stock’s overall performance if one had bought and held it. The aim is better returns in fewer days.

“The whole market mean reverts, it keeps returning to five,” said Quast. “So you can consider it this way, there’s a plane, an axis, called 5.0, and when you swing out above it, at some point, it’s going to mean revert. As that mean reversion begins to happen you want to leave. If it goes below 5, then wait till it comes back towards 5, and then you can catch the wave again.”

Market Structure Sentiment is a unique way of timing trades but no system is fool-proof. This rule won’t make money every single time but it will also help control losses, Quast said. 

“Statistically, and we have 15 years of data science, this approach will work 83% of the time. Which means 17% of the time it doesn’t. But you always want the math on your side. Call it an edge.” 

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Photo by Austin Distel on Unsplash

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.