Stock Trends Traders Network

05/06/08

A frustration that has long plagued traders is the Breakout/Pullback Blues-sometimes this malady leaves us black and blue from the whipsaw beating received. Traders at every level have experienced initial satisfactions of buying a recommended or discovered equity (I will stick to bullish thinking although the principles apply inversely as well), and shortly after watched their path to fortune fall clumsily to a depressing level.

A tactic employed to beat the “Blues” is a combined study of support and resistance levels of the equity of interest integrating this knowledge with the writing of put options. Selling options generates immediate capital gains, it cost nothing save commissions, the income earned reduces the price of the stock when and if it is put to you, a firm entry price is established, the option can be repurchased at anytime, if it is not exercised at or by the expiry date it expires worthless with you keeping all the premium, constant adjustment of buy on stop orders and other wiggles are eliminated.

There are some simply rules which have to be observed:
 You have to have a margin account and option privileges (talk to your broker).

 Never write a put on a stock that you do not wish to own.

 The capital necessary to cover your written position must be available for immediate use up to the date that the option expires. Equities can react with incredible rapidity and volatility to internal corporate hiccups and general market knee jerks-preparation to damage control is necessary. (Charting, experience and general risk management will allow for latitude here: initially follow the rule.)

 You cannot write or buy puts in an RRSP account. (Stupid!)

 Charting, both daily and weekly movements, of the stock will be of immense help (I would not use this tactic without this knowledge) determining support and resistance, trend as well as writing points.

An example is worth a thousands words as goes the wisdom. So the example we will use is RCI.B ( Rogers Communications).

The Rational:

Rogers appears to be forming a complex inverted Head and Shoulders formation with a neckline at or about $45.46. The stock has increased almost 40% from its March 20,08 low of $32.92. The stock reached a high of $45.99 but failed to close above the $45.46 resistance level on May 02, 2008, as of this writing the stock has fallen $1.05 for the week. Conformity is usually inherent in technical patterns of heavily traded large caps. And if this is true, then Rogers should form a second right shoulder somewhere between $43-41. Several short term indicators on the daily chart are starting to turn over-expect a pullback.

Price support exists in the $39-40 range and there are the beginings of a triple moving average bullish crossover just above $41 on the weekly chart. Rogers has only given short term buy signs not confirming a totally bullish trend. It would have been less than conservative to purchase the stock after the size of the run up in just eight weeks on the assumption that it would power through $45.46 and keep going without a pull back to catch its breath.

The ACTION:

All indications are that Rogers should be an issue to own but at the right price. Based on the support levels as previously noted, 10 Jan 42 put options were written @ $2.65 for a capital gain of $2,650.00 (minus commission of $22.45). A shorter time period could have been selected, however the January puts were accompanied by a good premium(greedy buggar) and should the stock muddle about breathing space is not a worry.

The FUTURE:

Should the stock make its second right shoulder as expected and launch into the bull trend the option can be left to expire, it can be bought back at a lower price since with the passing of time its value will decrease or it can rolled upward into to a new put strike price and expiry date. Nobody is going to put the stock to you if it is trading above $42.

Conversely should the price patterns break support the option can be bought back (there is a $2.65 cushion which is somebody else’s money), you can hold the position having the stock put to you should the belief exist that this is a minor set back.There are further option scenarios which can be brought into play as well.

If we do not have another financial or political tsunami spiking the market it is unlikely that the negative side will be seen in this play. Remember the tactics employed here were accomplished with no expenditure of personal capital. The investor was able to buy at a more favourable level (buy low) and did not have to experience the anguish of having 45K earning a 2% dividend while on a downhill bias.

Head Hunter

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Replies to This Discussion

HI

READ YOUR INTERESTING STRATEGY ON PUTS. I WOULD LIKE TO LEARN MORE. I HAVE NEVER TRADED IN OPTIONS AS I FIND IT HARD TO UNDERSTAND ESPECIALLY THE POINT OF STRIKE PRICE - HOW TO DECIDE WHICH STRIKE PRICE TO TAKE. I DO TRADE IN STOCKS & STOCK FUTURES.

I NEED YOUR HELP AND SUGGESTION ANOTHER ISSUE MOST CRITICAL TO ME - HOW TO FIND OUT THE CURRENT DIRECTION OF A STOCK/ GENERAL MARKET INDEX. AS WE KNOW THE CURRENT DIRECTION WILL POSSIBLY BE MAINTAINED TILL REVERSAL.

I HAVE TRIED MVA(E12X26), MACD(E12X26X9), ADX(14/14), RSI (STANDARD), E20, E13, MACD HISTO. NONE GIVE SATISFACTORY RESULT. I HAVE BEEN TRADING FOR LAST 5 YEARS AND CONSISTENTLY LOSING MONEY. SOME TIMES I HAD BIG PAPER PROFITS BUT COULD NEVER ENCASH. I WILL SHARE MY EXPERIENCE - MVA E12X26 CROSSES GIVE VERY LATE SIGNALS. MACD SAME. ADX SIGNALS (CROSSING ABOVE AND BELOW 25 FOR BUY AND SELL) ARE INEDIQUATE AS ADX FALLS BELOW 25 BUT SECURITY KEEPS RISING. ON GENERAL MARKET INDEX ADX RISES TOO LATE AND FALLS TOO EARLY. I AM UTTERLY FRUSTRATED WHAT PERMANENT DIRECTIONAL METHODOLOGY I SHOULD ADOPT FOR REASONABLY GOOD TRADES, I KNOW ALL TRADES CAN NOT BE RIGHT. BUT ATLEAST MAJORITY OF TRADES SHOULD BE CORRECT. ONE EXAMPLE DOW (DJIA). MVA CROSS HAS GIVEN LOSS TODAY. ADX NEVER ROSE ABOVE 25 SO NO TRADE. USING TRENDLINE FROM ABOVE (LOWER TOPS) I FEEL IT IS GOING DOWN. BUT WHEN I LOOK FROM BELOW (HIGHER BOTTOM) I THINK IT IS GOING UP. IF I DO NOT KNOW WHICH WAY GENERAL MARKET IS HEADED I AM UNSURE IN WHICH DIRECTION I SHOULD TAKE MY STOCK FUTURE TRADES.

I THINK I HAVE MADE MY PROBLEM CLEAR. IF U WISH TO KNOW MORE INFO. PL DO ASK. KINDLY HELP WITH THIS PROBLEM AS TO WHICH DIRECTIONAL SYSTEM I SHOULD I ADOPT WHICH WOULD GIVE ME MAXIMUM GOOD TRADES.

I SHALL BE ETERNALLY GREATFUL.
THNX
PRAMOD/ INDIA/BOMBAY
Hello Pramod,

Your search for a technical system of indicators is central to trend analysis. Your lack of success in trading trends, even if you had a directional system that was relatively effective, is likely more a result of poor trading practices. Stock Trends is a system of categorizing equities by long-term trend - defined by a lagging dual moving average indicator - and intermediate-term momentum indicator. While this system of categorization generally supports the trend characteristics of stocks (with expected exceptions in volatile stocks), the success in trading the trend will still be a function of timely entry and exit points. Your struggle, is every traders struggle: finding the right trigger signals. My suggestion is to have a look at the trades you executed and evaluate each trade. Perhaps you will recognize where you missed your proper trigger points. Be especially focused on missed sell signals. A good trading plan will always hinge on its exit strategy. Many top traders are turning in impressive results with a win-loss percentage below 50%. You don't always have to be right - just quick to exit when you are wrong. Stock Trends advises to be consistent with a trading methodology and disciplined in trading practices. I would venture to guess that your failed trades had less to do with the technical indicators you were applying and more to do with your trading practices. The fact that you could turn in paper profits but not real trading profits suggests faulty trading execution.
I do note that you are using time frames that put the DJIA in Bullish territory. However, Stock Trends longer-term parameters still categorizes the Dow as Bearish. Trend traders should really be focused on bullish sectors like materials, energy, tech.
Hopefully, other members will add to this discussion. Success in trading should not come easy - if it does it will be fleeting. You are on the right track.

Best to Bombay!
Mr. Agrawal:


Let me start at the top and work down through your questions and statements. What I do not cover or miss you will have to bring back to attention. We just may not know or have insufficient knowledge to pass along.

Options are complicated by their very simplicity, you can buy either calls or puts or sell the same at a variety of strike prices and expiry dates on an under laying security, index or bond. There is not much there compared to a share of stock with P/E ratios, book values, asset values, price to book ratios, earnings per share guidance and misguidance and a large raft of other confusions. Yet they are simply too deep in never ending combinations and variances to go into in general tutorial in this letter; also you are not hearing from a sophisticated option investor but a student of them only still in a long learning curve.

May I suggest the following reading:

Options: Essential Concepts and Trading Strategies
(The Options Institute: The Educational Division of the Chicago Board Options Exchange)

McMillian on Options
Options as a Strategic Investment
Profit with Options
(All written by Larry McMillian)

Also the American Stock Exchange and the Montreal Stock Exchange have on line educational material and courses. I have no idea what may be available in India or elsewhere.

I set my strike prices according to a numbers of different criteria among which include support and resistance levels, pattern formations or expected formations, indicator divergences, swing points and counter trend rallies or corrections. There is no one complete answer to meet all situations.
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In my humble opinion, at this point in your trading development you should curtail your futures operations until you become relatively successful with stocks/etf’s or do the opposite: stocks can be less rough on the pocketbook though. Too many positions, too large of positions, too high of expectations in too many types of markets are a sure formula to generate confusion, frustration and loss of capital especially if your trades are not going well. The tendency is to make rash or risky decisions based on concepts of survival between fear and greed rather then hard fundamental trading realities.

Our individual personalities are the greatest obstacles to our trading success! It is necessary, not so much to develop “new trading systems” or “new indicators”, but to recognise our individual investing demons, learn where they will lead us astray, control and use them to our advantage-they are a powerful force.

Holding on too long to a trade gone bad was one of my long pasted demon’s that is now safely locked away; still remembered and guarded against.

Ask yourself why could you make “big paper profits” yet “consistently lose money for 5 years” in actual trading? This is far from uncommon. Paper trading is usually done in a planned calm manner on a favourably positioned security, observing the learned fundamentals of trading. The only risk being your short term ego. However, it all changes when capital is involved. Now the possibility of real loss is involved, part of our life supporting assets, fear and greed make their appearance, and we push for the largest profit in the shortest time hoping to reduce risk. Literally we can lose all sense of proper trade execution when market stresses are applied. Pressure becomes even worst the longer the time is between wins.

As we all have had to, you should consider refining your trading psychology, philosophy and trade executions. When in doubt get out or don’t get in! Pick your trades in the same way that a predator picks it next meal-caution and stealth.

Check the website under “your trading beliefs”, good article. There is another high profile site but I cannot lay me hands on the info right now.
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The markets for the past year have never been more volatile. Trying to trade them a sure way to a nervous break down especially ultra short term trades on the indexes. If you are taking a bullish stand it has to be on a bullish instrument, the DJIA has not been bullish nor directionally orientated.

I would have to suggest that your lack of success has less to do with indicators, time periods and moving averages then with a solid grounding in the basics of trade execution-in and out. There simply is no single “permanent directional methodology” especially with horrific volatility. It is of the utmost importance that there is a “consensus of agreement” among your technical tools before you enter a trade. Entering a trade should have little to do with making money. It should have everything to do with calm correct execution such as an artist carving a piece of jade-profits naturally follow perfection.

The tools you mention are standards in technical work but they are only tools. You are the craftsman that guides and interprets acting upon their message. Really they are neither slow nor fast they are what they are. You can make them mover faster or slower, change to something else, use more complicated or simpler tools. It is all in your hands. Which are you most comfortable using-understand the best.

I use and have used the following for directional guidelines. However, remember I do not necessarily trade consistently on an ultra short time span basis and most of my tier one indicators have multiple meanings and uses, at least to me.

Simple moving averages (short term, intermediate, long term)
Simple trends lines and channels
MacD
Standard Error Bands
Stochastic Oscillator
Price Rate of Change (short, intermediate and long term)
Relative Volatility
Linear Regression Slope/r-Squared
Price Plot

ADX is used occasionally to verify the strength of a trend definitely not as a buy trigger.

Normally in either a buying or selling situation I have a progression of indicators changing direction. The more that agree with each other the stronger the possibility that a swing is in the making. I have long since stopped holding triggers lines as scared oracles of buy and sell. It is impossible to believe that a mythological line applies to all securities at all times in all situations. Using only one or two indicators will not work as well as a larger number that move in definite patterns to with each other

Enough, I hope this has been some help to you. Anyone who has braved the wilds of stock trading for half a decade with poor returns who keeps coming back for more has my respect. If you wish more detailed information just ask

HH

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