Hello readers, and welcome to the December issue of Technically Speaking.
We’re now in the last month of the year and before you know it, 2022 will be upon us!
It’s been quite a year for the market, hasn’t it? Don’t get me wrong, a crazy bull market (like 2020) is absolutely great, but lessons are learned when the market is choppy. And choppy it has been! When we chart back in history, it becomes quite clear that Year 2 in a bull market is basically moody at best! That’s pretty much what the market did this year.
We did get to experience several new things, however. Who would’ve thought that a Reddit thread could drive the price of Gamestop shares higher 18-fold!? The power of volume (and latent frustration) is what it comes down to, I guess. Adding to that, we now live in a world where compensation can be issued entirely in Bitcoin and you can buy land on Decentraland! NFTs are now a thing, and with a little more effort, you can make one yourself! Clearly, we live in a market which is vibrant, dynamic and ever changing. In this new age market, the average market participant definitely has a lot of catching up to do with all the new developments. If that’s something that is overwhelming you, then take a deep breath and get down to basics. It does seem like these concepts are here to stay, and it’s never too late to learn something new. Just don’t ignore it – that might turn into regret soon!
The market as we’ve seen has been messy all year round. While one month ago, we saw some breakouts come through, we’re back in range-bound territory when it comes to the US SMIDS (Small and Mid-caps). The large cap indices are going through a correction regardless of the geography you pick up, and risk-on indicators continue to move sideways. What’s also not holding its ground is the US 30-year yield; that has broken below the summer lows of 1.75%. Crude Oil has corrected to levels close to $66, US Dollar Index is trading around $96 and precious metals are still the worst place to park your money.
So, what does all the above mean for the market? A little bit of this, and a little bit of that. We have to be selective and treat each chart by its own merit. The market is messy and doesn’t seem to want to clear the haze out just yet.
Keeping that in mind, this month we have views on the US and Indian Equity market as well as something from the Fixed Income space to help understand the current trends better. Those of you looking to build a system, we haven’t forgotten about you! Dig in and you’ll find something interesting. There’s always something for everyone, like a buffet!
Wishing everyone a delightful December, Merry Christmas and a Happy New Year!
I’ll see you on the other side of the year. Until then, Think Technical!
Rashmi Bhatnagar, CMT
President's Letterby Brett Villaume, CMT, CAIA
Congratulations to Makenna Barbara, winner of the Charles H. Dow Award for 2021! Her paper, “The Efficacy of Modified Momentum Based Technical Indicators on U.S. Equities: A Study of Parabolic...
Month Ahead: Looking for Relative Outperformance in the S&P 500by Milan Vaishnav, CMT, MSTA
The month of November saw Equities starting to relatively outperform again compared to other asset classes like High Yield Corporate Bonds, Treasuries, and Commodities. However, renewed Covid fears...
Options: Short Stranglesby Sean McLaughlin
The majority of trades we do here with All Star Options tend to be directional in nature. And why not? We’re leveraging best-in-class technical analysis to give us an uncommon edge to participate...
Will the Banking Bloodbath Continue?by Kush Ghodasara, CMT, CFP
Stock markets around the world have been in mayhem over the past week and many market participants expect it to stabilize after just two days of recovery from the low. But I have a difference of...
Volatile Market Environmentby Arrush Adityadev
Indian markets are going through volatile times. What makes it so is a tug of war between DIIs and FIIs. Domestic institutions buy in the morning while foreign institutional investors sell in the...
CMT Association Targets Higher Education Initiativesby Buff Dormeier, CMT
The CMT Association co-sponsored one hundred sixty students from 27 universities at the Student Management Investment Fund Consortium Conference (SMIFC) hosted by Indiana State University’s...
Signal Diversificationby Jim Denholm
There is no perfect investing system. But there are unlimited effective ones. Diversification has been touted as a key component of a proper investment portfolio for decades by the financial...
The 30-Year Breaks and Treasury Spreads Tankby Ian Culley
US Treasury yields are a mess. Short rates are holding up fine, with the 2-year yield pressing to its highest level since early February 2020, while on the other end of the curve, the 30-year is...
Association Newsby Marie Penza
Membership The CMT Association would like to congratulate the following members on their new positions: Craig Fullen, Esq., CMT, Of Counsel at Porter Wright Morris & Arthur LLP Yug Patel, Content...
New Educational Content This Month
We’ve recently added recordings of presentations given by Matthew Caruso, CFA, CMT and Stewart Taylor, CMT to our video archives, along with the entire recorded APAC Summit from earlier this year.
The majority of trades we do here with All Star Options tend to be directional in nature. And why not? We’re leveraging best-in-class technical analysis to give us an uncommon edge to participate in emerging and/or continuing trends. And if we know anything as Traders, we know that if we have an edge, we should attempt to execute against that edge as often as possible.
Meanwhile, I recognize there is an entire cottage industry around “selling options premium” and for good reason — it works! That doesn’t mean it always works nor does it mean it’s easy. I just don’t like to make it my only thing.
That said, one of my favorite strategies is to sell premium via Short Strangles.
A Short Strangle is a delta-neutral options spread that consists of two legs: a naked short put position and an equally-sized naked short call position. Both option strikes are typically out-of-the-money. Here’s how a typical PnL graph for a Short Strangle would look:
It should be noted that due to the naked options, this type of spread will require margin and we have theoretically unlimited risk if the underlying were to take off in either direction on us.
The first order of business when putting these spreads on is to seek out instruments — preferably ETFs or large cap stocks — that are experiencing elevated implied volatility (IV). When IV is high, options premiums are elevated because market participants are bidding up the cost of calls and puts either to hedge some perceived risk or to take advantage of a speculative opportunity. Now, there is no precise IV value I look for. I just want the IV for the stock today to be in the upper end of the range of where it’s been over the past 6-12 months. High premiums offer us an edge as volatility tends to mean revert and when that happens, the high volatility options we sold at higher prices tend to see their value erode (a great thing when we’re short!)
When I’ve selected the right instrument, my initial instinct is then to identify the 25 delta strikes for both the calls and puts. But that isn’t always the strikes I end up selecting. More important to me is that the strikes line up just beyond obvious levels of support and resistance.
For instance, here’s a recent Short Strangle trade I put on in $XLI October options:
The horizontal lines represent the short call (107) and short put (98) strikes I had chosen. Notice how those strikes corresponded nicely with overhead resistance and downside support? It just so happened that both of these options were each sporting approximately 25 deltas. It’s amazing how often that ends up being the case. (Market makers are no dummies!)
My profit goal with Short Strangles is always to keep 50% of the original premium collected. Let’s say I collected a $3.00 credit for the spread on Day 1. Once I can buy-to-close the spread back for a $1.50 debit or less, I’ll do so, booking my profits and moving on to the next trade. When I put this $XLI trade on above, it had approximately 6 weeks until October expiration. But it only took me two weeks to cover this spread at my profit target of 50% of the original premium collected in the trade.
Why do I cover at 50%?
Because once the spread loses value (a good thing when we’re short it), we start getting to a point of diminishing returns. Let’s say that spread I sold for $3.00 is now only worth 75 cents. I’ve got a winner on my hands and that’s nice. But now I can only make 75 cents more if I hold all the way to expiration and the options expire worthless — but I’m still holding the entirety of the theoretically unlimited risk! That math doesn’t make sense. It doesn’t make sense to get paid so little to hold so much risk. So I’d rather just cut the trade loose once I’ve earned 50% of the original credit and then move on to new opportunities with less risk.
On the risk management side, I know a lot of people who trade Short Strangles like to move strikes on the winning side to bring in more credits to defend a losing position and that’s fine if you want to put in that kinda work. But for me, I chose my short strikes for a reason (because they were significant support & resistance levels), and therefore I’m going to hold the trade and trust its going to work as long as the stock or ETF stays inside those strikes. But if the underlying moves outside those strikes, why defend it? Clearly my reason for being in the trade (a stubborn range) has been violated and therefore my thesis is busted. I’m not going to defend this trade and argue with the market. No, I’m just going to close the trade, book the loss, and move on. Let it be somebody else’s problem.
I always try to have some strangles working in my portfolio most of the time. They are a good counterbalance to a portfolio of mostly directional trades. When markets start grinding sideways and breakouts are failing left and right, it’s nice to have some delta neutral trades like Short Strangles on the books that profit during sideways churns and offer some much needed profits.
Do you trade Short Strangles? If not, why not? I’d love to hear from you.
Indian markets are going through volatile times. What makes it so is a tug of war between DIIs and FIIs. Domestic institutions buy in the morning while foreign institutional investors sell in the afternoon, making it a non-trending market with a bearish bias that comes with a lot of noise.
From a technical standpoint, from the last decent correction, Nifty advanced from 14151 to 18604.
Now the 0.6180 Fibonacci retracement support is placed at 16,702. As the theory of technical analysis stresses more on the importance of the golden ratio of 0.618, so are markets pausing from the long downtrend around this mark.
If the 16700 mark is broken decisively, it will open the doors to further correction towards the levels of 16,200-16,000. Keep in mind, 16,000 was the same mark where the markets broke out of a tight range-bound market.
So far what has helped this correction was fall in crude oil, a leading indicator for the global market. In addition to that, we have the rise in US dollar and Japanese yen. Both are considered safe havens and rise in periods of uncertainty. Rise in the dollar often has a negative correlation with equity markets in India. Similarly, the yen is also considered a safe haven asset and rises in times of panic. Thus, Gold, Dollar, and Yen have a negative correlation with equities. In fact JPY/INR rose by 3% in 3 days. Which is significant for any currency.
Presently, these indicators are near the resistance.
Persistent weakness in gold prices and decline in dollar index suggests concerns of omicron virus are blown out of proportion and markets can correct that in the short term.
On the weekly charts, for first time Nifty is testing the support zone of its super trend. If respected, then the markets can bounce back!
Nifty/Gold is currently holding on to good support. Nifty/gold is trading at 9.65. If it goes below 9.40 we can expect a further correction in markets. If there is a decisive close above 9.90, we can expect some short covering the markets. From an Intermarket analysis point of view, gold and equities have a negative correlation.
Nifty relative to Dow Jones Industrial is at a strong support level too. After retesting the breakout zone, the ratio is now inching higher as can be seen in the chart below. This ratio shows the strength of the local market against the Global Markets. Indian Markets are weak if it goes below 0.50, strong if it goes above 0.55.
This is what the charts say, but let’s see how it unfolds!
The CMT Association co-sponsored one hundred sixty students from 27 universities at the Student Management Investment Fund Consortium Conference (SMIFC) hosted by Indiana State University’s Scott College of Business on Oct. 28th & 29th, 2021 in downtown Chicago. Conference speakers included professionals from Ariel Investments, Kingsview Partners, the CMT Association, Stifel, Nicolaus & Company, CBOE’s Options Institute, Invesco, the CFA Society Chicago, Northern Trust Asset Management and Wolverine Trading.
As technicians thoroughly understand, the art of managing money is not something that can be learned by lecture or textbook alone. When real money is at stake, impacting actual lives, the emotional intelligence acquired through genuine experience is a most admired trait by investment stewards. Student managed endowments provide university students (and their professors) the opportunity to gain such practical experiences.
Although I have not done the research to this claim, yet we all confidently know, most technicians did not come to technical analysis via higher education. Most of the technicians I know came to TA pragmatically. The traditional market theories and academic concepts learned and later employed did not adequately suffice our desire for achievement. This is the same situation students (and professors) of student managed endowments now find themselves in. Enter the CMT Association, introducing practical technical analysis concepts in addition to educational partnering opportunities for professors and associate membership benefits for CMT-inspired students.
The main objective of the conference is to deliver experiential learning, record best practices surrounding investment management, and provide professional development for finance students. The attendees engaged in networking events, panel discussions, competitions, and presentations involving portfolio construction and management (using fundamental analysis and technical analysis), behavioral finance, using derivatives in risk management, and impact of current economic changes on financial markets.
Two other CMT charterholders attended the consortium as university faculty members. Fellow CMT Edward Zychowicz had this to say: “The SMIFC conference and the SMIFC report competition are great learning experiences for the students. The interaction with students from SMIFs across the country is richly rewarding for the students as are the various presentations with finance professionals. As the faculty advisor to the Hofstra SMIF, the SMIFC conference affords me the opportunity to interact with faculty from across the country and to share respective SMIF experiences and learn from each other. Having an increased role at the SMIFC for the CMT Program is wonderful to see. The added criterion to the portfolio building project of technical analysis is an important advancement. This will highlight the importance of not only infusing Investment and Portfolio Management courses with more technical analysis concepts and applications, but it should encourage more stand-alone Technical Analysis courses at schools, as students and faculty recognize the importance. All in all, the students are tremendously satisfied with the SMIFC and the conference, as am I.”
During the conference, students demonstrated their knowledge through competitions on two Projects. Project 1 was a Poster Session (sponsored by CMT Association and Indiana State University). Students’ teams from SMIFC universities were judged on fund performance in 2021, display and visual quality, and presentation of investment strategies and results by students. The University of Tennessee – Martin took first place and $1,000 cash prize; Indiana State University placed second and won $750 cash prize; Taylor University placed third and won $500.
Project 2 was a portfolio building competition – sponsored by the CMT Association and Indiana State University. This project is an exercise of creating a long-term investment strategy and building an investment portfolio employing both fundamental analysis and technical analysis. The project consists of two parts. The first part, teams of 1 to 3 students were asked to create a paper trading portfolio with $100,000 invested in equities. Each team created a portfolio of up to 10 stocks and wrote a 5 to 8 page (including exhibits) paper describing their investment plan. These papers demonstrated their understanding and application of both fundamental analysis and technical analysis concepts. Technical analysis was one the criteria that could be used for selection, allocation, position sizing, and risk management of their portfolios.
As one of the judges for this competition, I was pleasantly surprised with implementation of technical analysis incorporated into their strategies. One paper cited Lo’s 2000 paper on double bottoms and inverse head & shoulders patterns as well as Brock’s (1999) and Han (2014) papers on moving averages. These students incorporated these concepts through the CANSLIM method propagated by O’Neil’s Investor Business Daily. Another university used a top-down approach to identify stock candidates. They then purchased those stocks trading above their moving averages and displaying relative strength. Yet another university created perhaps the most unique security screen of a rising 60 Day EMA combined with a put call ratio of less than one. These remaining candidates were ranked by relative strength divided by volatility. When all the judges scores were counted, Hofstra University ranked first winning the $1,000 cash prize; two teams from Indiana State University place second and third, collecting prizes of $750 and $500.
After the awards, I gave a presentation on technical analysis. The students were a very engaged and receptive audience. I could see the excitement in their eyes as I explained the logic and rationale of technical analysis. The energy really soared when I showed them my own application of technical analysis in my portfolio management strategies. When finished, a very long line of students and professors formed asking questions, wanting more. Many students commented it was their favorite talk of the conference. Several professors requested visitations or follow up. Professor Chuck Boughton from Truman State University had this to say: “Conferences like the SMIFC are critically important to the professional development of our students. Most current undergraduate finance curriculum are light on both technical analysis and derivatives. To understand how the techniques are applied and actually used in the field are valuable contributions from the practitioners that so generously contribute their time and expertise. This time and expertise help fill in the gaps in the undergraduate experience. All of us associated with the SMIFC conference are very appreciative on the long-standing and continuing support of the CMT Association.”
Next steps: in February, university students will employ the knowledge accumulated in part 1 of the Portfolio Building project to compete in the CMT’s live investment challenge (part 2). For this most robust competition, the CMT Association is partnering with Optuma software, a technical analysis platform, to build the paper trading platform allowing University portfolios to compete against one another. Awards will be presented by the CMT Association to the winning teams based on portfolio performance on absolute and risk adjusted basis.
Alumnus, is your university taking part? How about your local university? If this opportunity to partner with higher education excites you or if you have connections or resources to help us succeed, please contact the association at email@example.com or go to: https://cmtassociation.org/academic-partner-program/ for additional information.
There is no perfect investing system. But there are unlimited effective ones.
Diversification has been touted as a key component of a proper investment portfolio for decades by the financial industry. But asset diversification misses the point entirely. The purpose of diversifying a portfolio is to prepare for varying outcomes.
Owning different assets won’t do that. Correlations rise during periods of volatility. So you get underperformance when markets are strong, and not a corresponding amount of outperformance when markets are bad.
So what can you do?
Easy … diversify your signals, not your assets.
Any investment process is going to go through periods where it is out of sync with markets. A pure trend following system is bound to have whipsaws. Momentum-following systems can give buy signals at tops and sell signals at bottoms.
By recognizing the flaws in one system, you can develop another system to help offset the negative effects of those flaws. Then it becomes a decision of how much exposure you want to one system versus another. Or in reality, exposure to a variety of different systems.
Let’s look at an example of a trend following system combined with a momentum system.
- Trend System: Long SPY or Cash. 100% in SPY above the monthly pivot point, 100% cash below it. Buy and Sell signals are based on a specified period of consecutive daily closes above or below this level.
- Momentum System: Long S&P 500 Sector ETFs based on a weekly RRG chart, using SPY as the benchmark. Stop losses based on a percentage decline from purchase price.
(These are simplified versions of actual investing systems that we use at IronBridge Private Wealth.)
Let’s first look at a chart of a long/cash trend system using SPY and pivot points.
This chart shows us a few things:
- The green shaded areas are when the system is long SPY. Un-shaded areas are when it is in cash.
- The system is designed to be in most of the uptrend, while avoiding the major bear markets.
- During periods of volatility, this system experienced whipsaws. These whipsaws can result in both underperformance relative to the S&P 500 index, as well as experience losses in the portfolio.
By itself, this is not a bad system. However, what if we could combine this system with another one that didn’t reduce exposure on the smaller pullbacks?
The goal of a complimentary system to the strategy above would be to maintain exposure during the times when the trend system was in cash. The un-shaded areas above did not result in major market declines. After all, there are lots of 5-10% pullbacks over time, and many of them are quickly recovered.
Knowing what you’re trying to achieve, you can then create a system that is aimed at staying invested during those pullbacks. It could be created using RRG charts, moving averages, other trend markers…the options are endless. Plus, instead of having an exit based on that signal, you could have a simple stop-loss that is likely to not be triggered during these declines.
Your buy and sell signals in the second system are both independent and complimentary of the first system. And they are simple enough to be repeatable over time. You could even layer in ways to create potential outperformance in the uptrends to further enhance the effectiveness of the combined systems.
You can still diversify your asset exposure in addition to diversifying your signals. Simply apply the same rules to US stocks, international stocks, bonds, crypto … you name it.
But before implementing any type of investing system, you must be able to back-test it. This accomplishes a few important things:
- It forces you to create rules. You cannot back-test without specific buy/sell criteria.
- It allows you to objectively identify flaws. You can hope a system works in various market environments, but you won’t know for sure until you see the actual data.
- It allows you to test the effectiveness of complimentary strategies. Again, you don’t know if it works until you see it.
- It helps eliminate the biggest source of risk: YOU. Getting your emotions out of the process is the single most important aspect of any system. You can’t predict the markets, so stop trying.
Strive to create disciplined and repeatable investment processes, based upon diversifying your signals.
By doing this, you can then create an effective system for you or your clients in any market environment.