The market is a living, breathing organism that goes through many different moods and seasons within a given cycle. Different markets have different temperaments (as do all of us). And the analyst who takes time to understand all the moods of the market, tends to benefit from it. With the beginning of November, we have now entered one of the most opportune times, seasonally, to be invested in the market.
If “Sell in May and Go Away” is a saying followed by many, then “Always Remember to Invest in November” is something to plan for as well. But regardless of these phrases, what will always work in favour of us in the market is a good Risk Management strategy. If we have that in place, then half the battle is won!
Across the globe we are seeing the resumption of the bull trends which were consolidations until now. For instance, the Dow Twins are finally confirming the trend; after 9 months of nothing, the Small Cap index (IWM) has finally registered a breakout on the weekly chart, while the microcaps (IWC) seem to be picking up pace. We also have CAC 40 and DAX trade at record highs! Bank Nifty is adding to the strength as well. Definitely the kind of setup one could expect during a historically profitable seasonal time.
As we drive through breakout city, it becomes important to make decisions on the basis of our parameters, risk profile, investment goals and our investment personality. With so much information at the tip of our fingers, it’s easy to lose sight of our plan and make impulse decisions that we would otherwise frown upon later.
While technicians are taught to take every chart as it comes, there are times when we tend to force our view on the price. There are also times when we bargain with the market: risk management levels are sometimes altered over and over again, because failure is hard to acknowledge. A bad trade can quickly morph into an ugly trade, if not checked in time.
On the flip side, a small profit could turn into a major portfolio winner with the help of the appropriate technical tools. The goal is to cut the losses and let the profits run. Easier said than done, of course, but only practice can help us get better. When all is said and done, Technical Analysis, when followed correctly, will always keep you afloat – no matter the storm.
The market can be a battle, a city, a storm, anything. But as long as we follow our plan, we should be able to get to the other side with a good amount of profit and lessons to serve us a lifetime!
Here’s to a profitable beginning to a profitable season.
President's Letterby Brett Villaume, CMT, CAIA
The value of the CMT designation has been a subject of discussion between my financial industry colleagues and me, both inside the Association and out, for the entire time I have been a member –...
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Déjà Vu All Over Again – Rotation to Take Market Higherby Matt Pavich
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It was nearly fifteen months ago that Gold (XAUUSD) had marked its high of 2079 in August 2020. Since the marking of this high point, Gold has shown corrective retracement and it has not taken any...
My Favorite Options Strategies: Long Callsby Sean McLaughlin
Here’s the thing about options trading: you can make it as complicated as your heart’s content. And there are plenty of incredibly smart practitioners out there who run amazingly complex...
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Episode 11 of Fill the Gap: Now Streaming!by David Lundgren, CMT, CFA
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Membership Newsby Marie Penza
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New Educational Content This Month
We’ve added recordings of Buff Dormeier, CMT; Bill Kelleher, CMT, CFA; and Trent Derrick to our video archives this month. Keep an eye out for the APAC Summit recordings in the coming weeks!
Last November the announcement of a Covid Vaccine coming to market sprung equities back into high gear after a two-month respite. A return to normalcy danced in investors’ minds and a rotation from “stay at home” stocks (QQQ) to “recovery” stocks (IWM) was on. The table now appears set for a similar broad market rally sparked by another baton pass.
November begins the cooperative six months for equities. Starting in 1950 $10,000 invested in the DJI on May 1st and put under the mattress on Halloween through the following April 30th then repeated through 2014 netted a loss of $221! Yup over 64 years. Flip flop the six-month period and the nest egg grows to $838,486. Add a simple MACD Crossover signal and May-Oct drops to $6,499 while Nov-Apr grows to $2,389,552. This slide always stopped the audience when I did seminars. The MACD Crossover occurred in the S&P 500 on October 8th and the index rose over 5% into the end of the month. Good start for the cooperative season. Source: Stock Trader’s Almanac
Several key Indices/Sectors have broken out of well-formed bases or are on the verge of doing so. When this chart pattern dominates the technical landscape, as it does now, intermediate term higher prices usually ensue. In the chart above the Russell 2000 should break out of its eight-month base in November and lead the next leg as it did a year ago. Below are three that have already broken out and other percolators include the all-important Semiconductors, Value Line Index, MidCaps, Energy, Basic Materials, Home Builders, Retail and several foreign bourses.
The Dow Industrials have a similar look to the break outs above. Its close cousin the Transports were behaving more like a lost step child through the summer. Come October this key sector was 12% below its May high. A furious four-week rally took the index to within a whisper of an all time closing
high. I imagine by the time you read this piece that data point will have been attained? This will confirm the DJI high and the intermediate-long term Dow Theory signal will have been fired.
Failing Sell Signals
Another encouraging data point for the bullish backdrop are failures of sell signals. The Q’s led the rally in October and formed a stark MACD Negative Divergence on the two-hour chart Wednesday the 27th. Thursday afternoon AMZN and AAPL (19% of the index) both released disappointing Q3 earnings. Aftermarket trading that day had the Q’s down 1% indicating the MACD signal was executing well?
Q’s were still down 1% at the open Friday (Oct 29th) only to close at an all time high by day’s end. Typically, a sell signal like this usually lasts a few days, not three hours. A year ago, the Vaccine Rally began and these sell signals consistently failed into spring. A failure of a relatively strong signal is a relatively strong signal in the opposite direction, especially when it pulls off an ATH! Buy The Dippers appear back in charge.
Special Situation Sector
One of the more beaten-up sectors this year has been the Biotechs. The index is well off the highs the group made in February and has now formed a Positive MACD Divergence. Risk/reward appears reasonable with a bounce to the summer highs realistic and a stop just below 5500 appropriate. ETF’s to consider would be IBB (Big Caps), XBI (Small/Mid Caps), and ARKG (Disruptors).
The technical landscape has filled the Bulls sail, as they did a year ago, and another leg higher appears underway? An added potential bullish dynamic is sideline cash that is waiting for a correction. They could end up having to chase prices to satisfy performance numbers and yearend bonuses. A Déjà Vu melt up akin to winter 2020 looks to be a decent probability?
This could be the last leg of the QE Bull Market started in 2009 as the Fed’s messing around with Mother Nature meets Law Of Diminishing Returns. Several longer-term charts do point to a potential topping process later next year. In the meantime, make hay!
Here’s the thing about options trading: you can make it as complicated as your heart’s content. And there are plenty of incredibly smart practitioners out there who run amazingly complex strategies involving all kinds of volatility and statistical arbitrage.
They analyze 3D volatility surface graphs, use lesser understood greeks, and interpret things like “volatility smile” and dispersion.
If that works for you, great! I always say: if it works, do more of it!
But another beautiful thing about options trading is that there are many different ways to pull profits out of the market, and most of them aren’t as complicated as they may sound — even if the strategies have exotic sounding names like “iron condor” or “broken-wing butterfly.”
And my absolute favorite options strategy isn’t even really a strategy at all — it’s simply buying long calls when I’m bullish!
It’s the most basic of basic ideas. I pay a premium to purchase a call option, and if the stock or underlying goes up I make money and if it goes sideways or down, I lose money. But I can’t lose anything more than the purchase price of said option. It’s got risk management already built in! Easy.
I’ve oversimplified, but you catch my drift.
The first way I tilt edges in my favor with long calls is to only purchase them when implied volatility is relatively low. The surest way to lose money in a long call is to overpay. And if volatility is high (for whatever reason), then premiums will be elevated and I’ll look for a different strategy to express my bullish thesis.
Assuming volatility is low and I’ve gone ahead and purchased the call options, another way I tilt edges in my favor is to systematically reduce risk when a position goes my way. I’ve made it a best practice to sell half of my position if the calls have doubled in value. For example, if I purchased ten calls for $1.00 each, that would represent a $1,000 investment (multiply the premium paid for each option contract by 100 as each contract offers the right to purchase 100 shares of stock). If the value of the calls doubled to $2.00 per contract, I will sell five of my ten calls, which would net me a $1,000 credit.
This accomplishes a number of things for me:
1. Receiving the $1,000 credit for the 5 contacts I exited nets against the $1,000 debit I paid to enter the 10 contracts, leaving me with a net cash flow of zero while still holding the remaining 5 long calls! This means I’m essentially now holding these 5 calls for free!
2. As breakouts fail often, this protects me from turning a winning trade into a loser and increases my overall win rate when viewed over a longer series of trades.
3. Selling half dramatically reduces my temptation to trade out of an entire position too soon. As a position goes my way and profits begin to pile up, the daily and intraday PnL swings begin to increase in magnitude. At best, these swings become a distraction. At worst, they trigger all kinds of bad fear and greed impulses — none of which result in smarter decision making. Taking my original risk off the table is my way of saying to myself: “Ok Sean, now you’re playing with house money. Chill.”
4. Playing with house money gives me tremendous confidence to hold on to a position and play for a big win. To really go for the “unlimited profit potential” that is the embedded allure of any long call option. The Big One doesn’t come along often. Maybe once or twice a year. But you only need one to make your whole year and if I’m lucky enough to get ahold of two or three of them, then it becomes a very good year indeed!
Do I need twin advanced degrees in quantum mechanics and thermodynamics to work the math of a simple long call trade? Of course not.
I like to keep things simple around here. It helps me sleep and it keeps me out of trouble.
If nothing else, I hope this little riff on long calls inspires you to keep things simple. Do you have any fun stories about an adventure with long calls positions? I’d love to hear it. Shoot me a note — firstname.lastname@example.org or @chicagosean.