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THE TRADERS MAGAZINE SINCE 1982

www.traders.com MARCH 2017

VIX Or Historical
Volatility?
Use this unique approach
to size your positions 8

S&P Fuel Gauge


Measuring a rallys energy 14

Grand Illusion
Is the economy as strong
as it looks? 22

GAUGING Buy &


Sell Pressure
Heres a faster RSI 26

INTERVIEW
Gavin McMaster,
options trader 36

PRODUCT review
n NinjaTrader 8 (part 2)

MARCH 2017
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CONTENTS MARCH 2017, Volume 35 Number 3

7 The Reality Of REITs 26 Buy & Sell Pressure


by Leslie N. Masonson And A Faster RSI
Interested in learning more about by Tushar S. Chande, PhD
using exchange traded funds Most of you are familiar with the
(ETFs) in your trading? This time, relative strength index (RSI), but 41 Explore Your Options
we look at ETFs made up of real are you taking full advantage of by Tom Gentile
estate investment trusts (REITs) it? Here, we deconstruct the RSI Got a question about options?
what they are, the change that to lead to a more intuitive and
occurred in 2016, and a closer symmetrical gauge of buying
look at the more than 30 US REIT and selling pressure and a more 48 Golden Cross Breakouts
ETFs listed today. responsive indicator. by Ken Calhoun TIPS

In this monthly column on trad-


FEATURE ARTICLE ing breakouts, this professional
31 Futures For You trader shows how you can use the
8 VIX Or Historical Volatility? by Carley Garner golden cross on a chart as an
by Perry J. Kaufman Heres how the futures market entry signal for swing trades.
Position sizing is an often over- really works.
looked variable when it comes to AT THE CLOSE
strategizing your trades. There are
different ways to decide how big
32 About Those Binary Options 60 Successful Trader
your positions should be and here by Gail Mercer Must-Haves
we look at a unique approach to Whether youre a scalper, an intra-
by Claudio Demb
size your positions using volatility. day trader, or a longer-term trader,
Emotions can wreak havoc on our
binary options can provide several
trading lives. The first step toward
types of trading opportunities and
14 S&P Fuel Gauge: combating them is to be aware of
can work in any type of market
their existence.
An Introduction condition. What are they and how
by Chris Evans can you trade them?
Ever thought about how much PRODUCT REVIEW
energy a rally in the S&P 500 has? 35 Q&A
Heres a technique that could help 42 NinjaTrader 8 (Part 2)
by Rob Friesen Trading platform for active
measure that energy and may even
give you an edge. This professional trader answers equity, futures, and forex traders.
a few of your questions.
18 This Butterfly Wears Kevlar INTERVIEW DEPARTMENTS
by John A. Sarkett
Butterflies are a well-known op- 36 Gavin McMaster: 6 Opening Position
tions trading strategy. But heres Living Life As An 49 Traders Glossary
one thats a little different. Options Trader 50 Traders Tips
by Jayanthi Gopalakrishnan 57 Advertisers Index
22 The Grand Illusion You dont have to be an aggres- 57 Editorial Resource Index
by Tim W. Wood, CPA sive trader to make it as an options
trader, says this master of 58 Futures Liquidity
Is the economy as strong as it
looks? The charts may suggest options trading. Gavin McMas- 59 Classified Advertising
the economy is strong but the real ter specializes in income trading 59 Traders Resource
answer lies between the price bars. using options and likes to focus
Lets take a peek. on short volatility strategies. He This article is the basis for
believes that patience in waiting TIPS Traders Tips this month.
for the best setups is the key to
successful trading. We decided to n Cover: Brian Taylor
find out more.
n Cover concept: Brian Taylor/Christine Morrison

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4 March 2017 Technical Analysis of Stocks & Commodities


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March 2017 Volume 35, Number 3
Opening Position
The Traders MagazineTM

U
EDITORIAL
editor@traders.com

Editor in Chief Jack K. Hutson


Editor Jayanthi Gopalakrishnan
ncertainty begets risk, which is what
Production Manager Karen E. Wasserman gives markets their mysterious char-
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Barbara Star, Markos Katsanos The bull market cycle that started in 2009
is going to celebrate its eighth birthday in
OFFICE OF THE Publisher March 2017. No matter how many times it
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Industrial Engineer Jason K. Hutson
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6 March 2017 Technical Analysis of Stocks & Commodities


WhY tRADE ETFS?
2016 WINNER

The Reality Of
AI TRADING SOFTWARE

REITs
Winner
14 years
in a row!
Are you interested in learning more about using exchange pointed in their
traded funds (ETFs) in your trading? Leslie N. Masonson, outstanding price
an active ETF trader, is president of Cash Management appreciation. Build powerful
Resources, a financial consulting firm that focuses on ETF NA R EIT re-
strategies. He is the author of BuyDont Hold: Investing With search has shown
trading systems in
ETFs Using Relative Strength To Increase Returns With Less that from 1972 to MINUTES
Risk; and All About Market Timing, as well as Day Trading 2015, equity REITs
On The Edge. His website is www.buydonthold.com, where have delivered a
without coding
he writes a weekly blog. To submit topics for future columns, 12.0% total return,
reach him at lesmasonson@yahoo.com. which compares
favorably to 10.3%
by Leslie N. Masonson for the S&P 500

Im
index. Further-
sure youre familiar with the term REIT, or real more, according
estate investment trust. They were created by to JPMorgan As-
an act of Congress known as the Real Estate set Management,
Investment Trust Act of 1960. A REIT is simply REITs were the
a common stock fund similar to a mutual fund that buys or top performer of
www.NeuroShell.com
finances real estate property or mortgages. They are often 10 standard asset 301.662.7950
publicly traded on stock exchanges but many are non-public. classes from 2000
Three well-known benchmarks are the Dow Jones Equity All through year-end
REIT Index (REI), the MSCI US REIT Index (RMZ), and 2015. Actually, they were the number one performer in eight
the Cohen & Steers Realty Majors Portfolio Index (RMP). of those 16 years, which is quite an accomplishment.
REIT properties typically consist of hospitals, large shopping In their analysis, they found that REITs had an average
malls, office buildings, hotels, nursing homes, storage facili- annual return of 12.0% during this period, compared to large
ties, apartments, warehouses, and mortgages. However, most caps, which averaged 4.1%, and small caps, which averaged
REITs usually focus on only a single property type. 6.6%. Most investors would not have guessed this outcome if
asked which asset category would be the best asset class for
The devil is in the details such a long time period.
REIT investors receive periodic annual dividends that are With the phenomenal growth of the real estate sector over
subject to taxes as ordinary income, but the past few decades, there were dis-
can also receive a return on capital and cussions among industry participants
some long-term capital gains. REITs Largest REITs by Market Cap about potentially separating real estate
provide higher income than Treasur- Company Ticker Symbol from the financial market sector, which
ies, impressive total returns compared Simon Property SPG consists mostly of money center and
to the S&P 500 index, and other major Public Storage PSA regional banks, diversified financial,
averages. Real estate is a separate asset Prologis PLD insurance, consumer finance, and
class in addition to stocks and bonds, so General Growth Properties GGP capital markets. It was no surprise
adding it to a portfolio reduces risk by Welltower Inc. HCN
that on September 1, 2016, real estate
providing more diversification. stocks were removed from the financial
Ventas VTR
REITs can be bought or sold at any sector of the GICS (Global Industry
time during the day in a liquid market Avalon Bay Communities AVB Classification Standard) and placed in
source: NAREIT

without difficulty. Since REITs are Equity Residential EQR their own category. However, mortgage
required to distribute their taxable Boston Properties BXP REITs remained exclusively in the
income as dividends to shareholders, it Vornado Realty Trust VNO financial sector.
is not surprising that these vehicles are FIGURE 1: THE LARGEST ONES. They encompass The S&P 500 index contains 26
owned by investors looking for a solid regional shopping centers, outlet malls, storage units, REITs. The S&P 400 mid-cap index
high-quality apartment communities, senior housing,
high income stream of dividends and healthcare infrastructure, industrial development, and has 35 REITs, and the S&P small-cap
growth potential. And investors over office properties. Most REIT ETF portfolios contain all
the past decade have not been disap- or some of these companies. Continued on page 46
March 2017 Technical Analysis of Stocks & Commodities 7
8 March 2017 Technical Analysis of Stocks & Commodities
OPTIONS

The Equalizer

VIX Or Historical Volatility?


Position sizing is an often overlooked variable when you are counting on those trades being better. If you
it comes to strategizing your trades. There are differ- knew that, you would only take those trades and skip
ent ways to decide how big your positions should be all the others.
and here we look at a unique approach to size your
positions using volatility. Enter volatility
Volatility is like a volcanoquiet for long periods,

F
irst, lets agree that always trading 100 and then violent eruptions. To use volatility success-
shares, or one futures contract, isnt as good fully, traders need to know which onehistorical
as varying your position size based on price (HV) or implied (IV)is best. Historical volatility is
volatility. If you dont agree, my first example measured from actual prices, while implied volatility
will show why its a problem. Until then, Im going (also tracked as the VIX index) comes from options
to assume that well use volatility. When markets are pricing. I would like to think that IV would be more
quiet, positions will be larger; when they are volatile, accurate because it represents what traders are will-
positions will be smaller. The key here is: How big ing to pay today rather than the lagging calculation
and how small? represented by historical prices. You wont really
The principle behind correct position sizing is called know unless you try using it.
volatility parity, that is, you equalize the volatility of The chart in Figure 1 compares the long-term his-
each trade, which in effect equalizes the risk, more or torical and implied volatility (on the left) and 2008
less. There are more sophisticated ways to equalize on the right. The bigger picture makes it appear that
risk, but volatility parity is much simpler and gets you both methods produce close to the same values, but a
90% of the solution. closer look at 2008 shows the differences. Historical
By equalizing the risk of each trade, you give each volatility continues to increase after implied volatility
trade an equal opportunity to affect the results. From has flattened. But this pattern is not always the case.
that you can conclude youve maximized diversifi- IV can spike on surprising news, then disappear the
cation. If you concentrate your investment in a few next day when that news turns out to be only a rumor.
markets and trade larger positions in terms of risk, HV would show only a small change.

Historical and Implied Volatility Volatility Comparison, Jul-Dec 2008


120 120
100 100
80
80
60
60
40
20 40

0 20
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
/20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 0
6 /23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 07/01/2008 08/01/2008 09/01/2008 10/01/2008 11/01/2008 12/01/2008

VIX Historical volatility (annualized) Implied volatility Historical volatility


BRIAN TAYLOR

FIGURE 1: COMPARISON OF Historical AND implied volatility. The chart on the left looks at historical and implied volatility from 2000 to 2016. The
chart on the right looks only at 2008. The bigger picture makes it appear that both methods produce close to the same values, but a closer look at 2008 shows the
differences.

by Perry J. Kaufman
March 2017 Technical Analysis of Stocks & Commodities 9
Test Cap All PL Long PL Short PL All PF Long PF Short PF Comments
1 No 17,756 11,851 5,905 2.14 2.84 1.64 100 shares, unbounded

2 Yes 12,272 8,878 3,394 1.97 2.76 1.44 Most stocks are 10K

3 No 12,103 9,006 3,096 1.92 2.74 1.39 Size by price

4 No 1,029,655 785,402 244,253 2.30 3.50 1.51 Size by ATR unbounded


5 No 10,133 7,248 2,884 2.03 2.82 1.49 Inverse VIX
FIGURE 2: RESULTS OF FIVE SIZING TESTS USING SPY FROM 2000. For some of these tests, the exposure (position size times the entry price) is limited to
$10,000; in others there is no limit.

Both HV and IV have their good and bad characteristics, 2. 100 shares with a cap at $10,000 in exposure, so that any
which makes it difficult to decide intellectually which would be trade that costs more than $10,000 for 100 shares will be
a better choice for sizing. HV has a noticeable lag because it is reduced to a $10,000 investment.
based on a 20-day average. IV can be unreliable and erratic. 3. Size by price, that is, divide the investment of $10,000
by the current stock price. That assures that the exposure
Variations on position sizing is always $10,000.
If we use one share or one futures contract for each 4. Size by average true range (ATR) of price. The ATR is
trade, then those markets with higher prices and/or the maximum of the highlow range, but extended to
more volatility will overwhelm the performance of the previous close if there was a gap. This test allows
other markets with low volatility. If were trading any number of shares, not limited by the investment of
futures, crude oil will always have larger gains and losses per $10,000. For a stock with low volatility, the exposure can
trade than eurodollars, yet eurodollars and other interest rates be very large.
have been far more profitable over many years, with less risk. 5. Sizing using the reciprocal of the VIX, so that an implied
Using TradeStations EasyLanguage for testing, we apply a volatility of 70% would be interpreted as a 30% position
120-day moving average to the ETF SPY. I know that this mov- (1IV, but not less than zero); that is, as the volatility
ing average is profitable over time, so it will be a better basis for increases, the position size decreases. Any VIX value
seeing the changes caused by various methods of sizing. The over 100% results in a position size of zero.
table in Figure 2 shows the results of the tests, both the dollar
profits and the profit factor (PF is the gross profits divided by The chart in Figure 3 shows the position sizing based on
the gross losses). these five scenarios. Tests 1 through 3, which are displayed on
For some of these tests, the exposure (position size times the the left, show the number of shares. In test 3, the position size
entry price) is limited to $10,000; in others there is no limit. decreases as the price of SPY increases, which makes it look
The position sizing will be calculated five different ways: similar to the SPY prices, but upside-down.
In tests 4 and 5, you have very large position sizes because
1. 100 shares for all trades. This allows positions to be volatility can be low. Its not the position size that is important
greater than the investment of $10,000 when the price of here, but the pattern. Rather than declining as in test 3, the
SPY is above 100. position sizes fluctuate up and down in a more cyclic way. The

Comparison of Allocations, Tests 1, 2, and 3 Pattern of Allocations, Tests 4 and 5


160 2500 1200
140 1000
2000
120
100 800
1500
80 600
60 1000
400
40 500
20 200
0 0 0
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01 00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01
/ 2 6/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 /26/2 / 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2
06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06

T1 100 Shares T2 100 Shares (capped) T3 Size by price Implied volatility Historical volatility

Figure 3: SIZING Comparison. Tests 13 on the left show the number of shares. On the right, tests 45 show relative changes in position sizes. The actual
number of shares wont matter, only the relative change in the position size.

10 March 2017 Technical Analysis of Stocks & Commodities


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The principle behind correct
position sizing is called would cost $15,000. In mid-2016 it was 220, an investment
of $22,000 per trade.
volatility parity, that is, you When you cap the exposure in test 1 to $10,000 per trade,
equalize the volatility of each which gives each trade equal impact, the results drop and are
trade, which in effect equalizes far less attractive. Trades when SPY was under 100 will still
your risk, more or less. have smaller representation, but any trading priced over 100
will have its size reduced. As an aside, we can infer from this
that trades in SPY have been better at higher prices.

pattern of tests 4 and 5 are similar, with a few added spikes in Test 3: Size by price
test 4 that do not appear in test 5. This is the most common way of sizing that achieves equal
risk in a simple way. The per-trade investment of $10,000
Which is better? is divided by the current price of SPY to get the number of
These tests were designed to show the ideal returns of each choice shares. When you use this method for trading, you should
rather than the practical application, where the size is limited avoid stocks priced under $5. They are more volatile and
by the investment. In the first two tests, using 100 shares means erratic, plus the position sizes expand rapidly as the price
that a few trades taken under high volatility might have large falls under $5.
gains or large losses, overwhelming many trades that occur at The results were nearly identical to test 2 because that
low volatility. In Figure 2 you see a summary of the results. test had all trades that were entered when SPY was over
Intuitively, you expect the returns from the long positions 100 reduced to a total exposure of $10,000. That was most
to be better than the shorts because of the upward bias of the of the trades.
stock market. Still, the shorts were all profitable, which is a
good outcome. Trades that can be profitable on both the long Test 4: Real volatility parity
and short side show that the timing is good. This is an interesting test because it is the ideal case, that is,
money-is-no-object case of volatility parity. Each trade size
Tests 1 and 2: 100 shares, without and with capping creates exactly the same risk as every other trade. This means
Tests 1 and 2 both trade 100 shares, but test 1 doesnt care that the position sizes are very large during low volatility,
if the 100 shares give an exposure of $500 or $100,000. The and very small during high volatility.
higher price of the SPY in the more recent years will have The long profit factor of 3.50 is far above the others, showing
greater value and will influence the results to a much greater that, in theory, true equal risk is the best way to trade. On the
degree. In 1998 the SPY traded at 80 and now trades at about downside, it takes more than $1 million to trade this way.
220. The five-year bull market that followed the financial
crisis will have a greater impact than the bear markets of Test 5: Using implied volatility
2001 and 2008. That creates a poor portfolio risk profile This is where I thought implied volatility could outperform
because lower-priced stocks may be performing well but are historical volatility by a large factor. Instead, it produced an
overwhelmed by losses in a high-priced stock. Even though average result. My experience with this is that implied volatil-
the profit factor of 2.14 is high, I see this case as highly risky ity jumps up quickly, avoiding the lag in historical volatility.
because it can be distorted by a few big trades. But then it also disappears quickly when nothing happens.
In addition, you need an increasingly larger investment to That results in a lot of false volatility spikes.
keep trading. In 2000 the SPY traded at 150, so 100 shares It may also be that my formula for turning the VIX price

Cumulative Profits, Tests 1, 2, and 3 Cumulative Profits, Tests 4 and 5


25000 12000 1400000
20000 10000 1200000
8000 1000000
15000 800000
6000
Test 5

Test 4

10000 600000
4000
400000
5000 2000 200000
0 0 0
-5000 -2000 -200000
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01 00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01
/ 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 / 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2
06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06

T1 PL T2 PL T3 PL T5 PL T4 PL
FIGURE 4: volatility parity is the best solution. On the left, test 1 outperforms tests 2 and 3 (which overlap each other), but this is unrealistic because
the investment size exceeds the limit of $10,000 per trade. In this case, test 3 is the most practical. Test 5, using implied volatility, has some unacceptable rallies
and drawdowns from 2008 to 2010. Test 4 gives the best results overall, but the investment size varies enormously, making it impossible to implement.

12 March 2017 Technical Analysis of Stocks & Commodities


(or volatility) into a sizing factor could
be flawed. It is simply F = 100 VIX
or zero, whichever is larger. So when
volatility is very high we have no shares.
In reality, VIX has averaged 21% over
time, and most values stay in the range
13% to 30%, rarely going over 50%. But
the sizing using VIX should be different
from using price. It would have cut size
dramatically during 2008 and would
have increased significantly during the
long bull rally that followed.

Visualizing
the results
Sometimes numbers
arent enough. In Figure
4 you see the cumula-
tive profits for each of
the five tests. On the left,
test 1 outperforms tests
2 and 3 (which overlap each other), but is
unrealistic because the investment size
exceeds the limit of $10,000 per trade.
From these tests you would conclude that
test 3 is the most practical.
Tests 4 and 5 (on the right) are more
difficult to interpret because position sizes have been allowed Perry Kaufman is a trader and financial engineer. He is the
to exceed the $10,000 investment. Here you are looking for the author of many books on trading and market analysis, including
smoothness of the returns. This shows that test 5, using implied Trading Systems And Methods, 5th ed. (with the first edition
volatility, has some unacceptable rallies and drawdowns from published in 1978 as a seminal book in the field of technical
2008 to 2010, while using the ideal volatility parity sizing based analysis), and A Guide To Creating A Successful Algorithmic
on historical volatility (test 4) gives the best results overall. Un- Trading System (2016). For questions or comments, please go
fortunately, with test 4 the investment size varies enormously, to www.kaufmansignals.com.
making it impossible to implement. However, it does prove that,
theoretically, volatility parity is the best solution. Further reading
Kaufman, Perry J. [2013]. Trading Systems And Methods, 5th
Making the choice ed., Wiley.
Except for test 5, which uses IV, the others are extremely close. [2015]. A Guide To Creating A Successful Algorithmic
As a final measurement, I calculated the ratio of the total profits Trading System, Wiley.
divided by the standard deviation of the daily profits and losses, [2003]. A Short Course In Technical Trading, Wiley.
a reward-to-risk ratio similar to the Sharpe ratio. Results are [1995]. Smarter Trading, Wiley.
shown in the table in Figure 5. [2014]. A Better Trend, Technical Analysis of StockS
To be practical, test 3 is the easiest choice because you simply & commoditieS, Volume 32: April.
divide the investment per stock by the current price. While test 2 [2014]. Timing The Market With Pairs Logic, Technical
may have a slight edge because it trades smaller exposure when Analysis of StockS & commoditieS, Volume 32: March.
the value of 100 shares is less than $10,000, it wouldnt apply
to SPY now. Given a choice, I always prefer simpler.

Test 1 Test 2 Test 3 Test 4 Test 5


0.577 0.546 0.540 0.596 0.462
FIGURE 5: REwaRd-to-RIsk RatIos FoR all tEsts. Test 3 is the easiest choice
because you simply divide the investment per stock by the current price. Test 2 may
have a slight edge because it trades smaller exposure, but because the value of 100
shares is less than $10,000, it wouldnt apply to SPY now.

March 2017 Technical Analysis of StockS & commoditieS 13


Is Your Tank Half Full?

S&P Fuel Gauge:


An Introduction
Ever thought about how much energy a rally in the S&P 500 hedge or add to your positions. If you knew there was no skew
has? Heres a technique that could help measure that energy in likely returns in the S&P, then you could take the day off
and may even give you the edge youre looking for. and go to the gym or, even better, a trip to Bermuda.

by Chris Evans Heres the reality

T
Your challenge is to measure the potential energy available to
S&P500:MATTZ90/GAUGE: RFVECTORS/
SHUTTERSTOCK/COLLAGE: NIKKI MORR

he performance of the S&P 500 can tell you a lot make the market rally. It has little to do with recent momen-
about global asset returns. If it goes up materially, tum or the consensus view you hear and read about. In fact,
then bonds usually fall, and if it goes down, bonds if you go with what you hear in the media, you may end up
usually rise. If it goes up, traders prefer currencies buying after a bout of weakness. If you buy into a trend, you
like the Australian dollar over, say, the Japanese can only do it if the conditions are right. Heres how I look
yen. If you start your trading day with an advantage for the right conditions.
or appropriate bias, then you would know how to To measure energy, I have to be confident that I know all
14 March 2017 Technical Analysis of Stocks & Commodities
TRADING STRATEGY

the forces that matter in the short term that lead to rallies. I 250
must then prove that there is forecasting value in the index. I 200

A Occurrences
use a daily timeframe and to the extent that a high index level 150
persists, I may be able to hold onto a long position for one to 100
10 days. It can augment a shorter-term trading method, but it
may not help if you have a monthly perspective.
50
0

Wheres the energy?

00
80 0
85 5
90 0
95 95
55 5
60 0
65 5
70 0
75 5
45 5
50 0
30 0
35 5
40 0
10 0
15 5
20 0
25 5

7
8
8
9
6
7
5
5
6
3
3
4
4
1
1
2
2


1
0
There are three parts to the index:
Index Range
Figure 1: AN S&P FUEL GAUGE. The energy index ranges between zero and
100 with a mean of 52 and a median of 50. The distribution looks similar to what
1. fear you see here.
2. time since the last period of weakness
3. interest rates.
2,100.00 2,100.00
2,050.00 2,050.00
2,042.75
2,000.00 2,000.00
1,950.00 1,950.00

It is simply axiomatic that when investors are afraid, we want 1,900.00 1,900.00

to be buying. When everyone is happy or complacent, we can


1,850.00 1,850.00

50.00 50.00

wait to enter. If the market got hit and many investors were 40.00
30.00
Fear 40.00
30.00

forced out of the market, a special window, which I refer to


20.00 20.00
14.62
10.00 10.00

as a trauma window, opens. When this window opens, you


70.00 70.00
60.00 60.00
50.00 50.00

can buy it ahead of those people before they get back in, which
40.00 40.00
40.28
30.00
Bonds 30.00

ultimately they will all do. Finally, it is generally true that


20.00 20.00
10.00 10.00
Apr May Jun Jul Aug Sep Oct Nov Dec 16 Feb Mar Apr

lower interest rates help equity valuations and force people FIGURE 2: BONDS VS. FEAR. The two are not correlated and neither are they
out of lower-yielding bonds and into stocks. connected. Bonds, as a factor, are more volatile than the fear factor.

How is it behaving?
2,100.00 2,100.00
2,050.00 2,050.00
2,040.50

The energy index ranges between zero and 100 with a mean
2,000.00 2,000.00
1,950.00 1,950.00

of 52 and a median of 50. I break it up into two components 1,900.00 1,900.00

bonds and fear. I adjust both for volatility and where the index
1,850.00 1,850.00

stands in the trauma window. It is not normally distributed,


100.00 100.00
90.00 90.00
80.00 80.00

which means it doesnt cling to a mean with comparatively 70.00


60.00
70.00
60.00

few readings at the extremes. It is also not particularly sticky.


50.00 50.00
50.02
40.00 40.00

If you get a huge short-term rally or if bonds fall precipitously


30.00 30.00
20.00 20.00

due to some central bank announcement, this index can swing


Jun Jul Aug Sep Oct Nov Dec 16 Feb Mar Apr

FIGURE 3: A LOOK AT THE DAILY CHART.


quickly from bullish levels to bearish ones. If you have just
come out of a period of severe weakness, the index will
persistently stay in bullish territory. The distribution looks good returns from your short positions. Ill start by looking
similar to what you see in Figure 1. at the long positions.
Next, Ill look at the parts separately to see their indepen- From the table in Figure 4, you can see that if you buy S&P
dence and volatility (Figure 2). You can see that bonds and futures at ever-higher index levels, your average daily returns
fear are not connected or correlated. Bonds as a factor are rise and the numbers of instances fall. The relationship is
more volatile than the fear factor. Since I am able to see the not perfect since there are some extreme cases of volatility
daily levels of both, I will be able to run scenario tests to in this 10-year history. I dont expect a perfectly smooth beta
see prospective gains when the two parts are opposing one in this regression.
another. And when both factors are at attractive levels, I may You can also see that if you wait for higher index readings to
also prefer to take long positions.
The chart in Figure 3 displays the index. Its easy to see
how the sum of the two parts creates the aggregatethere is
no special weighting system. I allow each component to rise
slightly above 100 to make it possible to get a total that is Keep one eye on the road
greater than 100 for the index. In such cases, I set the index and the other on the S&P
to its maximum of 100. Thats why the distribution has an 500 fuel gauge, and you
abnormal number of readings equal to 100.
can work yourself up to
Filter it lead the pack.
The next step is to look at performance to see if the index is
helping to avoid lousy returns from your long positions and
March 2017 Technical Analysis of Stocks & Commodities 15
Filter Total Ret # Instances Avg Ret buy your positions, you lose opportunity and it is possible that
>90 277.00 183 1.514 you may not get such an attractive level within your desired
timeframe. Everyone must pick their own threshold.
>85 529.25 244 2.169
The table in Figure 5 shows that low readings in the index
>80 506.50 345 1.468
almost guarantee a mediocre return. This dataset includes a
>75 905.00 430 2.105 50% rally in the market overall with a 50% loss from its start-
>70 769.00 533 1.443 ing point. There are lots of high- and low-volatility periods to
>65 1028.25 633 1.624 study. Even with the rally, its clear that you need to wait till
>60 1023.70 751 1.363 index levels are low before you buy.
>55 1061.25 894 1.187 It is certainly true that even in raging bull markets, if the
>50 949.50 1053 0.902 index is low, high positive returns are rare and you are more
likely to earn meager returns.
>45 947.95 1249 0.759
>40 1168.45 1467 0.796
Make it cleaner
>35 1235.20 1655 0.746 If the market is rallying up and you are not long, you may
>30 1123.45 1781 0.631 worry that you will not be able to reap the returns others are
>25 1099.50 1876 0.586 seeing. You want to jump in even though the price level (and
>20 992.25 1996 0.497 the index) seems high.
>15 687.75 2097 0.328 The table in Figure 6 shows you by year how often you get
>10 542.50 2139 0.254 high readings. There are 250 trading days in a year, so if you
get, say, 80 trading opportunities, then you are long about one
>5 508.25 2148 0.237
FIGURE 4: BUY POSITIONS. If you buy S&P futures at ever higher index levels
third of the time, which may be sufficient.
you see your average daily return rise and the number of instances fall. You can The table in Figure 7 shows how much money you would
also see that if you wait for higher index readings to buy you lose opportunity and have made each year filtered by index level. The flaw with this
it is quite possible that you may not get such an attractive level in your desired table is that it fails to show you what the market offered as a
time frame.
return during the period. You can see, for example, significant
Filter Total Return # Instances Avg Return declines in early 2010 followed by gains, so that for the year,
<50 -459.00 1077 -0.426
the market and index gave you a positive result. Nevertheless,
you should not just blindly use the fuel index. There are a
<45 -406.45 877 -0.463
sufficient number of cases where the index was bullish, but
<40 -566.20 661 -0.857 the market was in a state of transitioning into a bear market,
<35 -746.20 476 -1.568 which was the case in 2010 and 2014.
<30 -503.70 361 -1.395 A bear market test is needed so that if the index does break
<25 -460.25 262 -1.757 down, it needs to reset to lower levels. As you see weakness in
<20 -433.75 138 -3.143 a market that is in a strong rally, you may find yourself getting
<15 -94.75 40 -2.369 more bullish, but if it breaks down below a certain threshold,
<10 -5.25 8 -0.656
you will have to abandon hope, at least for a while.
FIGURE 5: IS IT TIME FOR THAT ROAD TRIP? Low readings in the index almost
But then again, the markets have a tendency to mean-revert,
guarantee a mediocre return. This data set includes a 50% rally in the market overall which is why its always a good idea to use stops. Another
with a 50% loss from its starting point. thing you can do is wait for the index to give you an attractive

>40 >45 >50 >55 >60 >65 >70 >40 >45 >50 >55 >60 >65 >70
2007 94 89 87 83 79 75 71 2007 18.50 14.50 32.00 51.25 33.25 11.75 15.25
2008 174 151 129 110 94 83 75 2008 -93.25 94.25 58.50 70.75 93.25 120.50 51.00
2009 160 127 95 84 70 54 40 2009 278.45 108.45 86.25 96.50 108.00 132.50 165.75
2010 207 161 129 107 88 72 59 2010 77.50 -38.25 -13.50 -44.50 -78.30 -17.50 14.75
2011 171 158 135 109 81 66 56 2011 120.00 45.25 -67.50 128.50 86.00 132.50 49.50
2012 181 155 138 123 106 94 82 2012 131.00 64.75 72.75 134.00 191.25 213.50 172.75
2013 220 193 167 145 126 105 84 2013 434.50 391.50 335.75 297.25 194.00 179.00 181.50
2014 144 122 98 77 69 56 44 2014 94.75 15.75 108.25 48.75 21.00 -9.25 -27.25
2015 95 74 60 43 27 17 14 2015 188.00 298.25 333.50 319.25 332.75 222.75 161.25
2016 39 29 23 19 17 17 13 2016 78.75 37.75 66.00 30.25 113.25 113.25 77.50
FIGURE 6: HOW OFTEN DO YOU GET HIGH READINGS? This is a good metric FIGURE 7: HOW MUCH DID YOU MAKE EACH YEAR? You can see there were
to know just so you can have an idea of how often you need to be long to get suf- sufficient declines during 2010 but you cant determine how much of a return you
ficient returns. made in a specific year.

16 March 2017 Technical Analysis of Stocks & Commodities


600

400

Total S&P Points Earned


200
reading and then apply a shorter-term (for example, hourly bars)
trend-following system that can only buy. If it sees a breakout 0

to the upside, then you enter a long position. If the hourly chart -200
breaks down, you exit and wait for the next opportunity.
-400
Dont forget your daily
tune-ups
-600
-20 0 20 40 60 80 100 120
You know where the index stands every day, Interval Range Midpoint
and with that information, how can you figure
FIGURE 8: LOOKING AT A NARROWER RANGE. The size of each bubble is
out if the index is trending or not? The filters I proportionate to the number of occurrences. Each range band is 10 points. The
discussed will not work since they are group- most reliable levels where all the points are significantly above zero occur when
ing all outcomes above or below a threshold, the index range midpoints are >= 60.
and that dataset may include many better or
worse conditions than the current one. 2000
What you need to do is view the performance within a 1500
Cum ES Cum System

narrow band around the current level of the index. The most 1000
reliable levels where all the points are significantly above zero 500
occur when the index range midpoints are >= 60 (Figure 8). 0
Each range band is 10 points and the size of each bubble is -500
proportionate to the number of occurrences. -1000
I shall resist the temptation here to create a simple trading

/27 5
15
/13 4
/08 5
/01 3
/23 4
/16 3
/05 3
/27 2
/21 2
/14 1
/08 1
/02 0
/25 1
/17 9
/07 0
/30 9
/21 9
/13 8
/09 8
/28 7
/22 7

11 /201
02 /201
07 /201
05 /201
09 /201
07 /201
12 /201
09 /201
02 /201
12 /201
05 /201
10 /201
03 /201
07 /201
12 /200
05 /200
03 /200
07 /200
12 /200
05 /200
10 /200

/20
/07

system using the index. The index can be used just for risk
08

control but allow me this indulgence. Lets say you were forced FIGURE 9: S&P 500 VS. TRADING ONE ES CONTRACT WITH VARYING POSI-
to own the S&P contract. You can never be flat but you can TION SIZES. You can see there are some severe pullbacks. Thats because you
own the contract in proportion to the level of the index. The must be long through all markets. The nice thing is that the drawdown is 40% lower
and the total number of points earned is almost three times greater.
position quantity will be set at index/50 so the average position
over 10 years equals close to one1.03 to be precise. Lets
compare that with the S&P 500. You can see from Figure 9
that there are still some severe pullbacks. Thats because you the euro (Figure 11). I do this so I Filter Avg Ret
must be long through all markets but the drawdown is 40% can see the underlying behavior of >40 0.032
lower and the total number of points earned is almost three the Australian dollar without the >50 0.019
times greater. macro effect. For this, I would use >60 0.011
the following rules: >70 0.006
Boost the octane with bonds >80 0.012
An index that helps project equity returns might also indicate 1. Buy the A$/EC cross if the
>90 -0.004
when to buy or reduce bond exposure, since bonds, in the short index is > 65
FIGURE 10: WHAT ABOUT
run, are extremely negatively correlated to the S&P contract. 2. Short the A$/EC cross if the BONDS? The average bond
From Figure 10 you can see that the average bond return over index is < 35. return over this 10-year period
this 10-year period is 0.027 points per day. There has been is .027 points per day. Notice
a huge upward tilt in bond prices. Notice how as the index If the index is between 65 and how as the index reaches bull-
ish levels the returns on bonds
reaches bullish levels, the returns on bonds fall precipitously. 35, you wouldnt take a position. fall precipitously. Even if you
Even if you only trade bonds, you still can use this index to only trade bonds, you still can
manage your exposure or duration. Continued on page 45 use this index to manage your
exposure.
Top it up with forex 18
You may not have a strong feeling for how 16 A$/EC

the euro or the British pound may be af-


14
12
fected by an S&P rally, but you know there 10
8
are some reliable associations between the 6

S&P index and the foreign exchange mar-


4
2
kets. The Japanese yen has been a place of 0
-2
refuge during periods of western turmoil and the Australian -4

dollar is a commodity producer that outperforms during good


15
12 014

06 014

11 015
12 013

06 013
01 011

07 012

01 012

06 013
01 010

07 011
02 009

08 010
/12 7
03 007

08 008

02 008

08 009
0

/20
/20

/2
/2

/2
/2

/2

/2
/2

/2
/2

/2
/2

/2

/2

/2

/2
/2

/2

/25
/10

/04
/28

/20

/18
/12

/03
/06

/31

/26

/19
/21

/07

/28

/24

/18

/11

economic times or when the S&P rallies.


03

09

FIGURE 11: TRADING THE AUSSIE/EURO CROSS. Theres a relationship between


Lets look at the Australian dollar but adjust for the gen- the S&P500 and just about everything, including currencies. Study those relation-
eral direction of the US dollar by dividing by the price of ships and see how you can take advantage of them.

March 2017 Technical Analysis of Stocks & Commodities 17


up advising the firm on how to
make it even better. His pro-
fessional management experi-
ence includes both domestic
and foreign tours of duty at
IBM, Petrie Stores, PriceWa-
terhouseCoopers, and Unisys.
He presently serves as an
options consultant to hedge,
mutual, and pension fund
money managers, as well as
teaching options trading at a
new mentoring operation.

The story behind


Kevlar
All the while, there was one
constant: He was trading
options himself, for his own
account, and all the while
honing, perfecting, and striv-
ing to perfect his methods.
The passion never subsided
through the serpentine path
of ups and downs that every
veteran trader knows. Capi-
tal preservation became his
focus and is what makes his
approach somewhat differ-
ent. Everyone talks about
capital preservation; Riggio
builds his unique strategies
around it.
I realized, he says, in my
20 years of trading options,
almost every beat-down that
I ever received was because
of some combination of
my short gamma and short
vega. Since I, like most op-
Get Your Bullet-Proof Vest On

This Butterfly
tions traders, collect time
premium (positive theta), I
used to think that my short
gamma and short vega were

Wears Kevlar
just things that I would have
Butterfly: butterfly hunter/yellow kevlar: horban iryna/

to accept. Which I did. Until


the implosion of 2008, when
I made it my lifes mission
shutterstock/collage: christine morrison

Butterflies are a well-known options trading strategy. But heres one thats a little different. to collect theta without, or at
least with drastically reduced,
by John A. Sarkett gamma and vega risk.

In
Thus, the Kevlar butterfly
the history of options trading, Jim Riggio goes way back. He started trading more was born. The name came not
than two decades ago. He was among thinkorswims first 100 clients; trained as from Riggio himself but from
an engineer, with degrees in computer science and information management, he a student, who, on grasping
admired their advanced platform so much he became a broker there, and wound its power and efficacy, said,
18 March 2017 Technical Analysis of Stocks & Commodities
options

Wow, this butterfly can survive huge market Profit/Loss by Change in SPX Index Price
$
moves ... its like the butterfly is wearing 90000 +610%
a Kevlar jacket or something. The name 81000
T+37
T+19
+550%

stuck. (Kevlar is the near-indestructible 72000 T+0 +490%

synthetic fiber used in helmets and bul- 63000 +430%

letproof vests.) 54000 +370%

Most butterfly traders start with short


45000 +310%

strikes at-the-money (ATM). Most every


36000 +250%
27000 +180%
options textbook or trainer depicts the but- 18000 +120%
terfly that way. The Kevlar butterfly is notably 9000 +61%
different. It starts with a below-the-money 0 0%
(BTM) butterfly that shows negative delta -9000 -61%
but neutral or positive gamma. So in that -18000 -120%

sense, it can be viewed as bearish. -27000 -180%

But theres more, much more to the method -36000 -250%

than that, and it can generate profits in up -45000 -310%


1832.50 1867.50 1902.50 1937.50 1972.50 2007.50 2042.50 2077.50 2112.50 2147.50 2182.50 2217.50 2252.50 2287.50
markets as well. Its success is based on a -10.9% -9.2% -7.5% -5.8% -4.1% -2.4% -0.7% +1.0% +2.7% +4.4% +6.1% +7.8% +9.5% +11.2%

profound respect for the destructive capabili- FIGURE 1: Low IV and steep put skew. Here you can see that puts well below-the-money are expen-
ties of vega and gamma: The Kevlars risk sive compared to puts at-the-money (ATM). In this case, a symmetrical, below-the-money (BTM) butterfly
management methodology will exchange is paired with a deep in-the-money (ITM, with at least 60 delta) call.
theta (collecting time premium) for reduced
risk (gamma near zero and drastically lower short vega when He has two distinctly different approaches for the two main
IV is low). This had become an obsession of mine. If deltas market environments: low implied volatility (IV) (mode 1)
are under control, gamma is near zero, and vega is not too and high implied volatility (mode 2).
short when IV is low, the market is going to have a harder To determine low versus high IV, he looks at a VIX chart for
time defeating me. the past year. Which quartile are we in, he asks: 0-25, 26-50,
With a dash of self-deprecation that gives his online dis- 51-75, 76-100? The skews he gets from a proprietary source.
courses appeal, he says: Some people have called me paranoid Many platforms provide these as well: in thinkorswim, for
about the options market, to which I reply, I may be paranoid, example, go to Trade All Products Product Depth
but that doesnt mean the market is not still trying to take my Options. Change the filter from All to Puts, and change
money away. the view to show implied volatility (Impl Vol). Under Setup
Currently, he is sharing the ins and outs of the Kevlar but- Application Settings Calculations, you can change which
terfly at Capital Discussions, a new trade education and alert volatility calculation method is reflected (such as volatility
service featuring several top mentors he cofounded with op- smile or individual implied volatility).
tions veteran Tom Nunamaker. To his method, which volatility environment he is in at a
given time makes a significant difference. Once he determines
How he trades it where we are in the volatility universe, he feels confident to
Riggios vehicle of choice is the monthly SPX. He aims for move to create a position. In Figure 1 you see the risk curve
no more than one or two adjustments per cycle, and he targets of mode 1, where volatility is low and the put skew is steep.
5% to 10% gains per trade on a $50,000 account with less Note that puts well below-the-money are expensive compared
than 5% loss. He will scale into and out of trades. Target exit to puts at-the-money (ATM). In this case, Riggio creates a
time occurs at about 14 days to expiration (DTE), but this is symmetrical, below-the-money (BTM) butterfly paired with
flexible. He explains: The reason is that the risk, especially a deep in-the-money (ITM, with at least 60 delta) call. In the
the gamma risk, is much, much more as you get closer to SPX, he uses 100-point wings such as 1900/2000/2100.
expiration. I would prefer to take my measly 5% to 10% and In Figure 2 you see a risk curve of mode 2, or a high-
go home and start the next trade with 60 to 80 days to volatility environment and normal-to-flat put skew. In this
expiration. scenario, Riggio puts on a below-the-money (BTM) put broken
Indeed, in the Riggio schema, gamma is crucial. Riggio wing butterfly (BWB). The upper strike is usually 25 points
watches it like the proverbial hawk and he does whatever it above SPX price. This position has much more negative vega.
takes to keep it low. Here, the spacing is a right wing that is 75 points above the
All this seems sound and reasonable enough, but what short strike, and the left wing is 100 points lower. If the SPX
makes his approach unique is the entry scenario about which is 2050, then the BWB is put on at 1900/2000/2075. Theres
he is quite particular: operative entry elements are a) volatil- no long call this time.
ity and b) skew. It is best to enter both models on down days where implied
While other traders ignore these, he focuses on them like volatility is up. While its easier to trade all one type, for ex-
a laser. ample, all puts, he will employ iron butterflies (short put credit
March 2017 Technical Analysis of Stocks & Commodities 19
$ Profit/Loss by Change in SPX Index Price of rules ... for all the market conditions that
120K +240% I can think of, such as ... price, price trend,
110K T+56
T+28
+220%
speed of price move, greeks (today), greeks
(in one week from now), strikes, expiration
100K +200%
T+0
90K +180%
80K +160% cycle, days to expiration, implied volatility,
70K +140% skew, term structure, kurtosis, trade con-
60K +120%
figurations, tape reading, knowing when you
should be scared, and so on. These factors
50K +98%
40K +79%
30K +59% would all vary for every option structure.
20K +39% For example, if we had an existing broken
10K +20%
0%
wing butterfly with 100 points left wing vs.
75 right wing ... and when to adjust with a
0K
-10K -20%
-20K -39% symmetrical 25 wide wing put condor vs. a
-30K -59% 25/40 point asymmetrical condor ... and this
would be different if the center was 25 vs. 50
-40K -79%
-50K -98%
-60K -120% points below the current SPX point ... and this
1604.40 1639.40 1674.40 1709.40 1744.40 1779.40 1814.40 1849.40 1884.40 1919.40 1954.40 1989.40 2024.40 2059.40 2094.40 2129.40 2164.40
-16.2% -14.4% -12.6% -10.7% -8.9% -7.1% -5.3% -3.4% -1.6% +0.2% +2.0% +3.9% +5.7% +7.5% +9.4% +11.2% +13.0% would be different if the Brexit vote or US
FIGURE 2: High IV and normal-to-flat put skew. In this scenario, a below-the-money (BTM) put elections were tomorrow ... and this would
broken wing butterfly is put on. The upper strike is usually 25 points above SPX price. This position has be different if ... Do you get my point? There
much more negative vega. Here, the spacing is a right wing that is 75 points above the short strike, and are just too many potential ifs.
the left wing is 100 points lower.

Trade smart
spread under a short call credit spread) to generate credits and I could write 100,000 rules, and the next day, something will
conserve capital. The Kevlar butterfly mitigates risk by hav- happen in the market that I will need to write another 20 rules
ing a negative delta and a flat T+0 line. He says: In a market ... and following that, another 30 rules ... and the week after
decline, the S&P 500 market price must travel through my that ... well, you get the picture.
profit zone to get to my risk zone. This gives the Kevlar a strong For clients, he winnows down this mass of potentiality to a
defensive position for a market selloff, he says. Offense sells simple, specific recommendation, sent out by email and text
tickets, he says, but defense wins championships. as a real-time trade alert. And his platform keeps score with
a documented trade record and cumulative equity curve. We
Managing positions are transparent, he says simply.
While he is fairly rigid about entry, his adjustments are man- Most recently, while this piece was being written, in his
aged by the options greeks. To lift his T+0 (todays profit-loss current live trade, he elected to do that simplest and easiest
sum), he employs a variety of tools to flatten the profit peak adjustment: This old geezer is going to close the Oct Kevlar,
and generate credits. These might include condorizing his pick up my piggy bank, get a glass of lemonade, go to the
position with additional credit spreads, moving his position bathroom (if I am going to get out of my rocking chair, why
up or down, or just adding long puts or calls. waste the trip), and then go and sit back in my rocking chair
Veteran trader that he is, Riggio has a visceral reaction for with my measly 10% profit for the month.
how fast a profit can turn into a loss in an otherwise brilliant Self-deprecating, humorous, but with decades of options
options strategy, so his first adjustment can be as simple as wisdom stuffed into one pithy statement, he says: I know
taking a trade off when it reaches approximately 10% profit, Im not smarter than the market. Which is why he puts on
either entirely or by partials. For example, if a butterfly has 6 Kevlar garb when he ventures into it. And advises others
x 12 x 6 contracts, he might take off 2 x 4 x 2. exactly how to do the same.
If he feels motivated to stay in a positionwhich, by the
way, is a function of the math, not a feelinghe will look at Continued on page 25
a large variety of what ifs including but not limited to leaving
the position as is, selling calls, selling put condors (balanced
or unbalanced), adding put or credit verticals, and more.
What are his rules? He is not comfortable with the concept Anyone who learns sound
of rules, per se, and tells why: It is beyond naive to think options trading skills
that if you can get the perfect set of rules you will conquer and who masters risk
the options game. Anyone who learns sound options trading
skills and who masters risk management methodology should
management methodology
be able to become a profitable options trader. should be able to become a
It is all about understanding the tradeoffs when you are profitable options trader.
making decisions. I could put together a very, very long list
20 March 2017 Technical Analysis of Stocks & Commodities
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Too Much Braun

The Grand Illusion


Is the economy as strong as it looks? The charts may suggest into the 2002 four-year cycle low. Those efforts resulted in
the economy is strong but the real answer lies between the what was, at the time, the longest cyclical extension since
price bars. Lets take a peek. the inception of the Dow Jones Industrial Average (DJIA) in
1896, which in turn resulted in a banking crisis, a commodity
by Tim W. Wood, CPA bubble, and a housing bubble.

A
Then, when the extended cycle finally began to roll over,
rising stock marketit gives us a warm, fuzzy feel- the end result was the worst financial crisis seen since the
ing; it puts us in a state of complacency because Great Depression. Yet the response to the worst financial
it makes us think that everything is going to be crisis since the Great Depression was an even more extreme
just fine. In reality, that may not be the case. And version of the same policies that helped create the problem
heres why. in the first place.
Those resuscitation efforts have, for the most part, failed
Bear: DOUBLE BUBBLE/WORLD CURRENCIES: GRINGOS4/

Getting too inflated to stimulate the economy and have instead created an equity
I believe economic issues began in 2000 and have only been bubble. In 2015, the equity markets began what is still a ginor-
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON

made worse. The world economy is in a systemic crisis and we mous topping process. After the initial decline into the August
are in a stock market bubble that has resulted from attempts to 2015 low, I expected there would be false bottoms and false
resuscitate the underlying economy. In spite of equities push rallies. Since the topping process first began in 2015, there
to a new high in 2007 and again in 20162017, I have held all have been four intermediate-term advances, with the most
along that the secular bull market peaked in 2000 along with recent carrying the market to yet another new high, and there
the underlying economy. have been three intermediate-term declines with the fourth
The first attempt at stimulating the economy and resurrect- pending as of January 2017. Admittedly, I did not anticipate
ing the secular bull market came in the wake of the decline the extent or duration of these rallies being what they have
22 March 2017 Technical Analysis of Stocks & Commodities
cycles

been. However, the duration of S&P 500


these rallies has not changed
2300
2200

the fact that the advance out of


2100
2000

the 2009 low has been the most


1900
1800

extended cyclical advance 1700


1600
since 1896. 1500
1400
In spite of the duration of the 1300
1200
overall advance out of the 2009 1100

low or the four intermediate-


1000
4 900

term advances that have fol-


800
4 700

lowed in the wake of the August


4 600
4 500
2015 low, there has still been 4 400
300
no meaningful effect on the
4 200
4 Bullish/Price Volume Characteristics Bearish/Price Volume Characteristics 100
underlying technical or funda- associated with the Secular Bull Market associated with the Secular Bear Market 0

mental data, much less in the


25000

underlying economy. The three


20000
150000
intermediate-term declines 10000

and recoveries in 20152016 5000

caused great confusion while 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0

creating an environment of FIGURE 1: SECULAR BULL AND BEAR MARKETS. On this chart of the S&P 500 you see that between 1982 and 2000,
enormous complacency. volume expanded as price rose and contracted on the declines, which is bullish behavior. The bullish price/volume relation-
In light of the new high that ship began to change after 2000 to one that was more typical of secular bear markets.
has followed in the wake of the
election, a recent Gallup poll reports US economic confidence which again is indicative of a secular bear market rally. Even
levels to be at the highest levels ever recorded. Many are call- with the additional post-election parabolic advance, volume
ing this move a breakout. I called it a fakeout that may has continued to shrink.
likely prove to be the biggest bull trap of all time and which I Since the inception of the DJIA in 1896, the four-year cycle
think is also likely to leave the market positioned for a nasty has historically averaged 48.11 months. The point of these
multiyear unwinding process in which the 2009 lows could charts is to show you that even though we have seen two of
potentially be revisited. the most extended four-year cycle advances in stock market
history, the price/volume behavior remains bearish. Thus, in
Will the bubble pop? spite of the most coordinated global intervention efforts in
Im going to take a moment and step back to look at the the history of the stock market, which are still ongoing, these
bigger picture so you can get an idea of what to expect for efforts have failed to change this underlying basic price/volume
the inevitable unwinding. Overall, this is still part of a very behavior, even with the most recent four intermediate-term
large, ugly top. advances.
Ill first look at a chart of the S&P 500 (Figure 1). In their
1948 book Technical Analysis Of Stock Trends, Edwards & The bigger picture emerges
Magee wrote that in a bull market, volume increases when Even though we have seen not one but two of the longest four-
prices rise and dwindles as prices decline; in a bear market, year cycles in history, I maintain that we have been operating
volume increases when prices drop and dwindles as prices in a secular bear market since 2000. But given that we have
recover, which is a very basic technical principle. seen new highs, what difference does it make whether we call
In Figure 1 you can see that between 1982 and 2000, vol- these two extended four-year cycle advances bull markets or
ume expanded as price rose and contracted on the declines, rallies within a bear market? The result will be the same,
which was clearly bullish behavior. This goes in line with
the underlying secular bull market that was prevalent during
that time period.
Now look how the bullish price/volume relationship began to The advance out of the
change. Volume began to expand as price declined into the 2002 2009 low has been the most
low, and it began to contract as price moved into the extended
2007 four-year cycle top. As prices moved down into the 2009 extended cyclical advance
extended four-year cycle low, you see that volume expanded. since the inception of the
Following that low, the bearish volume behavior was further Dow Jones Industrial Average
confirmed. The declines into the 2010, 2011, and 2015 lows in 1896.
also confirmed this. But then in 20152016, as price began
going parabolic into those tops, volume continued to shrink,
March 2017 Technical Analysis of Stocks & Commodities 23
right? Wrong! The difference is that, like M2 Velocity
the extended rally into the 2007 top, it
was not organic. It was manufactured
220 220

215 215
and it lacks the underlying foundation 210 210

of secular bullish volume. The extended 205 205

advance into the 2007 top was a manufac- 200 200

tured, synthetic event that imploded, and 195 195

while the current advance has stretched 190 190

further than ever imagined, my belief


185 185

all along has been that this time will be


180 180

175 175
even worse. 170 170

Next, Ill look at the money supply 165 165

(M2). On the velocity of M2 chart in 160 160

Figure 2, you can see a divergent top that 155 155

occurred in conjunction with the 2000 150 150

top in equities, which clearly telegraphed


145 145

the peak in the underlying economy and


140 140
1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

which I feel was also suggestive of the FIGURE 2: Velocity of Money. A divergent top occurred in conjunction with the 2000 top in equities,
secular bull market top. These two pieces which clearly telegraphed the peak in the underlying economy. This could suggest a secular bull market top.
of data are related. But what about the continued contraction in M2 velocity that has reached the lowest levels since the inception
I want to point out that the liquidity of this data in 1959?
campaign policies associated with the
2002 to 2007 extended four-year cycle Whats next?
were able to positively influence the velocity of M2 in that it I have several points to make in regard to these charts.
did turn up in early 2003. This upturn then peaked in early
2006, ahead of the extended four-year cycle top in October 1. The evidence clearly suggests that the secular bull market
2007. Then theres the upturn that was seen in association with and the economy peaked in 2000.
the 2009 four-year cycle low and the collapse that followed. 2. It has been the deflationary forces surrounding these
Theres a continued contraction and the lowest levels since secular tops back in 2000 that the Money Masters have
the inception of this data in 1959. In spite of what economists been fighting ever since.
say, my belief is there has been no economic recovery. In fact, 3. These charts show that the monetary policies in associa-
it has been just the opposite. tion with the most extended two four-year cycles in the
I also want to look at the job participation rate (JPR) data, history of the US stock market have not had a positive
which can be found in Figure 3. When you tie velocity of M2 impact on the most basic underlying technical conditions
and job participation to volume charac-
teristics of the market and other technical
data, the bigger picture begins to come 68.0 Labor Force Data 68.0

into focus. I want to point out that the


67.5 67.5
67.0 67.0

JPR peaked in 2000, along with the stock 66.5 66.5

market and the initial contraction of the


66.0 66.0
65.5 65.5
velocity of M2. Interesting how that 65.0 65.0

works! This is all related. Here too, note 64.5 64.5

that the liquidity campaign associated


64.0 64.0
63.5 63.5

with the 2002 to 2007 extended four-year 63.0 63.0

cycle did positively influence this data 62.5 62.5

in that it finally found a bottom in late


62.0 62.0
61.5 61.5

2004 and there was an upturn into late 61.0 61.0

2006. It is also interesting to note here


60.5 60.5
60.0 60.0
that the peak in late 2006 followed the 59.5 59.5

April 2006 peak in the velocity of M2. 59.0 59.0

Makes sense, doesnt it? But now look at


58.5 58.5
58.0 58.0

what has happened in conjunction with 57.5 57.5

the extended four-year cycle advance out


48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

of the 2009 low. It collapsed, which is FIGURE 3: THE BIGGER PICTURE COMES INTO FOCUS. Job participation rate (JPR) peaked in 2000, along
with the stock market and the initial contraction of the velocity of M2. Note also that the peak in late 2006 fol-
consistent with the velocity of M2 chart lowed the April 2006 peak in the velocity of M2 and the collapse that followed. See how it is consistent with the
and the price/volume characteristics. velocity of M2 chart in Figure 2 and the price/volume characteristics seen in Figure 1.

24 March 2017 Technical Analysis of Stocks & Commodities


Noisy indicators
delay your analysis
of the market or the economy itself.
4. While the recent four-year cycle has been more extended
than the cycle into the 2007 top, these manipulative
efforts have been even less effective on the underly-
ing economy than they were in conjunction with the
advance into 2007.
Jurik algorithms
So not only has there been a diminishing return, but these deliver low lag,
policies may have failed with regard to the underlying low noise analysis
economy. These efforts have not affected the price/volume
characteristics of the stock market and they have now made
matters even worse in that they have left the equity markets
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
in a massive and unsustainable bubble. In short, it has all gone Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
to equities, which has served as camouflage for the underly-
ing economy.
Jurik Tools on live charts, on the web !
tinyurl.com/jurik-online
Accept reality
Throughout the extended advance into the
2007 top, reinflation efforts were only mak- Jurik Research
ing matters worse. In my opinion, efforts to
extend this advance are not only making mat-
ters worse, but this time I think it will be far 2010 -- 2011 -- 2012 -- 2013
worse than the extension of the previous cycle that led to the Add-In software

2007 top. This extended advance first began trying to peak in


2015, and now with the latest advance following the election, jurikres.com 800-810-3646 719-686-0074
along with the associated complacency and optimism, I feel
this is the most dangerous stock market environment since the with an extremely heavy price. The post-election advance has
inception of the DJIA in 1896. It has been a grand illusion generated maximum complacency. Dont be fooled.
and the market has served as camouflage for the continued
deterioration of the underlying economy. The ongoing evidence Tim Wood is the author of the newsletter Cycles News And
that we are in a massive topping process is telling us that the Views. He can be reached via his website, cyclesman.com,
global monetary policies are now failing with respect to the by email at tim@cyclesman.com, or by phone at 504 208-
markets. No amount of twisting or manipulating of any other 9781.
data changes or negates this data.
The bottom line is that there has been no economic recovery. Further reading
Like the extended advance into the 2007 four-year cycle top, Edwards, Robert D., and John Magee [1948]. Technical
this entire advance has been a manufactured event within the Analysis of Stock Trends.
context of a secular bear market, and this time, the bubble Wood, Tim [2016]. The Reckoning, Technical Analysis of
is even bigger. While most dont see it, this bubble is very Stocks & Commodities, Volume 34: March.
large and we are in a very ugly topping process. I believe the MetaStock
consequences of this extended advance are going to come See Editorial Resource Index

options

SARKETT/THIS BUTTERFLy WEARS KEVLAR further readinG


Continued from page 20 Sarkett, John A. [2017]. A Road Trip With Options Super-
traders, Technical Analysis of StockS & commoditieS,
John A. Sarkett is the author of Option Wizards: Real Life Volume 35: February.
Success Stories From The Financial Markets And Market See Traders Glossary for denition
Mentors (http://option-wizard.com). He writes frequently for
the nancial press and has been a contributor to STOCKS &
COMMODITIES magazine since 1995. Sarkett may be reached
at jas@option-wizard.com. More on Jim Riggio and veteran
options trader and educator Tom Nunamaker can be found at
http://capitaldiscussions.com and http://kevlartrade.com.
March 2017 Technical Analysis of Stocks & Commodities 25
are two columns of posi-
tive numbers, one showing
todays close minus yes-
terdays close (changes on
up days or zero), and the
other featuring yesterdays
close minus todays close
(changes on down days or
zero). These two columns
of positive numbers are then
smoothed using a varia-
tion of exponential moving
averages, whose length
can be estimated as twice
the length of the lookback
period minus one.
So, for the 14-day period
popular everywhere, a 27-
day exponential average
(EMA) is used to smooth the
data in the two columns. In
an intermediate calculation
step, the smoothed data is
next used to compute the
ratio of the up-day average
to the down-day average
(called the relative strength).
This ratio is then converted
into an oscillator on a 0100
A Quicker Reaction

Buy & Sell Pressure


scale.

The trouble with

And A Faster RSI


range compression
The complaint arises be-
cause the intermediate ratio,
relative strength, is calcu-
lated using relatively long
EMAs, which therefore
Most of you are familiar with the relative strength index (RSI), but are you taking full advan- have a long memory (that
tage of it? Here, we deconstruct the RSI to lead to a more intuitive and symmetrical gauge of is, they need a lot of data
buying and selling pressure and a more responsive indicator. to stabilize and are heavily
influenced by old data) and
by Tushar S. Chande, PhD make the RSI practically

M
unresponsive as the length
BUY GRAPHIC: HANOHIKI/CHART HAND CLOUD: RA2STUDIO/

any novice and even intermediate traders have told me over the years that they find the of the lookback period in-
ever-popular relative strength index (RSI) indicator confusing. The RSI is an oscillator creases. I have previously
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON

plotted on a scale of zero to 100, and is typically used as an overbought/oversold indica- proposed a solution to this
tor, which means that it is used to signal impending reversals in direction. However, during problem via the stochastic
strong trends, the RSI can remain at extreme levels, either high or low, for the duration of RSI or stochRSI.
the trend, and thus, its not precise as an indicator of impending reversals. This is partly due A bigger problem is that
to range compression, which I will discuss later in this article. because the RSI is plotted on
a fixed 0100 scale, as op-
Digging deeper posed to an open scale with
Even expert technicians have expressed their concern about the smoothing built into the indi- no upper or lower limit, there
cator. In brief, calculations begin by separating daily changes into absolute values separated is massive range compres-
by days on which a market (or stock) closes up on the day or down on the day, so that there sion at the extremes, or the
26 March 2017 Technical Analysis of Stocks & Commodities
Indicators

area of the most interest. Visualize the two columns of daily RS decreases from Length Smoothing Effective Length
close-to-close changes described earlier as buying pressure 1 to 0.1, a 10-times of RSI Factor of EMA
or selling pressure. If there is strong selling pressure, the drop, the RSI itself
6 0.16667 11
absolute daily close-to-close changes on down days will be drops from 50 to 9
8 0.12500 15
much greater than the close-to-close changes on up days. So or so.
the ratio of selling pressure to buying pressure could be 10:1 The fixed range 10 0.10000 19
or greater (and vice versa). has two effects: 12 0.08333 23
Imagine a stock that surges on strong earnings, with strong nonlinear range 14 0.07143 27
buying over many days as investors follow through. In this compression, and 16 0.06250 31
case, the proportion of buying to selling pressure, that is, the asymmetric val- 18 0.05556 35
ratio of the average of up-day close-to-close changes to the ues. First, when the 20 0.05000 39
average of the down-day close-to-close changes, could move range compression
22 0.04545 43
from 3:1 to 12:1, a 300% increase, and yet the RSI would only is nonlinear, the
24 0.04167 47
shift from 75.0 to 92.31, a mere 23% increase. As a short-term greater the dif-
trader, you would rather be alerted to the 300% increase ference between 26 0.03846 51
in buying pressure than a 23% increase in RSI. The range the up-closes and 28 0.03571 55
compression gets even more extreme as the ratio of buying down-closes av- 30 0.03333 59
pressure to selling pressure increases. erages, which is 32 0.03125 63
In defense of the design of the RSI, it is a brilliant and precisely when the 34 0.02941 67
practical solution to the problems of its time, when computers indicator should 36 0.02778 71
were uncommon and data were plotted by hand. In order to be drawing your
38 0.02632 75
speed up hand calculations, the use of moving averages that attention to that
40 0.02500 79
required just one row to be calculated anew each day was most stock or market.
convenient, even essential. Similarly, the ability to plot RSI Second, though 42 0.02381 83
data on a fixed 0100 scale greatly simplified the problem of the displacement FIGURE 1: SMOOTHING BUILT INTO THE RELATIVE
STRENGTH INDEX (RSI). The smoothing factor seen
updating a large number of charts by hand. However, today from the center in column 2 is an inverse of the length of the RSI.
we can rework the problem to overcome these computational is symmetric, the
or charting challenges. numeric readout

Understanding RSI calculations Up-closes Down-closes Relative Strength Relative Strength


Ill illustrate the quirks of the RSI calculations using a few EMA EMA (RS) Index (RSI)
simple calculations. First, I show the smoothing factors built 10 1 10.0000 90.91
into the calculations (see Figure 1).
9 1 9.0000 90.00
The first column shows a range of lookback periods rang-
8 1 8.0000 88.89
ing from six to 42 days incremented in steps of two days.
The smoothing factor corresponding to each length of RSI is 7 1 7.0000 87.50
simply an inverse of the length (see column 2). The equivalent 6 1 6.0000 85.71
length of the corresponding EMA is shown in column 3, using 5 1 5.0000 83.33
the usual formula that the index of the EMA is given by (2/ 4 1 4.0000 80.00
(L+1)), where L is the length of the average. Clearly, if you 3 1 3.0000 75.00
want the RSI to respond more quickly to market changes, you 2 1 2.0000 66.67
can shorten the length, or simply change the type of moving
1 1 1.0000 50.00
average used to calculate the smoothed quantities used in the
1 2 0.5000 33.33
calculations.
In Figure 2, I illustrate the range compression feature of RSI 1 3 0.3333 25.00
calculations by constructing a series of hypothetical values for 1 4 0.2500 20.00
the up-closes and down-closes EMA. I first vary the up-closes 1 5 0.2000 16.67
EMA from 10 to 1 in steps of 1, while keeping the down-closes 1 6 0.1667 14.29
EMA fixed at 1 (see columns 1 and 2, and the first 10 rows in 1 7 0.1429 12.50
Figure 2). I compute the relative strength (RS) by taking the 1 8 0.1250 11.11
ratio of the values in the first two columns. The fourth column
1 9 0.1111 10.00
converts the RS values into the equivalent RSI values using
1 10 0.1000 09.09
the formula RSI = (1-(1/(1+RS))*100. Note the range compres-
FIGURE 2: RANGE COMPRESSION IN RSI CALCULATIONS. When the RS
sion: When the RS increases from 1:1 to 10:1, the RSI only increases from 1:1 to 10:1, the RSI only increases from 50 to 91, approximately.
increases from 50 to 91, approximately. The range compression When the RS decreases from 1 to 0.1, a 10-times drop, the RSI itself drops from
also works similarly on the downside. For example, when the 50 to 9 or so.

March 2017 Technical Analysis of Stocks & Commodities 27


Up-closes Down-closes Relative RSI - Relative Chande Buy/Sell
EMA EMA Strength Strength Index Pressure (CBSP)
10 1 10.0000 90.91 10
9 1 9.0000 90.00 9
8 1 8.0000 88.89 8 to selling pressure, that is, buy/sell pressure or BSP. I
use the following formulas:
7 1 7.0000 87.50 7
6 1 6.0000 85.71 6
If RS < 1, CBSP = -1/RS and
5 1 5.0000 83.33 5 If RS >= 1, CBSP = RS.
4 1 4.0000 80.00 4
3 1 3.0000 75.00 3 You can just as easily rewrite the CBSP using the RSI
2 1 2.0000 66.67 2 values directly as follows:
1 1 1.0000 50.00 1
1 2 0.5000 33.33 -2 If RSI < 50, then CBSP = (0.01*RSI-1)/(0.01*RSI),
else
1 3 0.3333 25.00 -3
(RSI >= 50), then CBSP = (0.01*RSI)/(1-
1 4 0.2500 20.00 -4
0.01*RSI)
1 5 0.2000 16.67 -5
1 6 0.1667 14.29 -6 With this formulation, CBSP < 0 when RSI < 50, and
1 7 0.1429 12.50 -7 CBSP > 0 when RSI >=50, and the sign indicates which
1 8 0.1250 11.11 -8 is greaterthe buying or selling pressure.
1 9 0.1111 10.00 -9 In Figure 3 I show how the RSI values can be
1 10 0.1000 9.09 -10 converted into BSP values using the same synthetic
data as in Figure 2. First, when you compare columns
FIGURE 3: BUY/SELL PRESSURE CONVERTED FROM RSI FIXED SCALE TO OPEN SCALE.
The open scale tells you instantly the relative magnitudes of the two pressures, and the sign 3 and 5, note that BSP is the same as RS when the
tells you which is greater. RS is >=1, but is equal to -1/RS when RS is < 1. The
convenience of this definition is that now you get an
is not. For example, a 4:1 upside ratio or 1:4 downside ratio open scale and symmetric values of buy/sell pressure that
produces a similar 30-point deviation from the center line at instantly communicate the relative magnitudes of buying or
50, but the readout is 80 or 20, not symmetric as 4:1 or 1:4. selling pressure. For example, from the first line, when the
Thus, the RSI numerical values are not intuitively related to RS=10 and buying pressure is 10 times the selling pressure,
the force of buying or selling pressure. BSP =10. Symmetrically, from the last line, when the selling
pressure is 10 times the buying pressure, BSP = -10.
Chande buy/sell pressure (CBSP) Thus, the open scale instantly tells you the relative mag-
I would like to convert the usual RSI calculations away from nitudes of the two pressures, and the sign tells you which is
the fixed scale into an open scale to get away from range greater. This is a more intuitive formulation of buying and
compression and get a symmetric readout. I would also like selling pressure, and gets closer to the natural price action. I
to signal if buying pressure exceeds selling pressure or vice will now apply these calculations to a few real-life examples
versa. to appreciate their implications.
Recall that in the core RSI calculations, the RS = (up-day
average)/(down-day average). Rather than visualize the ratio The 2015 rally in Dupont (DD)
as relative strength, I look at it as a ratio of buying pressure In the fourth quarter of 2015, Dow 30 component Dupont
(DD) had been falling steadily, past the Chinese
revaluation selloff in August into October. Then,
as the rest of the market rebounded in October,
90
70
DD gapped higher, and rallied hard through early
50.79
30
December, ending with an exhaustion gap. In Fig-
10 ure 4 you see a chart of the DD price action along
74
72
with the 14-day RSI in the upper panel. Observe
70
68
how the RSI values remained above 70 for more
66
65.42 than 45 days as DD trended higher.
I reproduced the RSI calculations from Figure
64
62
60
58
4 in an Excel spreadsheet (see Figure 5) to pro-
56 vide the bridge to a later discussion. The ending
54
52
value, on December 31, 2015, is 50.79, which is
the same in Figure 4. Thus, I can cross-check my
stockcharts.com

50
48 calculations against a commercial package for
completeness. I can now use the RSI calculations
46
Jul 8 13 20 27 Aug 10 17 24 Sep 8 14 21 28 Oct 12 19 26 Nov 9 16 23 Dec 7 14 21 28
FIGURE 4: BUY/SELL PRESSURE IN DUPONT (DD). Dupont rallied in late 2015 and the RSI in Figure 5 and compare them directly to buy/sell
stayed above 70 for more than 45 days. pressure calculations (see Figure 6).
28 March 2017 Technical Analysis of Stocks & Commodities
Dupont: 14-day RSI with Wilders Smoothing Dupont Rally captured via Wilders RSI and Chande Buy/Sell Pressure
RSI Up Ref Dn Ref Wilders RSI Buy/Sell Pressure
100 120 12

Chande Buy/Sell Pressure with Wilder Smoothing


110 11
90
100 10

Wilders Relative Strength Index (RSI)


80 RSI Flattening
90 9
70 80 8
70 7
Relative Strength Index

60
60 6
50 50 5
40 40 4
30 3
30
20 2
RSI = 50.79 CBSP Surging
20 10 1

10 0 0
microsoft excel

15

15

15

15

15

15

15

15

15

15

15

15

15

15
/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0
0

/3 0

/0 7

/1 4

/2 1

/2 8

/0 4

/1 1

/1 8

/2 5

/0 2

/0 9

/1 6

/2 3

/3 0
09

10

10

10

10

11

11

11

11

12

12

12

12

12
15

15

15

15

15

15

15

15

15

15

15

15

15

15
/2 0

/2 0

/2 0
/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

/2 0

FIGURE 6: WILDERS RSI VS. BUY/SELL PRESSURE. The values are consistent
/16

/23

/30
/30

/07

/14

/21

/28

/04

/11

/18

/25

/02

/09

12

12

12
09

10

10

10

10

11

11

11

11

12

12

with those in Figure 3. The buying pressure was 10 times the selling pressure (values
FIGURE 5: 14-DAY RSI WITH WILDERS SMOOTHING. Here, the RSI calculations
above 10) with RSI greater than 90 just before DD flattened out in mid-November.
were reproduced in an Excel spreadsheet. The RSI value of 50.79 on December
The acceleration in CBSP values makes the buying pressure more obvious than
31, 2015 is the same as in Figure 4.
the flattening out seen in RSI values.

The rapid acceleration in buying pressure is more intuitively should be expected since I am using a larger fraction of the
obvious in Figure 6, even as the RSI values begin to flatten incoming data (0.13 vs. 0.07) to update the new value for the
out, topping out above 90 for BSP > 10, as can be expected moving averages used to calculate the relative strength.
from the calculations in Figure 3.
Ill now briefly revisit the internals of RSI smoothing. The spill in Kimberly Clark
Wilders formulation does not quite follow the usual EMA The shares of Kimberly Clark (KMB) had a bit of a spill in
formula. For example, for a 14-day RSI, it adds 1/14 of the late 2016. These defensive stocks have been following the
new value to 13/14 of old value, instead of adding 2/15 of the bond market lower, after bonds peaked in the immediate
new value to 13/15 of the old value to compute the updated aftermath of the Brexit scare. I show in Figure 8 how the
averages. This subtle change slows down the RSI computations. selling pressure reached -4, with the RSI in the range below
I compared the RSI values during the DD rally using the two 20, as is expected from Figure 3. The CBSP instantly com-
different smoothing schemes in Figure 7. The proper EMA municates selling pressure four times the buying pressure,
formulation, denoted by standard EMA smoothing in Figure whereas the RSI readout is merely an oversold condition
7, responds more quickly than the Wilder formulation, which below 30. Thus, when you compare the pressure of buying

Dupont: RSI with Wilders vs. Standard EMA Smoothing Kimberly Clark: RSI vs. CBSP (1:4 Selling Pressure)
RSI Standard EMA Smoothing Wilders RSI RSI Up Ref Dn Ref CBSP
80 3
120

70 2 Chande Buy/Sell Pressure (Graph with open circles)


100
60 1
Relative Strength Index (RSI)
Relative Strength Index (RSI)

80 50 0

40 -1
60

30 -2
40
20 -3

20 10 -4

0 -5
0
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
/26 16
16
/2 1
/2 1
/2 1
/2 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
/2 1

/20
10 0/20
15

15

15

15

15

15

15

15

15

15

15

15

15

15

/3
/20

/20

/20

/20

/20

/20

/20

/20

/20

/20

/20

/20

/20

/20

09
/30

/07

/14

/21

/28

/04

/11

/18

/25

/02

/09

/16

/23

/30

FIGURE 8: RSI CALCULATION AND CBSP. The selling pressure here is four times
09

10

10

10

10

11

11

11

11

12

12

12

12

12

FIGURE 7: WILDERS RSI VS. STANDARD EMA SMOOTHING. The RSI calculation the buying pressure, giving a CBSP reading of -4, intuitively clarifying that the stock
using the standard EMA formula reacts faster because it uses a larger proportion is under significant selling pressure. The RSI readout at about 20 merely shows an
of new data to update its internal moving averages. The more responsive RSI can oversold condition. Thus, the CBSP gives symmetrical readings (4:1 or 1:4, that is,
be quite attractive to short-term traders. +4 or -4) for the intensity of buying or selling pressure.

March 2017 Technical Analysis of Stocks & Commodities 29


NFLX: RSI with Wilders Smoothing and Standard EMA Smoothing Buy/Sell Pressure with Wilder vs. Standard EMA Smoothing
Standard EMA RSI RSI Wilder Smoothing UP Ref Standard EMA CBSP Wilder Smoothing
100 7

Chande Buy/Sell Pressure with different internal smoothing


90
6
80
Relative Strength Index (RSI)

70 5

60
4
50
3
40

30 2

20
1
10

0 0

10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
/25 16
16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/2 16
/2 16
/2 16
/2 16
/2 16
/25 16
16

/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
/2 1
/2 1
/2 1
/2 1
10 0/20

/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
/20

/3
/3

09
09

FIGURE 9: PRICE JUMPS AND RESPONSE TIME. The 20% or so jump in NFLX in FIGURE 10: BUY/SELL PRESSURE WITH WILDER VS. STANDARD EMA
a single day was heavily damped in the RSI calculations using the Wilder smoothing SMOOTHING. The Chande buy/sell pressure (CBSP) calculations using the regular
formula. However, using the standard exponential moving average formula led to exponential average definitions responded more quickly to the one-day jump in
a faster response from the resulting RSI. NFLX than the CSBP calculations using the Wilder smoothing method. The CBSP
intuitively shows the sudden surge in buying pressure, and shows that it is many
times the selling pressure.

Or they can recast it as Chande buy/sell pressure to get a


The open scale instantly tells symmetric, open-scale variant that instantly summarizes the
you the relative magnitudes of relative magnitudes of buying or selling pressure. Remember
the buying and selling pressures, that because the core calculations are closely related, the
and the sign tells you which shape of the variations will look alike, though the numeri-
cal readouts will differ.
is greater, making it a more
intuitive formulation of buying Tushar Chande, PhD, MBA, has two decades of experience
and selling pressure, and closer trading the futures markets as a CTA and hedge fund head of
to the natural price action. research. He is the developer of numerous widely used origi-
nal technical indicators such as VIDYA, CMO, and AROON.
He is the author or coauthor of several books on technical
or selling, the CBSP gives a more intuitive readout of which analysis. His website, ETFmeter.com, offers trend analysis
side is dominating and by how much. of more than 1,200 ETFs, stocks, and international indexes,
and buy/sell pressure data. Users can build and rebalance
A surge in Netflix risk-managed ETF portfolios.
Traders and investors rewarded Netflix (NFLX) with a 20%
or so jump in stock price when the companys performance Further reading
exceeded expectations in October 2016. The sudden one-day Chande, Tushar, and Stanley Kroll [1993]. Stochastic RSI
jump in price shows the lags due to the smoothing built into And Dynamic Momentum Index, Technical Analysis of
RSI calculations. I first compared the standard 14-day Wilder Stocks & Commodities, Volume 11: May.
RSI calculations to the RSI calculations using a standard 14- Chande, Tushar [2001]. Beyond Technical Analysis, 2d ed.,
day EMA (see Figure 9). It is clear that the Wilder smoothing John Wiley & Sons.
built into the RSI is less responsive than the usual definition , and Stanley Kroll [1994]. The New Technical Trader,
of an EMA. John Wiley & Sons.
The corresponding buy/sell pressure calculations can be seen [2016]. When Is Berkshire Hathaway Stock Good
in Figure 10. Once again, the calculations using the regular Value? Technical Analysis of Stocks & Commodities,
EMA formula respond much more quickly. This intuitively Volume 34: Bonus Issue.
shows that the buying pressure is six times greater than sell- StockCharts.com
ing pressure. This is easier to absorb than just an RSI reading See Editorial Resource Index
above 70, which merely indicates an overbought condition.

Variations on the ever-popular RSI


The ever-popular RSI indicator is used in many situations,
for both systematic and discretionary trading. Users can now
add a couple of variations to their menu. One, they can use
a different smoothing scheme, to get a more responsive RSI.
30 March 2017 Technical Analysis of Stocks & Commodities
FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the se-
nior strategist for DeCarley Trading, a division of Zaner, where she also works
as a commodity broker. She has written multiple books on futures and options
trading, the latest is titled Higher Probability Commodity Trading. Garner also
authors widely distributed e-newsletters; for your free subscription visit www.
DeCarleyTrading.com. To submit a question, email her at info@carleygarner-
trading.com or via www.DeCarleyTrading.com. Selected questions will appear
Carley Garner
in a future issue of S&C.

ES OPTIONS simple: Just because the stock exchanges report each individual trade to the IRS.
Why trade ES options, and not the SPX are closed doesnt mean financial mar- Instead, he receives a 1099 with a lump
or SPY options? kets around the worldand, therefore, sum of profit or loss. That single figure
Ive been asked on multiple occasions emini S&P 500 futures pricesarent is reported on the traders taxes.
why I recommend S&P 500 options moving.
trades using the emini S&P futures Lower barriers to entry and access to
options (ES) traded on the Chicago Preferable tax treatment option-selling strategies
Mercantile Exchange (CME) rather than Options on futures traders enjoy a Most equity brokers require their clients
equity products such as the SPX or SPY. 60/40% blend between long-term and to apply separately for access to trade
The truth is, I am a futures and options short-term capital gains rates on all trades options. Further, being granted the ability
broker who deals solely in futures con- regardless of how long they were held or to sell options is generally reserved for
tracts and options on futures contracts. which particular instruments are used. those with sizable speculative accounts.
But besides the fact that options on fu- This is a significant advantage for active For instance, most stockbrokers seem
tures are in my comfort zone and are the traders because most stock products to want at least $100,000 in a trading
bread and butter of my business, there require a trade be held for more than account before option-selling strategies
are some compelling reasons to trade a year to be eligible for the discounted are a possibility (although some brokers
emini stock index options and bypass long-term capital gains rate. will allow it in a $50,000 account). In
the equity market versions. any case, traders are expected to put up
at least five figures to trade short options
Around-the-clock market access Traders who trade and spreads in the stock market. Futures
The primary argument for trading emini options on futures stand options traders, on the other hand, are
S&P 500 options versus the stock market to potentially get more granted cheap and easy access to short
version, SPX, is that the futures options options and options spread trading. For
trade 23 hours per day. Accordingly, it is
bang for their buck when instance, my brokerage service allows
possible to exit them at any time of the day they are right in their options spread trading with as little as
or night, with the exception of the daily speculations. $2,500, but for naked option selling,
closure between 4 pm and 5 pm Central we prefer to see upwards of $10,000.
Time. This can be particularly helpful if In any case, it is a clear advantage for
there is some sort of event risk while the That said, the SPX is one of the few smaller traders to venture into options
stock market is closed. For instance, on stock products treated in this manner. on futures.
election night, traders holding long SPX Im not a tax expert, nor am I an equity
puts wouldnt have been able to exit their options expert, but I do believe the SPX Lower margin for less capital
position as the S&P futures plunged 100 options are afforded the same 60/40 Options on futures traders are provided
points, but those trading futures options blended tax rate under the IRS Section portfolio margining regardless of ac-
would have had the opportunity to lock 1256 provision. Youll need to consult count size. This means that traders who
in a profit on that Tuesday night before with your tax advisor for the details, but sell strangles are not charged full margin
the monster post-election rally started it is my understanding that SPY options for both the short call and the short put
on the following Wednesday morning. do not qualify for this. Nevertheless, the because they can only lose money on one
Similarly, they might have even had the tax benefit for futures options traders side of the trade. In other words, port-
foresight to go long calls in the overnight extends beyond tax rates to the hassle folio margining takes into account all
session while those waiting for the stock of reporting gains and losses. An emini positions held by the trader, determines
exchange open would have been chasing S&P options trader, unlike an SPX or
a rally that was already underway. Its SPY options trader, is not obligated to Continued on page 47
March 2017 Technical Analysis of Stocks & Commodities 31
Two Outcomes Or None

About Those Binary Options


Whether youre a scalper, an intraday trader, or a longer-term What are they?
trader, binary options can provide several types of trading While there are three binary options providers (Canton LP,
opportunities and can work in any type of market condition. CME, and Nadex) that are designated by the Commodity
What are they and how can you trade them? Find out here. Futures Trading Commission (CFTC) as contract markets in
the US, in this article, Ill use the Nadex binary options since
by Gail Mercer they offer several choices when it comes to expirations and

Y
markets (futures, commodities, and forex markets).
ou have probably heard the term binary options, but Binary options are short-term expiration contracts that
what are they really? Theyre different from tradi- provide a limited risk and limited payout environment for
rawpixel.com/shutterstock

tional options and if you arent all that familiar with traders. The maximum payout on any binary option is $100.
them, nows your chance to get to know them better. Risk is always limited to the price paid on entry. If the binary
Before jumping into all the different opportunities option indicative price expires in-the-money (ITM), the full
they provide, Ill start with a review of what binary payout is received ($100). The actual profit is $100 minus
options are. price paid on entry.
32 March 2017 Technical Analysis of Stocks & Commodities
OPTIONS

The binary option consists of a strike


A
statement that shows the following:

instrument B
price statement
> 1.2688
Sell Buy
- 6.00
expiration date and time. > 1.2678
Sell Buy
1.75 8.00
> 1.2668

The binary option ladder chart in Figure Sell


8.00
Buy
14.25

1 identifies the following information: > 1.2658


Sell Buy
18.00 24.50
> 1.2648

Point AInstrument and expira- C


Sell
32.25
Buy
38.75

tion time 1.26391


> 1.2638
Sell Buy

Point BStrikes closest to price for


49.00 55.50
> 1.2628

the specified time period (6 am8


Sell Buy
65.25 71.75

am EST). On the GBPUSD, there


> 1.2618
Sell Buy

are always nine strikes offered for


78.75 85.00

D
the two-hour expiration
12:00 16:00 20:00 Dec 14 04:00 08:00 expiry

FIGURE 1: Binary Option Ladder, GBPUSD. On this binary option ladder chart of the GBPUSD, you see
Point CIndicative price, which the instrument, price statement, expiration date, and expiration time.
is used as the expiration
Point DDate and time axis.
the trader believes the statement will be false at expiration,
Choosing risk levels then he clicks on the red button to sell. The risk is limited to
A trader with a bias to the upside on the GBPUSD believes the maximum payout minus the price shown on the red button
the binary option statement will be true at expiration. If the (unless the trader modifies the price using a limit order).
trader believes the statement will be true at expiration, then Using the earlier example, the binary short opportunities are:
he clicks on the blue button to buy. The risk is limited to the
price identified on the blue button (unless the trader modifies The > 1.2658 strike is considered DITM because price
the price using a limit order). is trading at least two strikes under it. Risk is limited
Using Figure 1, the long opportunities with risk and profit to $82.00 ($100 minus $18.00). The profit potential
potential are: would be $18.00.

The > 1.2618 strike is the deep ITM (DITM) option, The > 1.2648 strike is considered ITM because price
as price is trading at least two strikes above this level. is trading at least one strike under it. Risk is limited to
The risk is $85 with a profit potential of $15 ($100 $67.75 ($100 minus $32.25). The profit potential would
minus $85). be $32.25.

The > 1.2628 strike is the ITM option, as price is trading The > 1.2638 strike is the ATM because price is currently
at least one strike above this strike. The risk is $71.75 and trading at this strike level. Risk is limited to $51.00 ($100
the profit potential is $28.25 ($100 minus $71.75). minus $49.00). The profit potential would be $49.00.

The > 1.2638 strike is the at-the-money (ATM) option, The > 1.2628 strike is the OTM because price is trading
as price is currently trading at this level. The risk is above this strike level. Risk is limited to $34.75 ($100
$55.50 strike and the profit potential is $44.50 ($100 minus $65.25). The profit potential would be $65.25.
minus $55.50).
The > 1.2618 strike (also OTM). Risk $21.25 ($100 minus
The > 1.2648 strike is the out-of-the-money (OTM) op- $78.75). The profit potential would be $78.75.
tion, as price is currently trading below this strike level.
The risk on this option is $38.75 and the profit potential
is $61.25 ($100 minus $38.75).

The > 1.2658 strike (also OTM). The risk is limited to When trading binary options,
$24.50 and the profit potential is $75.50 ($100 minus traders can never lose more
$24.50).
than what they paid on entry.
A trader with a bias to the downside on the GBPUSD believes
that the binary option statement will be false at expiration. If
March 2017 Technical Analysis of Stocks & Commodities 33
In addition, because there are several GBPUSD - 15 min they paid on entry.
expirations available at any given time, the In this case, if the trader entered the five
trader could also have chosen additional long positions described earlier using only
two-hour binaries, as well as daily expi- the two-hour binary options from 6 am8
ration, since Nadex offers multiple daily am and trading only one contract each, the
expirations on the forex pairs. For example, results would be what you see in the table
there is also a 7 am, 11 am, 3 pm, 7 pm, and in Figure 3.
11 pm daily expiration, providing traders Of course, the trader could have entered
with even more opportunities. a single binary option or any multiple of
the binary options you see in Figure 3 plus
teChniCal analysis and any of the daily or weekly options that
binary options were offered at the time.
Technical analysis in the simplest of terms Slow Stochastic Binary options are also great for trend-
is a mathematical approach to creating ing markets because the trader can simply
visual tools for forecasting the direction build positions throughout the day, using
of prices using historical data points. It different option strikes as well as weekly
is this forecasting ability of technical expirations that end on Friday. And if
analysis, combined with the power of 22:00 23:00 12/14 01:00 02:00 03:00 04:00 05:00 06:00 markets are moving sideways, traders can
limiting risk, that makes binary options limit their trades to either ITM or ATM
FIGURE 2: dIvERGEncES BEtWEEn IndIcatOR
ideal for technical analysts. Take the case and pRIcE. when you look at this chart of the
strikes.
of divergences between indicator and price GBpusD with the slow stochastic indicator, you
as an example. see that price was making lower lows while the lean toWard simple
The chart of the GBPUSD in Figure 2 slow stochastic was making higher highs. this When trading binary options, keep these
indicates that a position to the upside was divergence indicates that an upside move is likely
and you could take a position that supports an
two points in mind:
more likely because as price was making upside price movement.
lower lows, the slow stochastic was making For long positions, the indicative price
higher lowsalso known as divergence. needs to expire one tick greater than
Plus, the close of the price was greater the strike price.
than the open, providing further confirmation that the market For short positions, the indicative price needs to expire
would likely go up. equal to or less than the strike price.
When trading leverage accounts, traders hesitate to enter
these types of trades because the trade is going against the Gail Mercer, founder of TradersHelpDesk, is a trader, men-
trend (known as countertrend trading). If price were to spike tor, author, and speaker residing in North Carolina. She has
down, then the trader could lose more than he anticipated as over 15 years of experience in trading and in the develop-
price could jump over the stop price, which is why margins ment of custom indicators. She is experienced in trading
are required. However, that cannot happen with binary options futures, forex, and binary options using volume analysis as
and therefore, margins are not required. Remember, when well as divergence. She can be reached via email at gm@
trading binary options, traders can never lose more than what tradershelpdesk.com.

Further reading
Strike (GBPUSD) Risk ($) Gross Profit ($) Exchange Fee ($) Net Profit ($) ROI (%) Mercer, Gail [2016]. Choosing A Bi-
1.2618 85.00 15.00 1.80 13.20 16 nary Option Provider, Technical
1.2628 71.75 28.25 1.80 26.45 37 Analysis of StockS & commodi-
1.2638 55.50 44.50 1.80 42.70 77 tieS, Volume 34: November.
1.2648 38.75 61.25 1.80 59.45 153 NADEX
See Traders Glossary for definition
1.2658 24.50 75.50 1.80 73.70 300 See Editorial Resource Index
totals 275.50 224.50 9.00 215.50 78*
FIGURE 3: tRadInG tHE tWO-HOUR BInaRy OptIOnS FROM 6 aM8 aM. here you see the results of trading
five long positions, one contract each. *total roi% is based on total net profit/total risk.

34 March 2017 Technical Analysis of StockS & commoditieS


Q&A

SINCE YOU ASKED


Confused about some aspect of trading? Professional trader Rob Friesen, president
& COO of Bright Trading (www.stocktrading.com), an equity trading corporation,
answers a few of your questions. To submit a question or suggest a topic, email him
at robfriesen@brighttrading.net, or post your question to our website at http://
Message-Boards.Traders.com. Answers will be posted there, and selected questions
will appear in a future issue of S&C.
Rob Friesen

A dollar saved becomes 1. Why would anyone want to stop out What we desire in mean-reverting
a dollar made a unit or layer of capital after put- trades is like the first line of the song
When I present on topics such as trade ting it on under such advantageous Spinning Wheel by Blood, Sweat &
some and hold some, as was the sub- conditions? Tears: What goes up, must come down.
ject of my column in this magazine last 2. Does a pair trade need or require But something that needs to be consid-
month, I have invariably been asked, that you plan for and utilize a ered is from the second line: Spinning
Well, what about stop-losses? stop-loss? wheel got to go round.
One of the benefits of spread trad- Applied to pairs or spread trading,
ing is the distribution of capital over a The answer is actually yes no that line would say to me: Is this a one-
range, by chosen methodology, allow- it depends. off, or single-opportunity trade, or is it
ing a dollar-cost-averaging approach to It depends on what the position size is compoundable? If it is a trade that can be
hedged trading. Not having to be right relative to your capital and the statistical repeated frequently, then it is treated dif-
on a single bet provides a reasonable edge. The position size might be so small ferently than a trade you have identified
level of comfort. that a stop-loss seems unwarranted. for this particular moment in time that
One of the problems with spread trad- might never present itself again.
ing is that which provides comfort also Traders would be less likely to require
creates anxiety when the layers have Anyone who has a stop-loss with pattern-based spreads
been applied and things are not going traded pairs or equity that have a significant statistical op-
swimmingly, in that you find yourself portunity to work it over a specified
swimming against the current.
spreads of any kind range, by keeping capital sliced into
Anyone who has traded pairs or equity has experienced the layers and distributing that up to their
spreads of any kind has experienced the symbols in that spread maximum planned-for capital. This is
symbols in that spread drifting apart drifting apart from each as we have shared in the past in this
from each other. This presents an op- columnharvesting the noise.
portunity that is even better than your
other. This presents an Back to the hook of this months
original starting point. Your plan may opportunity that is even column: A dollar saved becomes a dol-
have included this foresight through better than your original lar made. I touched on it in the February
running each potential scenario ahead starting point. 2017 issue when I wrote, Lets discuss
of time and planning your future trades. a technique for managing a pair going
In previous columns, I have spent quite a against you. I went on to explain the
bit of time on this and suggested this as Would you use fixed stops, trailing approach: Using the last in, first out
a process, method, and discipline. stops, time-based stops, or are you (LIFO) accounting method for your pair,
The philosophy of spread trading responding to any new informa- subtract a layer to reduce the losses of
would be to have capital available, that tion, or any change in the validity a pair trending against you by making
the bet size would be in keeping with of the trade? the effort to reestablish that pair at a
logical risk management formulas, and much better price. Use all your skills
that you would capture that window The general rule with leverage would and indicators to place that bet when
of opportunity as the spread moves be to utilize some form of stop-losses. conditions are suitable. In this case, a
to outlier regions. By definition, the So we have a quandary in spread dollar saved will become that dollar made
mean-reverting opportunity would only tradingthat stretched-out price, which when and if the spread travels once again
improve as the spread continues farther provides a great opportunity to get in in the direction of your bias. You may
from the main distribution areas. for the potential profit, is also flashing find it is warranted to remove all layers
This brings up two questions. red lights of warning of exponential
potential losses. Continued on page 45
March 2017 Technical Analysis of Stocks & Commodities 35
INTERVIEW

Patience Is A Virtue

Gavin McMaster: Living Life


As An Options Trader
You dont have to be an aggressive trader to make it as an options trader, says
this master of options trading. After learning as much as he could about
trading options, Gavin McMaster decided to take the task into his own hands
and start trading options. He didnt spend a single day working at a trading
desk for a financial firm, although the thought did cross his mind. McMaster
even went on to get a masters degree in applied finance and investment, but
admits that didnt help him learn anything about trading options. He now
specializes in income trading using options, is very conservative in his style,
and believes that patience in waiting for the best setups is the key to successful
trading. He likes to focus on short volatility strategies. McMaster has written
five books on options trading, available from Amazon. You can read more from
him at his blog at OptionsTradingIQ.com. He resides in Melbourne, Australia
with his family.
Stocks & Commodities Editor Jayanthi Gopalakrishnan communicated
with Gavin McMaster via email in January 2017 to find out more about his
options trading journey.

Gavin, tell us a little bit about only job available having to do with
yourself and how you got financial markets.
Having a written trading
interested in the financial plan is not only important,
markets. And did you end up becoming a stock its impossible to succeed
My earliest memory about the finan- broker or did you turn to something without one.
cial markets is from primary schoolI else?
think you call it elementary school in Once I got a bit older, I realized I
the USand a fictional story my teacher didnt want to become a stock broker. to do and could be risky. So when I first
told. It was about an investor who bought They are just glorified salesmen. I didnt learned about options, I was hooked.
a stock that went from $1 to $999 and want to be pushing stocks on people in
he was greedy and refused to sell. Sure return for a commission, so I decided to What was it about options that you
enough, the stock fell back down to zero go at it on my own. liked so much?
and this fictional investor was back to I liked the flexibility. When I was first
where he started. From then on, I was Youre a self-directed trader but youre learning about options, I read a booklet
fascinated with the financial markets, also a self-taught options trader. Can that described 26 core strategies. There
so it is no surprise that I ended up in you tell us how you started learning to was so much flexibility in the way you
this industry. trade options? could trade. You could do bullish, bear-
My parents were also a big factor. I first learned about options in 2004 ish, neutral, synthetics, ratio spreads,
They bought me $2,000 worth of some from a small book I got from the Wall and volatility trades. I was like a kid in
telecommunications shares in the mid- Street Journal called Guide To Under- a candy store learning all these differ-
1990s. I was around 13 or 14 at the time. standing Money And Investing. It had ent ideas. Trading stocks is so boring
I remember checking the newspaper each the typical basic info on stocks, bonds, in comparison because you can only
day to see how the shares had performed mutual funds, and indexes. But it also be long, short, or in cash. Not a lot of
the previous day. From there I started had a section on options. flexibility there.
watching other stocks each day and I always knew people could make I read a countless number of books and
really developed a fascination for the money when the markets went down, but started trading in 2004. And then in 2007
stock market. up until then, I didnt really know how I started trading credit spreads and iron
I wanted to be a stock broker when I it was done. I knew you could short a condors. The ability to generate income
grew up because I thought that was the stock, but I also knew that was difficult without having to pick the direction of a
36 March 2017 Technical Analysis of Stocks & Commodities
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thinking that I knew more than my trading as well. Having rules around
I actually did. delta/theta ratios and vega/theta ratios is
There is no substitute for I didnt understand how im- very important in managing risk.
experience and the only portant a written trading plan
way to get that is to get in is. I figured I didnt need it, as How are these ratios related to risk?
I could keep everything in my The greeks and their ratios tell me
the market and make some head. Ive since realized that what my exposure is to price and vola-
real-money trades. You having a written-down trad- tility. If those exposures get outside my
learn from your mistakes. ing plan is not only important, comfort zone, its an indication that I
but its impossible to succeed need to cut risk.
without one.
What mistakes taught you the most?
stock appealed to me. Who were your mentors or people you One particular mistake sticks out in
At that point I went back to school looked up to while you were learn- my mind. I had a position in NDX that
and completed a bachelors degree in ing? was too large for my portfolio size. I was
financial markets, then a masters in ap- Tony Sizemore had the biggest influ- stubborn, though, and didnt think the
plied finance and investment. In one of ence on my trading. Actually, I first market could continue moving upwards,
the masters courses, there was a subject learned about him in an article in this since it was already pretty extended.
that covered options. Reading through magazine [see Sizing Up For Success The next morning, the Fed announced
the course material, I realized I already in the further reading section at end], and more QE (quantitative easing) and the
knew everything in the course through I remember that some of the concepts he Nasdaq opened about 2% higher. Un-
my own reading and research. talked about just blew my mind. It really fortunately, I was leaving for vacation
opened up a whole new world to me. I that day, so I was scrambling, trying to
What led to the decision to go back was a member of his trading room for sort out this trade while my wife was
to school? over a year and that really accelerated packing for me.
I had a real thirst for knowledge and my learning curve. I should have just closed the trade
also wanted to get some more qualifica- then and there, but I adjusted it and kept
tions under my belt. I dont regret it, but As you were trading options, what are it open. This was a Friday and I was
I dont think getting a masters has really some things you came across that you stressed the whole day while we were
helped me that much, either. may not have learned about in books traveling because I couldnt really check
The program of courses was great for you read or from people you learned the markets.
getting some qualifications behind me, from? I also wouldnt have access to my ac-
but it didnt teach me anything about One of the most important metrics I count on the following Monday, so I was
trading. It taught the theory, but theory follow is the concept of delta dollars. No stressed the entire weekend and it really
is nothing until you put it into practice one else really seems to talk about it. Its ruined our weekend away. My wife was
and have real money on the line. simply the position delta multiplied by very understanding about it but I could
the underlying price. It helps me know tell she was disappointed.
Why do you think that is? the dollar exposure I have at any given From that experience, I learned not to
There is only so much you can learn time. I find it a really useful number in let my exposure get too big, and never
from a book. There is no substitute for terms of deciding when to adjust op- have open trades when going on vacation.
experience and the only way to get that tions trades. Well, small ones might be okay!
is to get in the market and make some Also, Sizemore is big on managing
real-money trades. You learn from your by the greeks, and this has influenced When you look back, what changes did
mistakes. you make to your trading that led you
I paid my fair share in tuition to to become the trader you are today?
the market via losing trades. In my first There are a couple of things that
options trade, I bought a put on a retail come to mind. One is learning to be
stock. The only reason I chose that stock patient. Once I learned that you dont
and that put option was because it was have to be in the markets all the time,
cheap. That trade cost me only $200. I became a much better trader. Rather
Needless to say, the trade was a bust and than trying to force things, I now wait
I lost 100% on that one. I also had some for my perfect setups. I actually really
big losses in 20082009 as the market enjoy those times when Im out of the
crashed. I made very amateur trades, markets because I can completely relax,
didnt manage risk, and didnt have a and if stocks tank, it doesnt affect me
proper trading plan. I was winging it and it gives me an opportunity to take
38 March 2017 Technical Analysis of Stocks & Commodities
advantage of the panic.
The other is to not take on too much
risk. I trade pretty conservatively these
days and I much prefer it that way. My
equity curve is smoother and I sleep
better at night.

What do you look at when making


your trading decisions? Do you look
at chart patterns, fundamental data,
indicators?
Im definitely more technical than
fundamental. I have a watchlist and Newly Redesigned Software for
each weekend Ill check short-term and
long-term charts. I dont trade direc- Futures, Forex & Stock Traders
tionally very often, but when I do, Im
more of a mean-reversion trader than a
trend trader.
For an options trade, Ill check a
12-month chart of implied volatility to
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see where the underlying sits currently
compared to the recent past.
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I like to get long vega and hope that it
makes a big move and vice versa. Up to 10X speed improvement in backtesting
Add custom columns & indicators to SuperDOM
What do you tradeoptions on equi- Historical bid/ask data
ties, futures, indexes?
I trade options on equities and indexes. Expanded C# development support
Mostly, Ill just trade the indexes. Thats
because I dont like the risk of a stock
making a big move after earnings or an
unexpected news item, unless Im trad-
ing long volatility. But I tend to be more NinjaTrader 8 is always FREE to use for advanced
short volatility.
charting, strategy backtesting and trade simulation.
How many trades, on average, do you
do in a week?
I only place about two to three trades things go pear-shaped. might go over a certain timeframe and
per week. I prefer to trade less often also what volatility might do. From there
but with bigger size. My theory is that When you say pear-shaped, what do I have six core strategies that I use and
two to three big trades are much easier you mean? Ill choose the most appropriate one.
to adjust than 20 to 30 smaller trades if Ha-ha, I think thats a British expres-
sion. It just means when things What variables do you consider before
go wrong/bad. placing a trade?
Other than the technical factors, Ill
I dont trade directionally When you consider trading look at strike placement, position size,
very often, but when I something, how do you decide the greeks, days to expiry, profit target,
do, Im more of a mean- what strategy to apply? stop-loss, and Ill have a plan in place
reversion trader than a Ill take a look at the charts for adjustments.
and also volatility. Based on
trend trader. what I see, Ill form an opinion What type of strategies do you like to
on where I think the underlying trade and why?
March 2017 Technical Analysis of Stocks & Commodities 39
positions and my portfolio as Warren Buffett averages about 15
The main characteristics a whole. 20% per year, so if a beginner expects
I think are necessary are Adding in some long volatil- to make more than that, they are doing
ity trades when the VIX is low better than Buffett and most hedge
patience, discipline, and is another strategy that helps funds. How likely is that for a beginner?
the desire to succeed. avoid large drawdowns in the Not very.
event of a sharp selloff.
What is necessary for someone to be-
My core strategies are iron condors, What led you to teach others to trade come a successful options trader?
trapdoors (which are a variation on the options? The main characteristics I think are
condor that I developed), butterflies, Ive always enjoyed teaching others. necessary are patience, discipline, and
diagonals, strangles, and the wheel. I Even from some of my early jobs as a desire. Patience to wait for the right set-
think of the wheel as covered calls on kid, I always felt comfortable training ups, discipline to have a plan and stick to
steroids. In a nutshell, the wheel is a new staff and its something that comes it, and desire, because if you dont have
systematic way to trade covered calls but naturally to me. I also get a real buzz a burning desire to succeed, you wont
you do it as part of a long-term strategy. when I explain something to a trader and make it through the hard times, and there
In fact, Ive described the strategy and I can see the light bulb go off. A lot of will be hard times.
others, such as trapdoors, on my blog at traders have told me I have a knack for
optionstradingiq.com. taking difficult-to-understand concepts Further reading
I separate my capital into trading capi- and breaking them down into easy-to- McMaster, Gavin [2014]. Bullsh*t-Free
tal and long-term capital. The wheel is a digest chunks. Guide To Option Volatility: Making
great long-term trade, so I can put that on Trading can be a lonely business and Sense Of Market Mayhem, IQ Finan-
and not think about it too much. Ive met so many great people through cial Services, LLC.
For the trading capital, I generally want teaching options, and I love chatting [2013]. Bullsh*t-Free Guide To
to be pretty neutral. I find directional with other traders over email, Skype, Butterfly Spreads: Your Ultimate
trading can be difficult. Condors and and online. None of my friends trade, Guide To Butterfly Spreads Plus 7
trapdoors are great for that. The trapdoor so teaching options has allowed me to Unusual Variations, IQ Financial
is similar to a condor but moves a lot develop an amazing network of traders Services, LLC.
slower and requires less maintenance that I talk to regularly. [2014]. 37 Quickfire Lessons In
and less adjustments. However, I dont Trading Options: 10 Years Of Trad-
like having these on when the market What are some common misconcep- ing Experience Compacted Into Easy
has had a strong run up. Thats where tions new traders have about trading To Digest Lessons, IQ Financial
diagonals and the bearish butterfly come options? Services, LLC.
in. So the strategies kind of complement Probably the main one is expectations Morris, Kenneth M., and Virginia B.
each other nicely. about returns. I get a lot of emails along Morris [2004]. The Wall Street Jour-
the lines of, Is it possible to make 10% nal Guide to Understanding Money
What type of risk management strate- per month? & Investing, 3d edition, Lightbulb
gies do you apply? I tell them, if youre aiming for a Press and Dow Jones & Co.
I have a number of rules based on the massive return, you have to take on Sarkett, John A. [2009]. Sizing Up
delta dollars metric and making sure a massive amount of risk. Thats just For Success, Technical Analysis of
my exposure doesnt get above a certain Finance 101. Stocks & Commodities, Volume
level in relation to my capital. People need to be realistic. Most begin- 27: December.
I also have other rules regarding the ners will not be successful at first. They See Traders Glossary for definition
greeks, both in terms of individual will probably make a lot of mistakes.

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40 March 2017 Technical Analysis of Stocks & Commodities


Explore Your Options
Got a question about options? Tom Gentile started his trading career on the floor
of the American Stock Exchange in 1994. He has appeared on many financial
TV and radio shows, as well as hosting a weekly talk show himself, and has co-
authored many books on the markets. He can be found at www.tomgentile.com.
To submit a question for Tom Gentile, post it to our website at http://Message-
Boards.Traders.com. Answers will be posted there, and selected questions will
appear in a future issue of S&C.
Tom Gentile

Debit spreads or credit spreads long leg and the one you sell is the short the most you could make is $5.00 per
which is best? leg. You would open both options at contract. The $5 potential profit is offset
Many people ask me this question the same time on the same order ticket by the cost of the spread trade, which is
about debit and credit spreads: I hear and your broker should charge you only the difference in the premiums already
one makes money and the other costs one commission, as this is one spread, calculated at $2.70. The max reward
money. Is that true? In a way, that is not two separate options trades. potential for this call debit spread is
correct, but its not as cut-and-dried as You would sell-to-open the short leg $2.30.
you may think. or the February 17, 2017 $1,530 call For that to happen, PCLN must be
Credit means you are generating a for $47.65 (all prices are based off the above the short leg strike price of $1,530
credit to the account. Technically, you mid-price shown). You dont want to end at expiration. With PCLN in-the-money
could say the credit or money brought up with a naked call position with sub- (ITM) at expiration, it is likely the ex-
in to the account is money made, but stantial risk and you also want to hedge/ ecution of the two strikes will take place
realize that this money must remain reduce risk so you would buy-to-open where the markets buy the stock from you
tied up until the trade is either closed or the long leg or the February 17, 2017 at $1,530. The account should execute
expiration happens. The credit received your buying PCLN at $1,525, making
to the account isnt money you can take that $5 per contract offset by the $2.70,
right now and go buy birthday gifts with, With both debit and leaving the profit of $2.30 all on a per-
because the trade is still open. Consider credit spread strategies, contract basis in the account. It should
money credited to the account like money happen without the actual purchase and
being held in escrow.
you are predefining your sale of the amount to buy and sell shares
Debit means you have incurred a debt. risk and predefining your taking place so that no requirements of
You spent money to open the position. max profit potential on all that capital and commissions will
The money you spent is your cost and the trade. take place.
is the most amount of money you will Recognize PCLN is already above
have at risk on the trade. the short leg strike. As long as it stays
With both option strategies, you are $1,525 call for $50.35. The difference above $1,530, this trade should be able
predefining your risk and predefining in premiums is $2.70 ($50.35 - $47.65 to realize max profit potential.
your max profit potential on the trade. = $2.70). This is your max risk/cost in I will now show you an example of a
This is different from the straight call or the trade. put credit spread on PCLN. The goal of
put buyer who has more profit potential The most a spread option trade of this this trade is the same in that you want to
but less of a probability of success than nature can make is the amount of the be profitable. You can anticipate PCLN
the spread trader. spread or difference between the strikes.
The question becomes, which one In this case, the strikes are $5 wide so Continued on page 44
should you trade? I will take a look at an
example of both spreads on the stock of
The Priceline Group, Inc. (PCLN). I will
look at a call debit spread and a put credit
www.tomsoptiontools.com

spread. Both mean I am anticipating a


moderate or greater price move higher
in the stock. Note that if you anticipate
the stock going down, you would do the
reverse spread strategies, that is, a put
debit spread or a call credit spread.
FIGURE 1: PCLN February 1530/1525 Call Debit Spread. The strikes are $5 wide so the most you could
In Figure 1 you see details of a call make is $5.00 per contract. The $5 potential profit is offset by the cost of the spread trade, which is the difference
debit spread. The option you buy is the in the premiums already calculated at $2.70. The max reward potential for this call debit spread is $2.30.

March 2017 Technical Analysis of Stocks & Commodities 41


product review

NinjaTrader 8
Part 2

NINJATRADER, LLC Developing strategies start building your own strategy. As


1422 Delgany Street, Suite 400 One feature that packs a punch to the NT8 with all windows in NT8, you can have
Denver, CO 80202 platform is NinjaScript. For program- different tabs along the bottom, which
Phone: 312 262-1289 ming novices, it may take some time to gives you the ability to work on differ-
Fax: 312 329-9888 master but once you do, it opens up a ent scripts.
Internet: www.ninjatrader.com world of infinite possibilities. NinjaScript In NT8, it almost seems as though you
Requirements: Minimum requirements is based on the C# programming lan- have no limits in what you can do with
are Windows Vista (SP2) w/platform guage, which makes it very versatile. NinjaScript. It goes well beyond creat-
update, Windows 7, 8, or 10, Windows You access NinjaScript via the Ninja ing trading strategies and gives you the
Server 2008 w/platform update, Win- Script editor. NT8 has a lot more .NET opportunity to create custom bar types,
dows Server 2008 R2 or later; 1 gigahertz plug-ins than previous versions did. On chart types, custom drawing tools, import
(GHz) or faster 32-bit or 64-bit processor; the right-hand side of the window youll types for importing historical data, your
2 GB RAM; Microsoft. NET Framework see the explorer panel, which lists all the own optimizer engines, and even Super
4.5; screen resolution of 1024x768; code that is currently available to users. DOM columns, among other things.
DirectX10 compatible graphics card. Youll notice its organized into several You can also integrate NinjaScript
Product: Trading platform for active folders to make everything easy to find. with Visual Studio. This allows you to
equity, futures, and forex traders. In Figure 1 you see an example of the debug NinjaScript objects while theyre
Price: Always free use for advanced NinjaScript editor. I selected the simple running, and that means you can test
charting, strategy backtesting, and strat- moving average crossover strategy, and your programs right then and there. If
egy simulation. For live trading in your the code is displayed in the ScriptEditor youre a programmer, youll know this
brokerage account, purchase it for $999 window. If you open up the folders is a big bonus.
(or four monthly payments of $299); listed in the explorer window, youll see If youve never written code or done
lease it for $600 annually, $330 semi- that you have a number of code sets to any programming but want to give it a
annually, or $180 quarterly; free through choose from. go, you can use the Strategy Builder,
a NinjaTrader brokerage account. If you still prefer to create your own which walks you through developing
script, you can do that as well. All you your own strategies. It takes a while
by Jayanthi Gopalakrishnan have to do is right-click on any of the to get the hang of it but the nice thing
indicators listed in the explorer window is that tech support is readily available

L
ast month in part 1, I reviewed some and select new strategy, or you can open via support forums, the help desk, and
of the many features of NinjaTrader up a new strategy builder window and online tutorials.
8 and ended by saying that this
month I would cover the strategy
development features and some of the
advanced order-handling features. As
mentioned in the first part, there are so
many features available in NT8 that its
impossible to cover all its features in a
review. My objective here is to scratch
the surface enough to reveal to you the
powerfulness, efficiency, and flexibility
of NT8. The platform will meet the
needs of active traders, whether youre
a long-term or short-term trader, and
whether you trade equities, futures, op-
tions, or forex. Theres something in it
for everyone and the nice thing is you
can take advantage of the free trial to
find out more about the platform. FIGURE 1: NINJASCRIPT EDITOR. NinjaTrader offers a number of code sets to choose from. Here you see
the code for a simple moving average crossover strategy.

42 March 2017 Technical Analysis of Stocks & Commodities


Backtesting
Once youve developed a trading strategy
that has been debugged and runs, your
next step is to backtest it. How well has
it done in the past? You can find out by
running tests using historical data. Open
up the strategy analyzer and select your
parameters from the settings panel on
the right-hand side (Figure 2). You can
choose the type of backtest youd like to
perform, that is, standard, optimization,
walk-forward optimization, or multi-
objective optimization. You also select
a strategy, strategy parameters, data
series, timeframe, and so on. Once youve
selected all the parameters, hit the run
button. When the test is complete youll FIGURE 2: STRATEGY ANALYZER. There are many options when it comes to backtesting your strategy and
be able to see the performance results
analyzing its performance. And you have different ways to view the performance. Here you see the results of
maximum drawdown in both a table and graphical format.
of your strategy. For example, Figure
2 displays an analysis of the moving
average crossover system applied to the completes even if its after the close. the basic order entry parameters, you can
March emini futures contract using the Here again, you see how NT8 caters to set your stop-losses, your profit targets
% analysis option, which is just one of the needs of all types of traders. (you can set several), and stop strategies.
the many different ways you can analyze And yes, you have the ability to create
the performance of your strategy. Advanced trade a custom stop strategy where you can
You may prefer to view the perfor- management set your auto breakeven points and auto
mance results graphically, and as you Now that you have a strategy that has trailing stops. You can save your custom
may have guessed, there are different been backtested and are happy with its stop strategy as a template and apply it
ways to graphically view strategy per- performance, youre now ready to place to any order you want to place.
formance results. In the bottom half of your trades. NinjaTrader supports several There are several other options for
the StrategyAnalyzer window in Figure online brokers and through them you creating your custom ATM such as auto
2, the maximum drawdown is displayed can place trades automatically, semi- chase, which allows you to define your
graphically. And you have the ability to automatically, or any number of different chase limits with options such as select-
create your own performance metrics ways. NT8 has made great strides in their ing your target chase, chase if touched,
using NinjaScript. Advanced Trade Management (ATM) and your chase limit. Theres also the
Heres where you see how thoughtful feature to make trading through the option of selecting a stop limit for a
the technology behind NT8 is. One of platform much easier and more efficient stop-loss, market if touched for profit,
the drawbacks of backtesting in general than before. Managing trades is an im- and shadow strategy. Shadow strategy
is that the results are not necessarily portant and necessary task for all traders is a method of simulating an ATM and
realistic since commissions, fills, and and, once again,
slippage arent factored in. But in NT8 NT8 has incorpo-
under setup in the settings panel, you can rated tremendous
choose to include commissions, whether flexibility when
you want conservative or liberal order it comes to trade
fills, and factor in some slippage. management.
I also want to bring your attention to AT M can be
the break at EOD option that is available accessed through
in the settings panel. If this is selected, the order entry
it means the bar will end at the close. If window. You can
its not selected, the bar will continue to create your cus-
form beyond the close until the bar ends. tom ATM strategy
Some traders will need to know when the from the dropdown
market closed, especially if their strategy menu available on FIGURE 3: CUSTOM ATM STRATEGY. Theres a ton of flexibility when it comes
to managing your positions at the time you place them and after a position is open.
is based on the closing price. Others may, the ATM strategy You can set your stop-losses, profit targets, and stop strategy. You have the ability
depending on what type of strategy they option (Figure 3). to create a custom stop strategy where you can set your auto breakeven points
are developing, prefer to wait till the bar From here, besides and auto trailing stops.
March 2017 Technical Analysis of Stocks & Commodities 43
Managing trades is an
important and necessary
task for all traders, and NT8
being able to forward-test it. Once you condition is met you can create an
select your parameters, typically, youre action, which can be either in the has incorporated tremendous
going to enforce these at the time you form of a sound or a popup. You flexibility when it comes to
place your order. But what if you only can also share the alert via social trade management.
have a split second to place a trade? media, and submit an entry or exit
When youre in such a situation, NT8 has order tied to the alert.
a solution for you. It allows you to apply
an ATM to an open and unprotected Just the tip of the iceberg Jayanthi Gopalakrishnan is Editor of
position. Once you create an ATM, you As you may have guessed by now, NT8 Stocks & Commodities.
save it as a template. To apply the ATM, may appear to be similar to its previous
go to the control center, then to positions, iteration but really theres more to it than Further reading
right-click on the open position, and meets the eye. One of the unique char- Gopalakrishnan, Jayanthi [2017]. Ninja
select apply ATM strategy. acteristics of NT8 is the stellar support Trader 8, part 1, product review,
Another feature worth mentioning is behind the product. NinjaTrader listened Technical Analysis of Stocks & Com-
the alerts feature. In previous versions of to their customers and redeveloped their modities, Volume 35: February.
NT you needed to program the alerts, but platform based on what customers told NinjaTrader
in NT8 theres an alert feature that allows them they need and want. The result is See Editorial Resource Index
you to set up conditions and actions. You a trading platform with a lot of thought
can access this from the chart window behind it and with something that meets
and set more than one condition. So if a the needs of any type of trader.

explore Your options


GENTILE
Continued from page 41

moving higher just like in the call debit


spread. The primary distinction between
the two is that you are generating a credit
into the account of a specific amount
versus incurring a cost or having an
outlay of capital to start. FIGURE 2: PCLN FEBRUARY 1530/1525 PUT CREDIT SPREAD. Here, the difference in premiums is $2.20
The option you buy is the long leg and ($42.00 - $39.80 = $2.20). This is your max profit potential in the trade.
the one you sell is the short leg. You would
open both options at the same time on the price of $1530, things should work out when both spreads use the same strikes
same order ticket and your broker should for the best for this trade. There is no and expiration.
charge you only one commission as this need to have a transaction or execution The debit spread I discussed can po-
is one spread, not two separate option of the options. tentially earn $2.30 per contract and the
trades. See Figure 2 for an example of Think about it. If PCLN is above credit spread can potentially earn $2.20
a put credit spread. $1,530 at expiration, would anyone need per contract. This means the risk for both
You would sell-to-open the short leg to exercise their right to put you to stock is close to the same as well. Other than
or the February 17, 2017 $1,530 put for or make you buy it at $1,530 when they that, the debit spread tends to need a slight
$42.00 (all prices are based off the mid- can sell it to the open market for a higher or moderate directional move more often
price shown). You dont want to end up price? Not likely. Therefore, you would than the credit spread does.
with a naked put position with substantial not have to have the account exercise the So when you are looking at spreading
risk and you also want to hedge/reduce right to put the stock to anyone or sell it your risk, ask yourself which one makes
risk so you would buy-to-open the long for $1,525. Both options expire and the the most sense for your personality. All
leg or the February 17, 2017 $1,525 put account then gets to realize that credit things equal, theres not much difference
for $39.80. The difference in premiums is amount of $2.20 per contract. except whether or not you hold the money
$2.20 ($42.00 - $39.80 = $2.20). This is The credit and the debit from a risk-to- or pay the money for the spread. In the
your max profit potential in the trade. reward standpoint is basically the same. end, its about risk and reward once the
Another distinction of the credit spread That is why you will hear some say there exit is made.
versus the debit spread is that as long as really isnt a difference. When they say
PCLN is higher than the short leg strike that, it is from the risk-to-reward view of
44 March 2017 Technical Analysis of Stocks & Commodities
Q&A
FRIESEN posted and when the news came out, the have not set a maximum allocation of
Continued from page 35 spread started its retracement. With the capital. It is a different experience for
increased risk you are now aware of, you those who proactively manage risk, are
except your original core layer, which you decide to take off the 4.75 layer at 4.00, willing to reduce systematically, and
maintain, using it for information. Then as it seemed to stabilize there. Next, the still be committed to the original plan,
reestablish the capital when appropriate, pair goes back out to 4.50, and you see a working it with discipline.
or occasionally, you may find you have to new range developing. You put on your In my experience with equity pairs,
exit the core layer as well, as there is often trade at 4.50 and then it drops to 3.75. once a range gets broken due to a
a new driver or catalyst that is affecting Lets add it up. You are still holding catalyst, it often trades in a new range,
one or both stocks of your pair. your original two layers and still view returning to predictable patterns. It may
Allow me to expand on this subject. the spread to have future mean-reverting be months before it returns to where it
This procedure is a form of stop-loss value. You lost $0.25 on the third layer, came from.
but also is in line with trade some, hold Its tragic that many traders abandon
some. In pairs trading for a multilayer the pair and make nothing from all the
approach, we use LIFO. If you put on
Once a range gets broken, activity. After taking all that pain, they
three layers, you would take off the last it often trades in a new arent committed to gain.
layer in a profitable situation first. Or range, returning to A one-off pair trade may look different
when you need to start reducing position, predictable patterns. than the distribution over a range. That
the same rules apply. type of pair may receive only one alloca-
Money has been saved. Capital has tion of capital, and the trade is for a par-
been shelved. This capital can be re- then reestablished that layer to make ticular expectation. It considers the risk,
deployed. $0.75, and then took another roll of pro- reward, probabilities (expected value
Heres an example. If you put on a duction to make yet another 0.75. formula), and has a time duration.
layer at 1.00, 2.00, and 3.75 and realized You are profitable on the overall On this type of trade, many traders
there were forces pushing it farther out, management of the third layer now by risk 1.00 to make 3.00 or greater. A pair
you could take off the 3.75 layer at, say, 1.25. The trading of the new range could or spread structure like this mimics a
4.00 and wait. Book that 0.25 loss on continue for days, weeks, or months. In single-stock trade in terms of directional
that layer. Later, the ducks could line a perfect world, the spread comes back implications. Traditional fixed stops and
up for you to reestablish. Your spread down and you eventually profit on the trailing stops could be utilized. The
has deflected off 5.00 and is on its way layer at 2.00 and then the 1.00. Remem- trader would have need of pair trading
back down. You take the trade at 4.75 ber LIFO. tools in order to monitor and manage
going with that retracement. It reaches What could happen, or what often positions in this way.
4.00 and seems stable. You are going happens to traders, especially the ones Risk management is a priority for any
through news during this time and see who have no management plan for lay- type of trader, and intelligent planning
a pertinent piece of information that ers after they established them, is they with complete rules can make a sig-
slightly increases riskhence, the rea- add, sit, and stare at the screen, only to nificant difference to any trader in the
son the spread went out. Of course, the capitulate at the worst possible times. outcomes and the bottom line.
spread went out before the news was This will also happen for traders who

TRADING STRATEGY

EVANS / S&P FUEL GAUGE positions when the S&P 500 is at poor levels. Keep an eye on
Continued from page 17 that S&P gauge and when it has risen to an attractive level, put
on those risk-on positions and plan your next vacation.
Having this information gives you a tremendous advantage
even though there are many other variables that affect such Chris Evans is an independent research provider. He has
currency cross rates. worked as a global macro portfolio manager for various hedge
funds in London and New York. He currently offers fuel gauge
AND YOU HAVE A FULL TANK updates and a weekly research blog to subscribers. He may
This type of trade governs many, if not all, market relationships. be reached via his website at www.paratradesystems.com.
Face it: We are in a low-yield environment and we could see
a slow-growing equity market, which could tempt us to pick
stocks blindly without considering the existence of volatility
in the S&P 500 index. High volatility could slice through all
your gains and that could lead you to desperately hedge your
March 2017 Technical Analysis of Stocks & Commodities 45
Comparison of REIT ETFs (As of December 20, 2016)
With low expense ratios, tax Ticker Symbol VNQ IYR ICF RWR XLRE
efficiency, and instant liquidity, Inception Date 9/23/2004 6/12/2000 1/29/2001 4/23/2001 10/8/2015
REIT ETFs offer investors a high Total Assets $32.8B $3.91B $3.47B $3.30 B $2.37B
level of dividend income and Net Expense Ratio 0.12% 0.44% 0.35% 0.25% 0.14%
capital appreciation potential.

source: Etfdb.com, www.etf.com


30-day SEC Yield 4.04% 4.21% 3.50% 4.42% 4.22%
No. of Holdings 147 126 30 100 29
3-Yr.Return 45.05% 38.85% 48.79% 46.54% N.A.
Benchmark RMZ REI RMP REI RE Select
MASONSON / The Reality Of REITs
Continued from page 7 Avg. Daily Volume 5.14M 9.40M 426,000 377,000 2.64M
Equity Beta 0.80 0.82 0.77 0.81 1.41
index has 32 REITs. Thus, the creation of REIT FIGURE 2: COMPARING THE LARGEST REIT ETFs. Five similar ETFs are compared here. VNQ
ETFs was a simple matter of selecting from this is the leader of the pack in terms of assets under management, the number of holdings, and the
lowest expense ratio.
universe or additional exchange listings. The top
10 REITs by market capitalization are listed in
Figure 1. properties. Specialized REITs can have investments in land,
prisons, data centers, movie theatres, and casinos.
Reit ETF choices The Vanguard REIT Index Fund (VNQ) has assets of $32.5
ETFs brought a new dimension to REIT distribution that has billion, accounting for 77% of the assets of the top four issuers.
broadened their appeal to investors and traders. There are Other smaller REIT ETFs focus on particular niches such as
now over 30 US-listed ETF REITs. With low expense ratios, small cap, global super dividend, equal-weight, Asia, global
tax efficiency, and instant liquidity, REIT ETFs offer inves- quality, and long-term care, among others.
tors a high level of dividend income and capital appreciation Figure 2 compares the top REIT ETFs by asset size. They
potential. include Vanguard REIT Index (VNQ); iShares Cohen & Steers
Based on the recent change in the GICS classification men- REIT (ICF); iShares US Real Estate ETF (IYR); SPDR Dow
tioned earlier, State Street Global Advisors Financial Select Jones REIT (RWR); and Real Estate Select Sector SPDR
SPDR (XLF) removed the REITs in that portfolio. The new Fund (XLRE).
SPDR sector was called the Real Estate Select SPDR (XLRE) Clearly, VNQ is the behemoth in size. IYR has the highest
that holds 29 REITs and real estate management and develop- daily trading volume at 9.4 million shares while RWR has
ment companies. There are now 11 sector SPDR ETFs. the lowest volume at 377,000 shares, but offers the highest
REIT ETFs range from pure US real estate to global real yield. ICF and the new XLRE have only 30 and 29 holdings,
estate, developed markets, and US mortgages. Most REITs have respectively. ICF has the lowest beta but the highest three-
a fairly concentrated portfolio. The top four ETF REITs have year return at 48.79% which is a desirable combination of
nearly $42 billion in assets under management. They invest over characteristics. Interestingly, XLRE had the highest beta at
95% of their money in commercial, specialized, and residential 1.41 but did not have the highest return. Probably the small

STOCKCHARTS.COM

FIGURE 3: HOW DID THEY PERFORM? Viewing four ETFs over a 12-year period from September 29, 2004 to December 29, 2016 shows that VNQ and ICF had nearly
identical results and were the leaders.

46 March 2017 Technical Analysis of Stocks & Commodities


number of stocks (29) in the portfolio negatively impacted For more comprehensive information on REITs in general,
the beta. I recommend a recently published book titled The Intelligent
REIT Investor. Based on the REIT performance over the last 16
Performance comparison years, investors and traders should definitely consider placing
According to www.etfscreen.com, among the ones that they a portion of their capital in this unique sector. Of course, due
track, the top-performing REITs for the one-year period ended diligence is necessary, so visit the ETFs website and look at
December 21, 2016 are KBWY (+28.40%), SRET (+21.82%), the top 10 REIT holdings. Obtain complete financial infor-
MORT (+20.64%) and REM (+19.75%). This compares to the mation including credit rating, quarterly and annual reports,
five ETFs mentioned earlier: VNQ (+7.74%), IYR (+6.71%), press releases, and other critical information. Also, check out
RWR (+5.83%), ICF (4.34%), and XLRE (+3.05%). So even the ETFs Morningstar rating to know what you are buying.
when investing in REITs, segments of the REIT market out- And dont forget to bring up 10-year, five-year, and one-year
perform at different times. Using relative strength analysis on charts with a few moving averages, MACD, and RSI indica-
the above-mentioned website can assist investors in finding tors to determine the timing of the purchase.
the outperformers over the past one, three, and six months as
well as one year. Further reading
Figure 3 compares the price performance of four ETFs Krewson-Kelly, Stephanie, and R. Brad Thomas [2016]. The
(excluding XLRE because of its short life) from September Intelligent REIT Investor: How To Build Wealth With Real
29, 2004 (earliest common date) through December 29, 2016. Estate Investment Trusts, Wiley.
VNQ (red color) led the way up with a 167.29% gain, followed Masonson, Leslie N. [2017]. ETF Factor-Based Investing,
by ICF (pink) up 164.14%, then RWR (green) at 150.99%, and Technical Analysis of Stocks & Commodities, Volume
finally IYR (blue) at 138.96%. 35: January.
Based on the performance and other characteristics, VNQ [2016]. ETF Sector Investing, Technical Analysis of
is the top performer. With its massive assets under manage- Stocks & Commodities, Volume 34: November.
ment (AUM) and low expense ratio, no wonder it continues to [2016]. ETF Perspectives, Technical Analysis of
gather the most assets of all other ETFs. Notably, it didnt come Stocks & Commodities, Volume 34: September.
public until September 23, 2004 compared to the other ETFs
that had three to four years lead time to garner assets. www.etf.com
For active traders looking to daytrade REITs with leverage, www.etfscreen.com
there are four ETFs available. Direxion introduced leveraged www.etfdb.com
bull and bear real estate ETFs in July 2009. They are Direxion www.REIT.com
Daily Real Estate Bull 3x Shares (DRN) and Direxion Daily www.vanguard.com
Real Estate Bear 3x Shares (DRV). Both have expense ratios us.spders.com
of 0.95%. ProShares offers double-leverage ETFs with ticker www.iShares.com/Low-Cost/ETFs
symbols URE and SRS, bullish and bearish, respectively. www.statestreetspdrs.com/SPDRs
Traders are cautioned to fully understand how to use these www.wiley.com
vehicles and understand all the risks before using them. Check
the websites of these ETF providers for more information. StockCharts.com

FUTURES FOR YOU


GARNER or against you. But the reality is, options but that doesnt mean they are the best
Continued from page 31 on futures traders stand to potentially get option. The emini S&P futures options
more bang for their buck when they are give you the ability to take action dur-
a net risk level, and then levies a margin right in their speculations. Thats because ing the overnight trading session, which
requirement accordingly. Stock options emini S&P futures options are written could be a game changer. Plus, the ease of
traders might or might not be granted against an already leveraged product. market access for smaller traders opens
portfolio margining by their broker but Naturally, the options are generally more the door to trading strategies that were
those who are generally have in excess of expensive but they are priced that way for once reserved for the big boys.
$100,000 in their trading account. a reasonthey can really move!

More leverage Mo better


We all know that leverage is a double- Trading SPX or SPY options is conve-
edged sword in that it can work for you nient for those with substantial capital
March 2017 Technical Analysis of Stocks & Commodities 47
TRADING ON MOMENTUM

Golden Cross Breakouts


A golden cross on a chart is typically defined as when the Step 1: Look for a 90-day daily candlestick chart in which a
50-day moving average crosses above the 200-day moving 50-period SMA line crosses above a 200-period SMA line.
average, seen as a bullish sign. In this monthly column on In the chart of Spirit Aerosystems Holdings, Inc. (SPR) in
trading breakouts, this professional trader shows how you Figure 1, you see this occurred on October 20, 2016.
can use this pattern as an entry signal for swing trades.
Step 2: You may enter your trade anytime after this cross-
by Ken Calhoun over signal is seen.

W
henever you are looking for swing trading breakout Step 3: As long as both SMA lines remain uncrossed in an
entries, it helps to use the same signals that institutional uptrend, you keep your position open. Close your position
traders follow. One of the most popular patterns is the once a trailing stop of two points or more is taken out, as
golden cross, in which a 50-period simple moving seen on December 13, 2016 at $59 per share.
average (SMA) line crosses above a 200-period SMA. In this Alternatively, you could use a trailing stop at the 50 SMA
months column, you will see how to trade this useful breakout level, especially for longer-term swing or position trades.
swing trading pattern. (In the chart in Figure 1, that would be $54.)

Swing Trading the Golden Cross Entry Insights: Why this technique works
When the 50-period SMA breaks above the 200-period The golden cross is particularly effective because it combines
SMA, it signifies a major short-term trend reversal. This can the shorter-term 50 SMA momentum signal with the longer-
help identify swing trading breakout entries when combined term major 200 SMA trendline. This combination provides a
with price action patterns such as bullish cups, ascending breakout confirmation signal because it uses both short- and
triangles, and increasing volume. It is important to note that long-term trendlines working together.
golden crosses, like most technical trading patterns, should
not be used in isolation. Instead, you should combine them Trade management tips
with other breakout entry signals. One of the keys to using moving average signals successfully,
as with most of the breakout patterns you learn about in this
Step-by-step action plan column, is to visually scan for charts with wide trading ranges.
Heres how you can start using this strategy with your swing You can see that this chart has nearly 20 points of range ($43
trades: to $61 on a 90-day chart). Price action also follows a classic
45-degree angle breakout trend pattern.
Further, note how cleanly defined the
trend isit is not a choppy, uncertain
chart. The more up-and-down oscilla-
tions a chart has, the tougher it is to trade
profitably. The cleaner, more in-focus the
chart is, the easier it is to trade, as you
can see in Figure 1.
As with all of our professional swing
and intraday charts, it is best to use this
strategy with stocks and ETFs priced in
the $20$70 per share range, because
these charts tend to have stronger, more
sustainable trends that you can trade. This
strategy should not be used with cheap,
risky penny stocks or stocks priced under
$10 per share, due to the high risk and
choppiness of these poor trading instru-
ments. You will often see strong upside
esignal

Figure 1: TRADING USING THE Golden Cross. Here you enter a swing trade when the 50-period simple
price action following golden crosses,
moving average (SMA) crosses above the 200-period SMA. Note that the exit takes place after the two-point because institutional traders use this same
trailing stop is hit. pattern to put on large block trades.
48 March 2017 Technical Analysis of Stocks & Commodities
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. Use the golden cross on stocks and
He is a UCLA alumnus and is the founder of TradeMastery. ETFs priced in the $20$70 per share
com, an educational resource site for active traders.
range, because these charts tend
Further reading to have stronger, more sustainable
Mustapha, Azeez [2016]. Golden Cross And Death Cross, trends that you can trade.
Technical Analysis of Stocks & Commodities, Volume
34: September. analysis programs. Accompanying program code can be found in
the Traders Tips area at Traders.com.
See our Traders Tips section beginning on page 50 for commentary
on implementation of Calhouns technique in various technical

At-the-MoneyAn option whose strike price option changes for every dollar move in Near-the-MoneyAn option with a strike
is nearest the current price of the underly- the underlying instrument. price close to the current price of the
ing deliverable. Delta-HedgedAn options strategy that pro- underlying tradable.
Black-Scholes Option Pricing ModelA tects an option against small price changes Out-of-the-Money (OTM)A call option
model developed to estimate the market in the option's underlying instrument. whose exercise (strike) price is above the
value of option contracts. These hedges are constructed by taking a current market price of the underlying
Bollinger BandsDeveloped by John Bol- position in the underlying instrument that security or futures contract. For example,
linger. Bollinger Bands widen during is equal in magnitude but opposite in sign if a commodity price is $500, then a call
increased volatility and contract in de- (+/-) to the option's delta. option purchased for a strike price of $550
creased volatility, and when broken, are Delta NeutralThis is an "options/options" is considered out-of-the-money.
an indication that the trend is powerful or "options/underlying instrument" posi- PremiumThe price a buyer pays to an option
and may continue in that direction. tion constructed so that it is relatively writer for granting an option contract.
Butterfly SpreadA sideways market strat- insensitive to the price movement of the PutA contract to sell a specified amount of
egy using all calls or puts, designed to underlying instruments. This is arranged a stock or commodity at an agreed time
profit from a stock trading in a specific by selecting a calculated ratio of offsetting at the stated exercise price.
range. short and long positions. StraddleThe purchase or sale of an
Calendar SpreadAlso known as a time Delta PositionA measure of option price equivalent number of puts and calls on an
spread or horizontal spread, calendar vs. the underlying futures contract or underlying stock with the same exercise
spreads exploit differences in time value stock price. price and expiration date.
between options. GammaThe degree by which the delta StrangleThe purchase or sale of an equiva-
CallA contract that gives the buyer of the changes with respect to changes in the lent number of puts and calls on an under-
option the right but not the obligation to underlying instruments price. lying stock with the same expiration date
take delivery of the underlying security at GreeksA loose term encapsulating a set of but a different exercise price. Usually, the
a specific price within a certain time. risk variables used by options traders. put has a low strike price and the call has
CondorEssentially, a butterfly spread with Historical VolatilityHow much contract a higher strike price.
two different strikes that make up the price has fluctuated over a period of time Strike PriceThe price per unit at which the
body of the option. in the past; usually calculated by taking a holder of an option may receive or deliver
Covered CallSelling a call option while standard deviation of price changes over the underlying unit; also known as the
holding an equivalent in the underlying a time period. exercise price.
tradable. Implied VolatilityThe volatility computed VegaThe amount by which the price of
Covered WriteWriting a call against a using the actual market prices of an option an option changes when the volatility
long position in the underlying stock. By contract and one of a number of pricing changes.
receiving a premium, the writer intends to models. For example, if the market price Vertical SpreadA stock option spread based
realize additional return on the underly- of an option rises without a change in the on simultaneous purchase and sale of op-
ing common stock or gain some element price of the underlying stock or future, tions on the same underlying stock with
of protection (limited to the amount of implied volatility will have risen. the same expiration months but different
the premium less transaction costs) from In-the-Money (ITM)A call option whose strike prices.
a decline in the value of that underlying strike price is lower than the stock or Volatility A measure of a stocks tendency
stock. future's price, or a put option whose strike to move up and down in price, based on
Credit SpreadThe difference in value of two price is higher than the underlying stock its daily price history over the last 12
options, where the value of the one sold or future's price. For example, when a months.
exceeds the value of the one purchased. commodity price is $500, a call option Volatility Index A widely used measure
Debit SpreadThe difference in value of with a strike price of $400 is considered of market risk. Sometimes referred to as
two options, where the value of the long in-the-money. the investor fear gauge.
position exceeds the value of the short Iron ButterflyThe iron butterfly spread ZetaThe percentage change in an op-
position. is a limited risk, limited profit trading tions price per 1% change in implied
DeltaThe amount by which the price of an strategy volatility.

March 2017 Technical Analysis of Stocks & Commodities 49


For this months Traders Tips, the focus
TRADING ON MOMENTUM

Golden Cross Breakouts


A golden cross on a chart is typically defined as when the
50-day moving average crosses above the 200-day moving
average, seen as a bullish sign. In this monthly column on
trading breakouts, this professional trader shows how you
can use this pattern as an entry signal for swing trades.
Step 1: Look for a 90-day daily candlestick chart in which a
50-period SMA line crosses above a 200-period SMA line.
In the chart of Spirit Aerosystems Holdings, Inc. (SPR) in
Figure 1, you see this occurred on October 20, 2016. is Ken Calhouns article in this issue,
Golden Cross Breakouts. Here, we pres-
Step 2: You may enter your trade anytime after this cross-
by Ken Calhoun over signal is seen.

W
henever you are looking for swing trading breakout Step 3: As long as both SMA lines remain uncrossed in an
entries, it helps to use the same signals that institutional uptrend, you keep your position open. Close your position
traders follow. One of the most popular patterns is the once a trailing stop of two points or more is taken out, as
golden cross, in which a 50-period simple moving seen on December 13, 2016 at $59 per share.
average (SMA) line crosses above a 200-period SMA. In this Alternatively, you could use a trailing stop at the 50 SMA

ent the February 2017 Traders Tips code


months column, you will see how to trade this useful breakout level, especially for longer-term swing or position trades.
swing trading pattern. (In the chart in Figure 1, that would be $54.)

Swing Trading The golden CroSS enTry inSightS: Why thiS technique WorkS
When the 50-period SMA breaks above the 200-period The golden cross is particularly effective because it combines
SMA, it signifies a major short-term trend reversal. This can the shorter-term 50 SMA momentum signal with the longer-
help identify swing trading breakout entries when combined term major 200 SMA trendline. This combination provides a
with price action patterns such as bullish cups, ascending breakout confirmation signal because it uses both short- and

with possible implementations in various


triangles, and increasing volume. It is important to note that long-term trendlines working together.
golden crosses, like most technical trading patterns, should
not be used in isolation. Instead, you should combine them trade management tipS
with other breakout entry signals. One of the keys to using moving average signals successfully,
as with most of the breakout patterns you learn about in this
Step-by-Step action plan column, is to visually scan for charts with wide trading ranges.
Heres how you can start using this strategy with your swing You can see that this chart has nearly 20 points of range ($43
trades: to $61 on a 90-day chart). Price action also follows a classic

software.
45-degree angle breakout trend pattern.
Further, note how cleanly defined the
trend isit is not a choppy, uncertain
chart. The more up-and-down oscilla-
tions a chart has, the tougher it is to trade
profitably. The cleaner, more in-focus the
chart is, the easier it is to trade, as you

The code for the following Traders Tips


can see in Figure 1.
As with all of our professional swing
and intraday charts, it is best to use this
strategy with stocks and ETFs priced in
the $20$70 per share range, because
these charts tend to have stronger, more
sustainable trends that you can trade. This
strategy should not be used with cheap,

selections is posted here:


risky penny stocks or stocks priced under
$10 per share, due to the high risk and
choppiness of these poor trading instru-
ments. You will often see strong upside
price action following golden crosses,
because institutional traders use this same
pattern to put on large block trades.
48 S &c

Traders.com HomeS&C Magazine


Traders Tips
The Traders Tips section is provided to help readers im-
plement a selected technique from an article in this issue
or another recent issue. The entries here are contributed
by software developers or programmers for software that
is capable of customization.

F TRADESTATION: MARCH 2017 TRADERS TIPS CODE Figure 1: TRADESTATION SCANNER. Here, the golden cross breakout strategy is
In Golden Cross Breakouts in this issue, author Ken Calhoun applied to a daily chart of Blackstone Group LP along with a TradeStation Scanner
results list of candidate symbols.
describes his methodology for trading using the popular chart
pattern commonly known as the golden cross. He defines the
golden cross as a 50-period simple moving average crossing if BarsSinceCross > 0
and BarsSinceCross <= MaxBarsSinceCross
above a 200-period simple moving average. The author sug- and PercentRange >= MinPercentRange then
gests using this indicator in conjunction with other price-action Alert ;
patterns.
Strategy: Golden Cross Breakouts
The TradeStation platform has many built-in indicators
that can be evaluated along with the golden cross. Here, we // TASC MAR 2017
// Golden Cross Breakouts
are providing TradeStation EasyLanguage code for a golden // Ken Calhoun
cross strategy based on the authors concepts. We have also
included an indicator that can be used in the TradeStation inputs:
FastLength( 50 ),
Scanner application to help identify trading opportunities. SlowLength( 200 ),
TrailAmountDollars( 2 ),
Indicator: Golden Cross Breakouts BreakoutLookBack( 20 ),
VolumeMultRequired( 1.5 ) ;
// TASC MAR 2017
// Golden Cross Breakouts variables:
// Ken Calhoun FastAvgValue( 0 ),
SlowAvgValue( 0 ),
inputs: BarVolume( 0 ),
FastLength( 50 ), AvgVolume( 0 ),
SlowLength( 200 ), BreakOutPrice( 0 ),
MaxBarsSinceCross( 10 ), EntryOK( false ),
MinPercentRange( 25 ) ; MP( 0 ),
TT( 0 ) ;
variables:
FastAvgValue( 0 ), MP = MarketPosition ;
SlowAvgValue( 0 ), TT = TotalTrades ;
BarsSinceCross( 0 ),
PercentRange( 0 ) ; FastAvgValue = Average( Close, FastLength ) ;
SlowAvgValue = Average( Close, SlowLength ) ;
FastAvgValue = Average( Close, FastLength ) ;
SlowAvgValue = Average( Close, SlowLength ) ; if BarType >= 2 and BarType < 5 then
BarVolume = Volume
PercentRange = 100 * ( Highest( High, FastLength ) - else
Lowest( Low, FastLength ) )/ Close ; BarVolume = Ticks ;

if FastAvgValue > SlowAvgValue then AvgVolume = Average( BarVolume, FastLength ) ;


BarsSinceCross += 1
else if FastAvgValue crosses over SlowAvgValue then
BarsSinceCross = 0 ; begin
BreakOutPrice = Highest( High, BreakoutLookBack ) ;
Plot1( BarsSinceCross ) ; EntryOK = true ;

50 March 2017 Technical Analysis of Stocks & Commodities


end ;

if MP <> MP[1]
or TT <> TT[1]
or FastAvgValue crosses under SlowAvgValue then
EntryOK = false ;

if EntryOK
and Close > BreakOutPrice
and BarVolume >= AvgVolume * VolumeMultRequired then
Buy next bar at Market ;

if Close crosses below FastAvgValue then


Sell next bar at Market ;

SetStopShare ;
SetDollarTrailing( TrailAmountDollars ) ;

To download the EasyLanguage code for the indicator and


strategy, please visit our TradeStation and EasyLanguage
support forum. The code can be found here: https://com- Figure 2: TC2000. Here is a chart of FOX showing the daily timeframe. The
golden cross column shows checkmarks on stocks with golden crossovers in the
munity.tradestation.com/Discussions/Topic.aspx?Topic_ last 10 days. The column properties show the golden cross condition and the condi-
ID=147651. The ELD filename is TASC_MAR2017.ELD. tion for price being between $20 and $70.
For more information about EasyLanguage in general,
please see http://www.tradestation.com/EL-FAQ. We used the new scan columns and enhanced formula
A sample chart is shown in Figure 1. language in version 17 to scan for stocks between $20 and
This article is for informational purposes. No type of trading or $70 where the 50-day simple moving average has crossed
investment recommendation, advice, or strategy is being made, given, up through the 200-day moving average within the last 10
or in any manner provided by TradeStation Securities or its affiliates. days.
Doug McCrary
TradeStation Securities, Inc. The formula for the golden cross uses the new
www.TradeStation.com XUP function in the custom formula language:
XUP(AVGC50,AVGC200,10). This returns true when
AVGC50 (50-period simple moving average) was less
than AVGC200 10 days ago and it is now greater than
AVGC200.
F METASTOCK: MARCH 2017 TRADERS TIPS CODE The sample chart in Figure 2 shows the golden cross (point
Ken Calhouns article in this issue, Golden Cross Breakouts, 1) that occurred six days previous. Using the simulated trad-
presents a trading system based on a popular pattern. The ing features in TC2000, we entered a long position of 100
MetaStock formulas that implement the buy and sell signals shares of FOX at $29.01 and set a trailing stop at the 50-day
for the pattern are given here: moving average (point 2).
You can try the simulated trading yourself at www.
Buy signal
Cross( Mov( C, 50, S), Mov( C, 200, S) ) TC2000.com.
Patrick Argo
Sell signal Worden Brothers, Inc.
bsig:= Cross( Mov( C, 50, S), Mov( C, 200, S) ); www.TC2000.com
ssig:= Cross( Mov( C, 200, S), Mov( C, 50, S) );
stop:= C - 2;
trade:= If( PREV<=0, If( bsig, stop, 0),
If( ssig, -1, If( L < PREV, -2, Max(PREV, stop))));
trade < 0
F eSIGNAL: MARCH 2017 TRADERS TIPS CODE
William Golson For this months Traders Tip, weve provided the study
MetaStock Technical Support
www.metastock.com GoldenCrossBkout.efs based on the formula described in Ken
Calhouns article in this issue, Golden Cross Breakouts. In
it, the author presents a strategy of trading the golden cross,
which is when the 50-day moving average crosses above the
200-day moving average.
F TC2000: MARCH 2017 TRADERS TIPS CODE The eSignal study contains formula parameters that may
The golden cross breakout strategy described by Ken Calhoun be configured through the edit chart window (right-click on
in his column in this issue titled Golden Cross Breakouts the chart and select edit chart). A sample chart is shown
can be easily applied in TC2000 version 17 using the new in Figure 3.
EasyScan columns and enhanced custom formula language. To discuss this study or download a complete copy of
March 2017 Technical Analysis of Stocks & Commodities 51
information. The idea of the article is that these well-understood
tools and rules can be used with new strategies.
We took this strategy and built it using our proprietary
scripting language, thinkscript. We have made the loading
process extremely easy. Simply click on the link http://tos.
mx/szjMnh and then choose to view thinkScript strategy.
In Figure 4, you can see the GoldenCrossBreakoutsLE
strategy added to a six-month daily chart of Spirit Aerosys-
tems (SPR). Based on Calhouns article, when the 50-day
moving average (the blue line) crosses above the 200-day
moving average (the pink line), it is a buy signal. The strat-
egy on thinkorswim charts start calculating the trade from
this point. We have also added the prebuilt TrailingStopLX
strategy to help chartists understand about taking profits or
protecting capital. See the article in this issue for more de-
Figure 3: eSIGNAL. Here is an example of the GoldenCrossBreakout study plot- tails on the strategy.
ted on a daily chart of Spirit AeroSystems Holdings (SPR). thinkorswim
A division of TD Ameritrade, Inc.
www.thinkorswim.com
the formula code, please visit the EFS Library discussion
board forum under the forums link from the support menu at
www.esignal.com or visit our EFS KnowledgeBase at http://
www.esignal.com/support/kb/efs/. The eSignal formula F WEALTH-LAB: MARCH 2017 TRADERS TIPS CODE
script (EFS) is also available for copying & pasting from The golden cross system for swing trading described by Ken
the Stocks & Commodities website at Traders.com in the Calhoun in his article in this issue, Golden Cross Breakouts,
Traders Tips area. can be recreated in Wealth-Lab entirely from the building
Eric Lippert
eSignal, an Interactive Data company
blocks known as rules in a drag-and-drop manner. No cod-
800 779-6555, www.eSignal.com ing is required.
Figure 5 illustrates the necessary conditions and the or-
der in which they should be stacked. When you combine the
rules as shown in Figure 5, the system will exit with a dollar-
based trailing exit or after an opposite eventthe crossunder
of 50-day and 200-day moving averages (MAs).
To add more interactivity, click a nearby parameter to
F THINKORSWIM: MARCH 2017 TRADERS TIPS CODE expose it as a parameter slider. This way, its value can be
In Golden Cross Breakouts by Ken Calhoun in this issue, we changed by dragging the slider on the bottom-left part of
get a lesson on a classic market condition with some in-depth the screen. When you run the system on the chart of a single
stock (as opposed to a multisymbol portfolio), Wealth-Lab
automatically and conveniently applies changed parameters

Figure 4: THINKORSWIM. Here, the GoldenCrossBreakoutsLE strategy is shown Figure5: WEALTH-LAB. Here is a guideline for setting up the example system
on a six-month daily chart of Spirit Aerosystems (SPR). using drag-and-drop rules.

52 March 2017 Technical Analysis of Stocks & Commodities


Figure6: WEALTH-LAB. Here, the system is applied to a matching ETF (PFF).

so you have a chance to see how entries and exits change


interactively on the chart.
On a closing note, to apply the system to stocks of a dif-
ferent price range, you might want to either replace the rule
with a percent-based or ATR-based trailing stop, or simply
change the trailing dollar value. Figure 7: AMIBROKER. Entry and exit points are shown with arrows on a daily
A sample chart implementation is shown in Figure 6. candlestick chart of SPR (Spirit Aerosystems) with 50/200 day moving averages,
Eugene, Wealth-Lab team replicating the chart from Ken Calhouns article in this issue.
www.wealth-lab.com

F NEUROSHELL TRADER: MARCH 2017


TRADERS TIPS CODE
A golden cross breakout trading system such as the
F AMIBROKER: MARCH 2017 TRADERS TIPS CODE one described by Ken Calhoun in Golden Cross Breakouts in
In Golden Cross Breakouts in this issue, author Ken Calhoun this issue can be easily implemented in NeuroShell Trader.
shows a simple swing trade strategy based on the golden cross Simply select new trading strategy from the insert menu
pattern, which is 50-period simple moving average (SMA) and enter the following in the appropriate locations of the
crossing over a 200-period SMA. trading strategy wizard:
A ready-to-use AmiBroker formula is presented here that
replicates the chart shown in the article with the moving av- BUY LONG CONDITIONS: [all of which must be true]
erages and trading system with the golden cross entry and Avg Crossover Above (Close, 50, 200)
two-point trailing stop. LONG TRAILING STOP PRICES:
A sample chart is shown in Figure 7. TrailPricePnts( Trading Strategy, 2)

AmiBroker code: If you have NeuroShell Trader Professional, you can also
sm = MA( C, 50 );
lm = MA( C, 200 );

GoldenCross = Cross( sm, lm );

// Buy when GoldenCross occurs


Buy = GoldenCross;
Sell = 0; // exit by stop only
// trailing stop based on close prices
ApplyStop( stopTypeTrailing, stopModePoint, 2, False );
Equity( 1 ); // evaluate stops

// charts
Plot( C, "Price", colorDefault, styleCandle );
Plot( sm, "MA50", colorRed );
Plot( lm, "MA200", colorBlue );

// buy/sell arrows
PlotShapes( IIf( Buy, shapeUpArrow, 0 ), colorGreen, 0, L );
PlotShapes( IIf( Sell, shapeDownArrow, 0 ), colorRed, 0, H );

Tomasz Janeczko, AmiBroker.com Figure 8: NEUROSHELL TRADER. Here is a sample NeuroShell Trader chart
www.amibroker.com showing the golden cross trading system for SPR.

March 2017 Technical Analysis of Stocks & Commodities 53


choose whether the parameters should be optimized. After
backtesting the trading strategy, use the detailed analysis
button to view the backtest and trade-by-trade statistics for
the strategy.
Users of NeuroShell Trader can go to the Stocks & Com-
modities section of the NeuroShell Trader free technical
support website to download a copy of this or any previous
Traders Tips.
A sample chart is shown in Figure 8.
Marge Sherald, Ward Systems Group, Inc.
301 662-7950, sales@wardsystems.com
www.neuroshell.com

F AIQ: MARCH 2017 TRADERS TIPS CODE


The AIQ code based on Ken Calhouns article in this
issue, Golden Cross Breakouts, can be found at
www.TradersEdgeSystems.com/traderstips.htm.
I tested the authors system using the NASDAQ 100 list
of stocks from the year 2000 through 1/11/2017. I also coded Figure 9: AIQ. Here are sample summary test results for the strategy described in
an alternative exit that held positions much longer. Figure 9 Ken Calhouns article in this issue.
shows the authors system and exit, and Figure 10 shows the
same golden cross entry but with my alternative exit. My
alternative exit has the following rules:

1) Sell when the 50-day moving average crosses through


the 200-day moving average, or
2) Sell using a profit-protect type of trailing stop set to
trigger when profit is greater than or equal to 15%,
then exit if profit drops to 1% (do not let a profit of
X% turn into a loss).

The alternative exit significantly extended the average


holding period from 32 calendar days to 304 calendar days
and reduced the number of trades from 7,782 to 936. The
ROI and reward-to-risk ratio were both better with the al-
ternative exit.

!GOLDEN CROSS BREAKOUTS


!Author: Ken Calhoun, TASC March 2017
!Coded by: Richard Denning, 1/8/17
!www.TradersEdgeSystems.com

!INPUTS: Figure 10: AIQ. Here are sample summary test results for the same entries as in
len1 is 50. Figure 9 for the golden cross strategy but using my alternative exit rules.
len2 is 200.
stopamt is 2.
minPrice is 5.
maxPrice is 70. Sell if Golden=0 or [close] < {Position High Price}-stopamt.

SMA1 is simpleavg([close],len1). Buy1 if Golden and PriceOK.


SMA2 is simpleavg([close],len2). Sell1 if Golden=0. !and use built-in profit protect[1,15]

GoldenCrossUp if SMA1 > SMA2 and valrule(SMA1<SMA2,1).


Golden if SMA1 > SMA2. Again, the code and EDS file can be downloaded from www.
PriceOK if simpleavg([close],10) >=minPrice and TradersEdgeSystems.com/traderstips.htm.
simpleavg([close],10)<=70. Richard Denning
info@TradersEdgeSystems.com
Buy if Golden and PriceOK. for AIQ Systems

54 March 2017 Technical Analysis of Stocks & Commodities


Figure 11: TRADERSSTUDIO. Here is a sample equity curve trading 200 shares
of each of the NASDAQ 100 list of stocks from March 2000 through June 2016.

Figure 12: NINJATRADER. The GoldenCrossBreakout strategy displays the long


F TRADERSSTUDIO: MARCH 2017 entry for the crossing of the 50 SMA over the 200 SMA on the SPR daily chart for
TRADERS TIPS CODE October 2016.
The TradersStudio code based on Ken Calhouns article in
this issue, Golden Cross Breakouts, can be found at www.
TradersEdgeSystems.com/traderstips.htm.
The following code file is provided in the download:
F NINJATRADER: MARCH 2017 TRADERS TIPS CODE
System: GOLDEN_XA system that buys on golden cross The golden cross breakout strategy, as discussed in Golden
up and sells on golden cross down. Cross Breakouts by Ken Calhoun in this issue, is available
for download at the following links for NinjaTrader 8 and
Figure 11 shows the equity curve trading 200 shares of NinjaTrader 7:
each of the NASDAQ 100 list of stocks from March 2000
through June 2016. I did not use the two-point trailing stop NinjaTrader 8: www.ninjatrader.com/SC/March2017SCNT8.zip
for this test.
NinjaTrader 7: www.ninjatrader.com/SC/March2017SCNT7.zip
The code is shown here:

'GOLDEN CROSS BREAKOUTS Once the file is downloaded, you can import the strat-
'Author: Ken Calhoun, TASC March 2017
'Coded by: Richard Denning, 1/8/17 egy into NinjaTader 8 from within the Control Center by
'www.TradersEdgeSystems.com selecting Tools Import NinjaScript Add-On and then
selecting the downloaded file for NinjaTrader 8. To import
Sub GOLDEN_X(len1, len2, stopamt, minPrice, maxPrice)
'INPUTS: into NinjaTrader 7, from within the Control Center window,
'len1 = 50 select the menu File Utilities Import NinjaScript and
'len2 = 200 select the downloaded file.
'stopamt = 2
'minPrice = 20 You can review the strategys source code in NinjaTrader
'maxPrice = 70 8 by selecting the menu New NinjaScript Editor Strat-
Dim SMA1 As BarArray egies from within the Control Center window and selecting
Dim SMA2 As BarArray
Dim Golden,PriceOK the GoldenCrossBreakout file. You can review the strategys
SMA1 = Average(C,len1) source code in NinjaTrader 7 by selecting the menu Tools
SMA2 = Average(C,len2) Edit NinjaScript Strategy from within the Control Center
Golden = SMA1 > SMA2 window and selecting the GoldenCrossBreakout file.
PriceOK = Average(TSCLose,10)>=minPrice And NinjaScript uses compiled DLLs that run native, not in-
Average(TSCLose,10)<=maxPrice
terpreted, which provides you with the highest performance
If Golden And PriceOK Then Buy("LE",1,"",Market,Day) possible.
If Golden=0 Then ExitLong("LX","",1,"",Market,Day) A sample chart implementing the strategy is shown in
'If C < (Highest(C,BarsSinceEntry,0))-stopamt Then ExitLong("LX
stop","",1,"",Market,Day)
Figure 12.
Raymond Deux & Patrick Hodges
End Sub NinjaTrader, LLC
www.ninjatrader.com
Richard Denning
info@TradersEdgeSystems.com
for TradersStudio
March 2017 Technical Analysis of Stocks & Commodities 55
F UPDATA: MARCH 2017
TRADERS TIPS CODE
Our Traders Tip for this month is based on Ken Calhouns
column in this issue, Golden Cross Breakouts.
In the article, Calhoun proposes that this classical techni-
cal analysis setup be used in conjunction with other filters,
such as rising volume, to better identify trends with the po-
tential for persistence, with the suggestion that ETFs in the
$20$70 range are those products with better potential.
The Updata code for this article is in the Updata library
and may be downloaded by clicking the custom menu and
system library. Those who cannot access the library due to
a firewall may paste the code here into the Updata custom
editor and save it.
A sample chart is shown in Figure 13.

NAME Golden Crossover System FIGURE 13: UPDATA. Here is an example of the golden cross breakout system
applied to daily chart of Spirit Aerosystems Holdings Inc. (SPR).
Parameter "Period 1" #PERIOD1=50
Parameter "Period 2" #PERIOD2=200

INDICATORTYPE TOOL
In this trading simulation, we buy at the open of the next
DISPLAYSTYLE 2LINES bar.
PLOTSTYLE LINE RGB(255,0,0) The price hits our two-point trailing stop on 12/13/2016
PLOTSTYLE2 LINE RGB(0,255,0)
SHOWEQUITYCURVE and we sell at the open of the next bar.
The Excel spreadsheet I have created for this issue (and
FOR #CURDATE=#PERIOD2 to #LASTDATE which is posted for you at the Stocks & Commodities
IF HASX(MAVE(#PERIOD1),MAVE(#PERIOD2),UP)
COVER magazine website at www.Traders.com in the March 2017
BUY Traders Tips area) is set up to process 2,500 bars, or just
ELSEIF HASX(MAVE(#PERIOD1),MAVE(#PERIOD2),DOWN) short of 10 years of historical data.
SELL
SHORT The transaction summary tab shown in Figure 15 shows
ENDIF that in that period, there were six trades including a couple
@PLOT=MAVE(#PERIOD1) of nice wins, a couple of so-so wins, and a couple that lost a
@PLOT2=MAVE(#PERIOD2)
NEXT bit. Gotta love those trailing stops!
Figure 16 takes a closer look at the 6/11/2009 trade, which
Updata support team began with a signal on 06/10/2009. The signal bar was very
support@updata.co.uk nearly the highest bar on the chart, and things moved down-
www.updata.co.uk hill from there. The trailing stop pulled us out of this one.
That was pretty much at the same point that a stop based on
the 50-bar average would have hit.
F MICROSOFT EXCEL: MARCH 2017 TRADERS TIPS CODE
In Golden Cross Breakouts in this issue, author Ken Calhoun
explains the workings of a simple trend-following trading
Suggestions
There are several keys to using the golden cross indicator:
system based on the golden cross chart formation.
For any given security, you may not find more than one
Access to 200-plus bars of recent historical data for a lot
golden cross in any given year, and some years you may not
of symbols
find any. Thus, you should expect to scan quite a few securi-
A mechanism to scan across this symbol universe and
ties to find one.
flag symbols showing a golden cross signal in the last
But when you do find one, it can provide an interesting
several days. This may be a very small number of sym-
ride, as demonstrated by the Spirit Aerosystems Holdings ex-
bols much of the time
ample given in Figure 1 of Calhouns article in this issue.
Really good money management / position sizing for any
As I write this in the middle of January 2017, I have access
trades taken based on this indicator
to a few more bars of data than were available when Calhoun
Strict adherence to the stop-loss.
produced Figure 1 for his article. So we can see a bit more of
how this example played out (Figure 14).
For those who are not shy about taking short positions,
The golden cross signals a buy with the 50-bar average
crossing above the 200-bar average on 10/20/2016.
Continued on page 62
56 March 2017 Technical Analysis of Stocks & Commodities
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March 2017 Technical Analysis of Stocks & Commodities 57


FUTURES LIQUIDITY

T
rading liquidity is often over- very high volumes. The greatest number three-year period. Thus, all numbers in
looked as a key technical of dots indicates the greatest activity; this column have an equal dollar value.
measurement in the analysis futures with one or no dots show little Columns indicating percent margin
and selection of commodity activity and are therefore less desirable and effective percent margin provide
futures. The following explains how to for speculators. a helpful comparison for traders who
read the futures liquidity chart pub- Courtesy of CBOT wish to place their margin money ef-
lished by Technical Analysis of Stocks ficiently. The effective percent margin
& Commodities every month. is determined by dividing the margin
value ($) by the three-year price range of
Commodity futures contract dollar value, and then multiply-
The futures liquidity chart shown be- ing by one hundred.
low is intended to rank publicly traded
futures contracts in order of liquidity. Stocks
Relative contract liquidity is indicated Trading liquidity has a significant ef-
by the number of dots on the right-hand fect on the change in price of a secu-
side of the chart. rity. Theoretically, trading activity can
This liquidity ranking is produced by serve as a proxy for trading liquidity
multiplying contract point value times All futures listed are weighted equally and equals the total volume for a given
the maximum conceivable price motion under contracts to trade for equal dol- period expressed as a percentage of the
(based on the past three years historical lar profit. This is done by multiplying total number of shares outstanding. This
data) times the contracts open interest contract value times the maximum pos- value can be thought of as the turnover
times a factor (usually 1 to 4) for low or sible change in price observed in the last rate of a firms shares outstanding.

Trading Liquidity: Futures


Commodity Futures Exchange % Margin Effective Contracts to Relative Contract Liquidity
% Margin Trade for Equal
Dollar Profit
S&P 500 E-Mini (Mar 17) GBLX 4.6 18.6 2 >>
10-Year T-Note (Mar 17) CBOT 1.3 15.3 7 >
Crude Oil WTI (Mar 17) NYMEX 6 5.8 1 >
Russell 2000 Mini (Mar 17) ICEUS 4.7 14.5 2
5-Year T-Note (Mar 17) CBOT 0.8 17.6 13
Ultra T-Bond (Mar 17) CBOT 3.9 17.7 2
T-Bond (Mar 17) CBOT 2.9 15.8 2
Euro FX (Mar 17) CME 2.7 9.1 2
Gasoline RBOB (Mar 17) NYMEX 7.1 6.9 1
Natural Gas (Mar 17) NYMEX 7.7 8.2 2
Nasdaq 100 E-Mini (Mar 17) GBLX 4.3 12.6 2
Soybeans (Mar 17) CBOT 5 11 3
ULSD NY Harbor (Mar 17) NYMEX 6 6.3 1
British Pound (Mar 17) CME 5 13.9 2
2-Year T-Note (Mar 17) CBOT 0.3 15.7 18
Eurodollar (Dec 17) CME 0.1 10.4 20
Corn (Mar 17) CBOT 5.4 12.9 9
Gold (Feb 17) COMEX 5.5 33.9 3
Dow Indu 30 E-Mini (Mar 17) CBOTM 4.2 17.9 3
Japanese Yen (Mar 17) CME 4.5 30.1 4
High Grade Copper (Mar 17) COMEX 3.7 13.1 4
S&P Midcap E-Mini (Mar 17) GBLX 4.3 14.8 1
Silver (Mar 17) COMEX 7.5 24.5 3
Sugar #11 (Mar 17) ICEUS 8.1 16.2 6
Wheat (Mar 17) CBOT 5.2 7.1 4
Live Cattle (Apr 17) CME 4.2 9.3 3
Soybean Meal (Mar 17) CBOT 5.8 11.9 4
Australian Dollar (Mar 17) CME 2.9 11.6 4
Canadian Dollar (Mar 17) CME 2.5 11 4
Lean Hogs (Apr 17) CME 4.7 5.2 3
Mexican Peso (Mar 17) CME 8.3 12.3 4 CBOT Chicago Board of Trade, Division of CME
Coffee (Mar 17) ICEUS 6.3 13.3 2 CFE CBOE Futures Exchange
Cotton #2 (Mar 17) ICEUS 5.4 16.9 6 CME Chicago Mercantile Exchange
Hard Red Wheat (Mar 17) KCBT 4.5 4.8 3
COMEX Commodity Exchange, Inc. CME Group
U.S. Dollar Index (Mar 17) ICEUS 2 9.4 3
GBLX Chicago Mercantile Exchange - Globex
Cocoa (Mar 17) ICEUS 8.3 14.8 6
ICE-EU Intercontinental Exchange-Futures - Europe
Crude Oil Brent (F) (Mar 17) NYMEX 6 5.4 1
Feeder Cattle (Mar 17) CME 5.7 6.4 1 ICE-US Intercontinental Exchange-Futures - US
Platinum (Apr 17) NYMEX 5.4 9.9 3 KCBT Kansas City Board of Trade
Soybean Oil (Mar 17) CBOT 3.8 13.3 12 MGEX Minneapolis Grain Exchange
Swiss Franc (Mar 17) CME 3.2 14 2 NYMEX New York Mercantile Exchange
30-Day Fed Funds (Apr 17) CBOT 0.1 10.1 25
Brazilian Real (Feb 17) CME 8.7 19.4 5
New Zealand Dollar (Mar 17) CME 3.5 16.7 4
Palladium (Mar 17) NYMEX 5.2 13.5 2 1703
Trading Liquidity: Futures is a reference chart for speculators. It compares markets Relative Contract Liquidity places commodities in descending order according to
according to their per-contract potential for profit and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easi-
or sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difficult. Relative
when compared to others in the same column. Contract Liquidity is the number of contracts to trade times total open interest times a
The number in the Contracts to Trade for Equal Dollar Profit column shows how volume factor, which is the greater of:
many contracts of one commodity must be traded to obtain the same potential return In volume
as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price 1 or exp 2
In 5000
Excursion).

58 March 2017 Technical Analysis of Stocks & Commodities


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March 2017 Technical Analysis of Stocks & Commodities 59


The Invisible Force

Successful Trader Must-Haves


How often have you sat at your trading desk with a solid plan necessary elements to become a successful trader? To answer
that you want to follow and how often, after placing a trade, this question could lead into a long academic discussion. You
have you deviated from that plan? Emotions can wreak havoc could say that the psychological lens is a very powerful ele-
on our trading lives and theres nothing you can do to make ment, but right in this statement lies the first problem. We can
them disappear. The first step toward combating them is to reference a psychological lens, but do you actually see your
be aware of the existence of emotions. emotions or do you feel them? You dont see your emotions.
You feel them, and that can be a problem when it comes to

I
by Claudio Demb trading. But that doesnt mean emotions are all bad.
It is much easier to see things that are concrete or tangible.
am tempted to start with the end and give away the punch Numbers are an example of something that is concrete.
line. So here it goes: Psychology is destiny. I agree that Feelings are extremely important, but since you cannot see
it sounds very categorical, and whether or not this is true them, it can be difficult to understand and accept them. It is
doesnt really matter. You still have to go through the mo- not unusual for people to believe they have control over their
tions. As a good friend of mine often said, Not everything actions. They can speak clearly about their methods and trad-
ESD PROFESSIONAL/shutterstock

is psychological. I know that what he said is true, but to be ing plans. But when feelings kick up in high gear, it is very
fair, he had to learn to deal with his emotional issues in order possible to do something totally different, sometimes even
to become a good trader. take a 180-degree turn from the original plan. To sum it up,
we think we know, we believe we have a solid plan, but there
What does it really take? is some invisible force that takes over, uninvited, that helps
If not everything is psychological, then what are the other us to depart from our plan.
60 March 2017 Technical Analysis of Stocks & Commodities
at the close

Not all is lost


Just because emotions are intangible, it doesnt mean you are
helpless. Theres hope. With practice, patience, help, and time We think we know, we believe
you can get a handle on your emotions. Taking the step to be-
ing aware of what is going on and even anticipating what you we have a solid plan, but there is
might feel as the trade unfolds is an indication that you are some invisible force that takes
on the right track. Its a sign that you are no longer blinded over, uninvited, that helps us to
by your feelings. depart from our plan.
To go into the nitty-gritty details about all that is involved in
working with a fellow trader on his or her psychological issues
would be a lengthy project. Even if I were to miraculously
do it in a couple of pages, it wont be much use since every
person is unique. The twists and turns that one trader takes tory signals. Before you know it, you are underwater and you
will not apply to those of another trader. But there are some need to think fast. You were bullish and dead sure about your
key ingredients such as time, commitment, trust, hard work, long position, but the market is telling you the opposite. Who
and exposure to vulnerabilities that affect all of us. are you going to listen to?

What you see Know what youre dealing with


I will now shift gears and move on to a more concrete, easy- In situations like these, you need an innate ability to withstand
to-see subject. Getting back to the title of this article, what negative feelings. Oftentimes, way more than you would like,
are the essential traits a successful trader must have? This list many trades wont go as planned, losses will mount, and you
may not be all-inclusive but for sure will include the ones that will need the mental fortitude to keep going. This will keep
are beyond any questioning. happening so you need to be able to act quickly. And having
First, a trader must have a passion for trading. Anything that agility is what makes you a successful trader. Its not
less will not suffice. You have to have the bug to the point that about how much you make on a trade or how many winning
you cannot resist its call. Otherwise you will not be able to trades you have. Its about being aware and able to act quickly
withstand the grueling demands it requires. On the surface, to keep your drawdowns to a minimum.
trading looks easy. In fact, its almost seductive, but that is just
an illusion. The reality is that it is very difficult. So passion is Claudio Demb has been an independent trader and investor
one of the must-haves to be a successful trader. for over 20 years. He is a practicing psychiatrist and lives
You also need some smarts with numbers. Its not that you with his family in Brookline, MA. He may be reached via
need to be a mathematical wizard, but you need to have some email at claudiodemb@gmail.com.
comfort with numbers. You need to be able to analyze data and
be able to identify elucidating patterns and think abstractly. Further reading
Another necessity is dedication and focus. You must be Demb, Claudio [2017]. How Feelings Influence Your Trad-
willing to sit down and work at it. You need mental flexibility, ing, Technical Analysis of Stocks & Commodities,
almost like having the agility of a wild animal. That may sound Volume 35: January.
esoteric but just think about this for a moment: Say youre
trading with your best trading idea and it is getting contradic-

Sneak preview...

Trading The Open Harmony and PATH Trading Elliott Waves Using
by Adam Ryan by Patrick Hughes A Top-Down Approach
The open of any trading day sets the When learning technical analysis, traders by Mircea Dologa
tone for the rest of the trading day. tend to look for perfection instead of look- When applying Elliott wave counts to your
Heres how you can take advantage ing at how perfection is created. Heres a charts, one of the challenges is knowing which
of the volatility of the open to generate
technique that could give you a deeper trend to use. Here is an approach that could
profits from it.
insight into the relationship between time help you identify which to use.
and price. Coming soon!

March 2017 Technical Analysis of Stocks & Commodities 61


Figure 14: EXCEL, Golden cross trade. A two-point trailing stop was hit on 12/13/2016, and a 50-day moving average stop would have hit on
01/12/2017.

Continued from page 56

the death cross indicator is the exact mirror of the


golden cross indicator. You would sell when the
50-bar average crosses below the 200-bar average
and buy back when the two-point stop-loss hits.
Because the death cross alternates with the
golden cross, there were five or six death cross sig-
nals buried in the data used to create my list of
sample transactions.
The spreadsheet file for this Traders Tip can be
downloaded from www.traders.com in the Traders
Tips area. To successfully download it, follow these
steps: Figure 15: EXCEL, EXAMPLE transactions SUMMARY. Over the course of nine
years, we find six golden cross events, including a couple of nice wins.
Right-click on the Excel file link (GoldenCross- Ron McAllister
Breakout.xlsm), then Excel and VBA programmer
Select save as to place a copy of the spreadsheet file on rpmac_xltt@sprynet.com
your hard drive.

Figure 16: EXCEL, One of the small-loss trades. A strategy based on the golden cross makes for an interesting, simple trading system.

62 March 2017 Technical Analysis of Stocks & Commodities


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