THE TRADERS’ MAGAZINE SINCE 1982
VIX OR HISTORICAL VOLATILITY? Use this unique approach to size your positions
8
S&P FUEL GAUGE Measuring Meas uring a rally rally’’s energy 14
GRAND ILLUSION Is the economy as strong as it looks?
22
GAUGING BUY & SELL PRESSURE Here’ss a faster RSI Here’
26
INTERVIEW INTER VIEW Gavin McMaster, options trader
PRODUCT REVIEW n NinjaT NinjaTrader rader
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MARCH 2017
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Daily technical commentary Daily commentar y by expert analysts to help you make smarter investment decisions From daily blogs to live webinars, StockCharts.com hosts free current market analysis and educational commentary from some of the industry’s industry ’s most distinguished technical analysts.
Free daily blogs featuring over a dozen renowned technical commentators John Mu M urphy
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Ar thu r Hi Hill
Tom Bo Bowley
Greg Sch Schnell nell
Chip Chi p Ande Anderson rson
Carl Ca rl Swe Swenli nlin n
Erin Er in He Heim im
Gati atiss Ro Roze ze
Julius Jul ius de Kem Kempena penaer er
StockCharts.com hosts free daily blog content from over a dozen professional technical analysts, including prominent names such as John John Murphy, Murphy, Martin Pring and Arthur Hill. Thousands of online investors trust StockCha StockChart rts.com s.com to provide the unbiased expert exper t analysis and enriching educational commentary they need to cut through the noise and make smarter investment decisions.
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CONTENTS 7
The Reality Of REITs
MARCH 2017, VOLUME 35 NUMBER 3
26
by Leslie N. Masonson Interested in learning more about using exchange traded funds (ETFs) in your trading? This time, we look at ETFs made up of real estate investment trusts (REITs)— what they are, the change that occurred in 2016, and a closer look at the more than 30 US REIT ETFs listed today.
FEATURE ARTICLE
8
VIX Or Historical Volatility? by Perry J. Kaufman Position sizing is an often overlooked variable when it comes to strategizing your trades. There are different ways to decide how big your positions should be and here we look at a unique approach to size your positions using volatility.
14
18
This Butterfly Wears Kevlar by John A. Sarkett Butteries are a well-known options trading strategy. But here’s one that’s a little different.
22
by Tushar S. Chande, PhD Most of you are familiar with the relative strength index (RSI), but are you taking full advantage of it? Here, we deconstruct the RSI to lead to a more intuitive and symmetrical gauge of buying and selling pressure and a more responsive indicator.
31
The Grand Illusion by Tim W. Wood, CPA Is the economy as strong as it looks? The charts may suggest the economy is strong but the real answer lies between the price bars. Let’s take a peek.
41
Explore Your Options by Tom Gentile Got a question about options?
48
Golden Cross Breakouts TIPS by Ken Calhoun In this monthly column on trading breakouts, this professional trader shows how you can use the “golden cross” on a chart as an entry signal for swing trades.
Futures For You by Carley Garner Here’s how the futures market really works.
AT THE CLOSE
32
About Those Binary Options by Gail Mercer Whether you’re a scalper, an intraday trader, or a longer-term trader, binary options can provide several types of trading opportunities and can work in any type of market condition. What are they and how can you trade them?
S&P Fuel Gauge: An Introduction by Chris Evans Ever thought about how much energy a rally in the S&P 500 has? Here’s a technique that could help measure that energy a nd may even give you an edge.
Buy & Sell Pressure And A Faster RSI
35
Q&A by Rob Friesen This professional trader answers a few of your questions.
INTERVIEW
36
Gavin McMaster: Living Life As An Options Trader by Jayanthi Gopalakrishnan You don’t have to be an aggressive trader to make it as an options trader, says this “master” of options trading. Gavin McMaster specializes in income trading using options and likes to focus on short volatility strategies. He believes that patience in waiting for the best setups is the key to successful trading. We decided to fnd out more.
60
Successful Trader Must-Haves by Claudio Demb Emotions can wreak havoc on our trading lives. The frst step toward combating them is to be aware of their existence.
PRODUCT REVIEW 42 • NinjaTrader 8 (Part 2) Trading platform for active equity, futures, and forex traders.
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March 2017 • Volume 35, Number 3
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ncertainty begets risk, which is what gives markets their mysterious character. You never know what the market will do next. If you expect something, it’s most likely to do the opposite. All the more reason to approach the markets each day with an open mind. The bull market cycle that started in 2009 is going to celebrate its eighth birthday in March 2017. No matter how many times it looked like it had made its peak, it bounced back and continued its bullish ride. Bears are always saying how the market is way overvalued, and they’re correct. In spite of the high valuation, volatility, overall, has been quiet. If you look at the CBOE Volatility Index (VIX) you’ll see that although there were a few spikes, the index has generally maintained low levels. The same goes for the number of corrections since 2009. Relatively speaking, they have been few. So, just looking at these variables, the indications show no signs of any panic. But maybe that doesn’t mean anything. We have a new administration in Washington, which brings with it a certain amount of uncertainty. But that’s nothing new to traders, who thrive in an environment of uncertainty. In fact, the more uncertainty, the better it is for traders.
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As
a trader, you have a unique relationship with the market. You still have to be fully aware of what the markets are doing, regardless of whether you have positions open or not. In other words, you need to feel the pulse of the markets so you can nd opportunities that give you t he returns you want. And you have to be able to recognize the signals that tell you that things could go awry any time soon. Each one of us is different and we eac h have our own way of interpreting the markets. As an example, some traders feel the pulse of the markets through the VIX. When the VIX is high and stays high, they feel that something big is about to happen. Others may feel the number of buyers vs. sellers is a great indicator to show a shift in market behavior. And if you’re not attached to an indicator, I encourage you to look at historical charts and look at previous market peaks or troughs to see how the market behaved in the months prior to the high or low. Was volatility high? Were corrections more frequent? Were there divergences between price movement and i ndicators? Get to know the markets, understand them, feel them. Then approach them knowing fully well they are mysterious and could easily wipe you out.
6 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
Jayanthi Gopalakrishnan, Editor
k c o t s r e t t u h S / i r e l l a v a C d r a h c i R n w o t n w o D i m a i M
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Are you interested in learning more about using exchange traded funds (ETFs) in your trading? Leslie N. Masonson, an active ETF trader, is president of Cash Management Resources, a nancial consulting rm that focuses on ETF strategies. He is the author of Buy—Don’t Hold: Investing With ETFs Using Relative Strength To Increase Retur ns With Less Risk; and All About Market Timing, as well as Day Trading On The Edge. His website is www.buydonthold.com, where he writes a weekly blog. To submit topics for f uture columns, reach him at
[email protected].
pointed in their outstanding price appreciation. Build powerful NAREIT retrading systems in search has shown that from 1972 to MINUTES 2015,equity REITs without coding have delivered a 12.0% total return, which compares favorably to 10.3% for the S&P 500 by Leslie N. Masonson ® index. Furthersure you’re familiar with t he term REIT, or real more, according estate investment trust. They were created by to JPMorgan Asan act of Congress known as the Real Estate set Management, Investment Trust Act of 1960. A REIT is simply REITs were the www.NeuroShell.com a common stock fund similar to a mutual fund that buys or top performer of 301.662.7950 nances real estate property or mortgages. They are often 10 standard asset publicly traded on stock exchanges but many a re non-public. classes from 2000 Three well-known benchmarks are t he 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 propert ies typically consist of hospitals, large shopping In their analysis, they found that REITs had an average malls, ofce buildings, hotels, nursing homes, storage facili- annual return of 12.0% during this period, compared to large ties, apar tments, warehouses, and mortgages. However, most caps, which averaged 4.1%, and small caps, which averaged REITs usually focus on only a single property t ype. 6.6%. Most investors would not have guessed this outcome if asked which asset category would be the best asset class for such a long time period. THE DEVIL IS IN THE DETAILS 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 discan also receive a return on capital a nd cussions among industry participants Largest REITs by Market Cap some long-term capital gains. REITs about potentially separating real estate Company Ticker Symbol provide higher income than Treasurfrom the nancial market sector, which Simon Property SPG ies, impressive total returns compared consists mostly of money center and to the S&P 500 i ndex, and other major regional banks, diversied nancial, Public Storage PSA averages. Real estate is a separate a sset insurance, consumer finance, and Prologis PLD class in addition to stocks and bonds, so capital markets. It was no surprise General Growth Properties GGP adding it to a portfolio reduces risk by that on September 1, 2016, real estate Welltower Inc. HCN providing more diversication. stocks were removed from the nancial Ventas VTR REITs can be bought or sold at any sector of the GICS (Global Industry Avalon Bay Communities AVB time during the day in a liquid market Classication Standard) and placed in Equity Residential EQR without difculty. Since REITs are their own category. However, mortgage Boston Properties BXP required to distribute their taxable REITs remained exclusively in the income as dividends to shareholders, it nancial sector. Vornado Realty Trust VNO is not surprising that these vehicles are FIGURE 1: THE LARGEST ONES. They encompass The S&P 500 index contains 26 regional shopping centers, outlet malls, storage units, owned by investors looking for a solid REITs. The S&P 400 mid-cap index high-quality apartment communities, senior housing, high income stream of dividends and has 35 REITs, and the S&P small- cap healthcare infrastructure, industrial development, and growth potential. And investors over office properties. Most REIT ETF portfolios contain all or some of these companies. the past decade have not been disapContinued on page 46
I’m
T I E R A N : E C R U O S
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 sizing is an often overlooked variable when it comes to strategi strategizing zing your trades. There are a re different ways to decide how big your positions should be and here we look at a unique approach to size your positions using volatility. volatility.
irst, let’s agree that always trading 100 shares, or one futures contract, isn’t as good as varying your position size based on price volatility.. If you don’t volatility don’t agree, agre e, my rst example will show why it’s a problem. Until then, I’m going to assume that t hat we’ll we’ll use volatility. When markets are a re quiet, positions will be larger; when they are a re volatile, positions will be smaller. The key here is: How big and how small? The principle behind correct position sizing is called volatility parity, that is, you equalize the t he volatility of each trade, which in effect equalizes the risk, more or less. There are more sophisticated ways to equalize risk, but volatility parity is much simpler and gets you 90% of the solution. By equalizing the risk of each trade, you give each trade an equal opportunity to affect a ffect the results. results. From that you can conclude you’ve maximized diversidiversication. If you concentrate your investment in a few markets and trade larger positions in terms of risk,
F
you are counting on those trades being better. If you knew that, you would would only take those trades and skip all the others. ENTER
VOLATILITY
Volatility is like a volcano—quiet for long periods, and then violent eruptions. To use volatility successfully, traders need to know which one—historical (HV) or implied (IV)—is ( IV)—is best. Historical volatility is measured from actual actua l prices, while implied volatility volatility (also tracked as the VIX index) comes from options pricing.. I would like to think pricing thi nk that IV I V would be more accurate because it represents what what traders are a re willing to pay today rather than the lagging calculation represented by historical prices. You won’t really know unless you try using it. The chart in Figure 1 compares the t he long-term long-term historical and implied volatility (on the left) and 2008 on the right. The bigger picture makes it appear that both methods method s produce close to the same values, but a closer look at 2008 shows the differences. Historical volatility continues to increase after implied volatility has attened. But this pattern is not always the case. IV can spike on surprising surpr ising news news,, then disappear the next day when that news news turns tur ns out to be only a rumor. ru mor. HV would show only a small change.
Historical and Implied Volatility 120
120
100
100
80
80
60
60
40 20
40
0
20
0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 0 0 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 2 0 2 0 2 2 / / / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 3 3 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 R O L Y A T N A I R B
Volatility Comparison, Jul-Dec 2008
VIX
0 07/01/2008
08/01/2008
Historical volatility (annualized)
09/01/2008
10/01/2008
Implied volatility
11/01/200 8
12/01/2008
Historical volatility
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
1
No
17,756
11,851
2
Yes
12,272
3
No
4 5
Sh o r t PL
All PF
Long PF
Short PF
5,905
2.14
2.84
1.64
100 shares, unbounded
8,878
3,394
1.97
2.76
1.44
Most stocks are 10K
12,103
9,006
3,096
1.92
2.74
1.39
Size by price
No
1,029,655
785,402
244,253
2.30
3.50
1.51
Size by ATR unbounded
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
Comments
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, which makes it difcult to decide i ntellectual ntellectually ly which would be a better choice for sizing. HV has a noticeable lag because it is based on a 20-day average. IV can be unreliable and erratic. VARIATIONS
2. 100 shares with a cap at $10,000 $10,000 in exposure, so that any trade that costs c osts more than $10,000 $10,000 for 100 100 shares will wil l be reduced to a $10,000 $10,000 investment. 3. Size by price, that is, divide the investment of $10,000 by the current stock price. That assures t hat the exposure is always $10,000. 4. Size by average true range (ATR) of price. The ATR is the maximum of the high–low range, but extended to the previous close if there was a gap. This test allows any number of shares, not limited by the investment of $10,000. $1 0,000. For a stock with low volatility, the exposure can be very large. 5. Sizing using the reciprocal of the VIX, so that an i mplied volatility of 70% would be interpreted as a 30% position (1–IV, but not less than zero); that is, as the volatility increases, the position size decreases. Any VIX value over 100% 100% results i n a position size of zero.
ON POSITION SIZING
If we use one share or one futures contract for each trade, then those markets with higher prices a nd/or more volatility will overwhelm the performa nce of other markets with low volatility. volatility. If we we’re ’re trading futures, crude oil will always have larger gains and losses per trade than eurodollars, yet eurodollars and other interest rates have been far more protable over many years, with less risk. Using TradeStation’s EasyLanguage for testing, we apply a 120-day moving average average to the t he ETF SPY SPY.. I know k now that this mov mov-ing average is protable over over time, so it will be a better bett er basis for seeing the changes caused by various methods of sizing. The table in Figure 2 shows the results of the tests, both the dollar prots and the prot factor (PF is the gross prots divided by the gross losses). For some of these tests, the exposure (position size ti mes the entry price) is limited to $10,000; in others there is no limit. The position sizing will wil l be calculated calculat ed ve different ways: ways: 1. 100 shares for all trades. This allows positions to be greater than t han the i nves nvestment tment of $10,000 $10,000 when the pr ice of SPY is above 100.
The chart in Figure 3 shows the position sizing based on these ve scenarios. Tests 1 th rough 3, which are displayed on the left, show the number of shares. In test 3, the position size decreases as the price of SPY increases, which makes it look similarr to the SPY prices, but upside-down. simila In tests 4 and 5, you have very large position sizes because volatility can be low low.. It’s It’s not the position size that is i mportant here, but the pattern. Rather than declining as in test 3, the position sizes uctuate up and a nd down in a more cyclic way. way. The
Comparison of Allocations, Tests 1, 2, and 3 160 140 120 100 80 60 40 20 0
Pattern of Allocations, Tests 4 and 5 2500
1200
2000
1000 800
1500
600
1000
400
500
0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 0 0 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 2 0 2 0 2 2 / / / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 / 6 6 6 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
T1 100 Shares
T2 100 Shares (capped)
T3 Size by price
FIGURE 3: SIZING COMPARISON. Tests 1–3 on the left show the
200
0
0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 0 0 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 2 0 2 0 2 2 / / / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 3 3 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Implied volatility
0
Historical volatility
number of shares. On the right, tests 4– 5 show relative changes in position sizes. The ac tual number of shares won’t 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 volatility parity , that is, you equalize the volatility of each trade, which in effect equalizes your risk, more or less. pattern of tests 4 and 5 are similar, with a few added spikes in test 4 that do not appear in test 5. WHICH
IS BETTER?
These tests were designed to show the ideal returns of each choice rather than the practical application, where the size is limited by the investment. In the rst two test s, using 100 shares means that a few trades taken under high volatility might have large gains or large losses, overwhelming many trades that occur at low volatility. In Figure 2 you see a sum mary of the results. Intuitively, you expect the returns from the long positions to be better than the shorts because of the upward bias of the stock market. Still, the shorts were all protable, which is a good outcome. Trades that can be protable on both the long and short side show that the timing is good. Tests 1 and 2: 100 shares, without and with capping Tests 1 and 2 both trade 100 shares, but test 1 doesn’t care if the 100 shares give an exposure of $500 or $100,000. The higher price of the SPY in the more recent years will have greater value and will inuence the results to a much greater degree. In 1998 the SPY traded at 80 and now trades at about 220. The ve-year bull market that followed the nancial crisis will have a greater impact than the bear markets of 2001 and 2008. That creates a poor portfolio risk prole because lower-priced stocks may be performing well but are overwhelmed by losses i n a high-priced stock. Even though the prot factor of 2.14 is high, I see t his case as highly risky because it can be distorted by a few big trades. In addition, you need an increasingly larger investment to keep trading. In 2000 the SPY traded at 150, so 100 shares
would cost $15,000. In mid-2016 it was 220, an investment of $22,000 per trade. When you cap the exposure in test 1 to $10,000 per trade, which gives each trade equal impact, the results d rop and are far less attractive. Trades when SPY was under 100 will still have smaller representation, but any trad ing 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. Test 3: Size by price This is the most common way of sizing that achieves equal risk in a simple way. The per-trade investment of $10,000 is divided by the current price of SPY to get the number of shares. When you use this method for trading, you should avoid stocks priced under $5. They are more volatile and erratic, plus the position sizes expand rapidly as the price falls under $5. The results were nearly identical to test 2 because that test had all trades that were entered when SPY was over 100 reduced to a total exposure of $10,000. That was most of the trades. Test 4: Real volatility parity This is an interesting test because it is the ideal case, that is, money-is-no-object case of volatility pa rity. Each trade size creates exactly the same risk as every other trade. This means that the position sizes are very large during low volatility, and very small during high volatility. The long prot factor of 3.50 is far above the others, showing that, in theory, true equal risk is the best way to trade. On the downside, it takes more than $1 mill ion to trade this way. Test 5: Using implied volatility This is where I thought implied volatility could outperform historical volatility by a large factor. Instead, it produced an average result. My experience with this is that implied volatility jumps up quickly, avoiding the lag i n historical volatility. But then it also disappears quickly when nothing happens. That results in a lot of false volatility spikes. 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 5 t s e T
10000
2000
0
0
-5000
-2000
T1 PL
T2 PL
T3 PL
600000
4000
5000
0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 0 0 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 2 0 2 0 2 2 / / / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 3 3 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 2 / / 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6
800000
6000
400000
4 t s e T
200000 0 -200000
0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 0 0 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 2 0 2 0 2 2 / / / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 / 3 3 3 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 2 / 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6 0 6
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 awed. 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 signicantly during the long bull rally that followed. VISUALIZING THE RESULTS
Sometimes numbers aren’t enough. In Figure 4 you see the cumulative prots for each of the ve 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 difcult to interpret because position sizes have been allowed Perry Kaufman is a trader and nancial engineer. He is the to exceed the $10,000 investment. Here you are looki ng for the author of many books on trading and market analysis, including smoothness of the retur ns. This shows that test 5, using implied Trading Systems And Methods, 5th ed . (with the rst edition volatility, has some unacceptable rall ies and drawdowns from published in 1978 as a seminal book in the eld of technical 2008 to 2010, while using the ideal volatility parity sizing based analysis), and A Guide To Creating A Successful Algorithm ic 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 i mplement. However, it does prove that, theoretically, volatility parity is the best solution. FURTHER READING Kaufman, Perry J. [2013]. Trading Systems And Methods, 5th ed., Wiley. MAKING THE CHOICE Except for test 5, which uses IV, the others are extremely close. [2015]. A Guide To Creating A Successful Algorithmic Trading System, Wiley. As a nal measurement, I calculated the ratio of the total prots divided by the standard deviation of the daily prots 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 practica l, test 3 is the easiest choice because you simply & COMMODITIES, Volume 32: April. divide the investment per stock by the current price. Whi le test 2 [2014]. “Timing The Market With Pairs Logic,” Technical Analysis of STOCKS & COMMODITIES, Volume 32: March. may have a slight edge because it t rades smaller exposure when the value of 100 shares is less than $10,000, it wouldn’t 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 wouldn’t 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 has? Here’s a technique that could help measure that energy and may even give you the edge you’re looking for.
hedge or add to your positions. If you knew there was no skew in likely returns in the S&P, then you could take the day off and go to the gym or, even better, a trip to Bermuda.
by Chris Evans
HERE’S THE REALITY Your challenge is to measure t he potential energy available to make the market rally. It has little to do with recent momentum or the consensus view you hear and read about. In fact, if you go with what you hear in the media, you may end up buying after a bout of weakness. If you buy into a trend, you can only do it if the conditions are right. Here’s how I look for the right conditions. To measure energy, I have to be condent that I know all
T
he performance of the S&P 500 can tell you a lot about global asset returns. If it goes up mate rially, then bonds usually fall, and i f it goes down, bonds usually rise. If it goes up, traders prefer currencies like the Australian dollar over, say, the Japanese yen. If you start your trading day with an advantage or appropriate bias, then you would know how to
14 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
/ S R R R O T O C M E I V K F K I R N : : E E G G A U A L L G / O 0 C 9 / Z K T C T O A T S M : R 0 E 0 T 5 T P U & H S S
TRADING STRATEGY
the forces that matter in the short term that lead to rallies. I must then prove that there is forecasting value in the i ndex. I use a daily timefra me and to the extent that a high index level persists, I may be able to hold onto a long position for one to 10 days. It can augment a shorter-term t rading method, but it may not help if you have a monthly perspec tive. WHERE’S THE ENERGY? There are three parts to the index:
1. fear 2. time since the last period of weakness 3. interest rates. It is simply axiomatic that when investors are afr aid, we want to be buying. When everyone is happy or complacent, we can wait to enter. If the market got hit and many investors were forced out of the market, a special window, which I refer to as a “ trauma window,” opens. When this window opens, you can buy it ahead of those people before they get back i n, which ultimately they will all do. Finally, it is generally true that lower interest rates help equity valuations and force people out of lower-yielding bonds and into stocks. HOW IS IT BEHAVING? The energy index ranges between zero and 100 with a mean of 52 and a median of 50. I break it up into two components— bonds and fear. I adjust both for volatility a nd where the index stands in the trauma window. It is not normally distributed, which means it doesn’t cling to a mean with comparatively few readings at the extremes. It is a lso not particularly sticky. If you get a huge short-term rally or if bonds fal l precipitously due to some central bank announcement, this index can swing 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 similar to what you see in Figure 1. Next, I’ll look at the parts separately to see their independence and volatility (Figure 2). You can see that bonds and fear are not connected or correlated. Bonds as a factor are more volatile than the fear factor. Since I am able to see the daily levels of both, I will be able to run scenario tests to see prospective gains when the two parts are opposing one another. And when both factors are at attractive levels, I may also prefer to take long positions. The chart in Figure 3 displays the index. It’s easy to see how the sum of the two parts creates the aggregate—there is no special weighting system. I allow each component to rise slightly above 100 to make it possible to get a total that is greater than 100 for the index. In such cases, I set the index to its maximum of 100. That’s why the distribution has an abnormal number of readings equal to 100. FILTER IT The next step is to look at performance to see if the index is helping to avoid lousy returns from your long positions and
250 s200 e c n e 150 r r u c c100 O A
50 0
0 1 5 2 0 2 5 3 0 3 5 4 0 4 5 5 0 5 5 6 0 6 5 7 0 7 5 8 0 8 5 9 0 9 5 0 0 1 1 5 – 7 0 – 7 5 – 8 0 – 8 5 – 9 0 – 5 – 0 – 1 0 – 1 5 – 2 0 – 2 5 – 3 0 – 3 5 – 4 0 – 4 5 – 5 0 – 5 5 – 6 0 – 6 9
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 you see here. 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
1,900.00
1,900.00
1,850.00
1,850.00
50.00 40.00 30.00 20.00 10.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00
50.00
Fear
40.00 30.00 20.00 14.62 10.00 70.00 60.00 50.00 40.00 40.28 30.00 20.00 10.00
Bonds Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
’16
Feb
Mar
Apr
FIGURE 2: BONDS VS. FEAR. The two are not correlated and neither are they connected. Bonds, as a factor, are more volatile than the fear factor. 2,100.00
2,100.00
2,050.00
2,050.00 2,040.50
2,000.00
2,000.00
1,950.00
1,950.00
1,900.00
1,900.00
1,850.00
1,850.00
100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00
100.00 90.00 80.00 70.00 60.00 50.00 50.02 40.00 30.00 20.00 Jun
Jul
Aug
Sep
Oct
Nov
Dec
’16
Feb
Mar
Apr
FIGURE 3: A LOOK AT THE DAILY CHART.
good returns from your short positions. I’ll start by looking at the long positions. From the table in Figure 4, you can see that if you buy S&P futures at ever-higher index levels, your average daily returns rise and the numbers of instances fall. The relationship is not perfect since there are some extreme cases of volatility in this 10-year history. I don’t expect a per fectly smooth beta in this regression. You can also see that if you wait for higher index readings to
Keep one eye on the road and the other on the S&P 500 fuel gauge, and you can work yourself up to lead the pack.
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 15
Filter
Total Ret
# Instances
Avg Ret
>90
277.00
183
1.514
>85
529.25
244
2.169
>80
506.50
345
1.468
>75
905.00
430
2.105
>70
769.00
533
1.443
>65
1028.25
633
1.624
>60
1023.70
751
1.363
>55
1061.25
894
1.187
>50
949.50
1053
0.902
>45
947.95
1249
0.759
>40
1168.45
1467
0.796
>35
1235.20
1655
0.746
>30
1123.45
1781
0.631
>25
1099.50
1876
0.586
>20
992.25
1996
0.497
>15
687.75
2097
0.328
>10
542.50
2139
0.254
>5
508.25
2148
0.237
FIGURE 4: BUY POSITIONS. If you buy S&P futures at ever higher index levels you see your average daily return rise and the number of instances fall. You can also see that if you wait for higher index readings to buy you lose opportunity and it is quite possible that you may not get such an attractive level in your desired time frame.
Filter
Total Return
# Instances
Avg Return
<50
-459.00
1077
-0.426
<45
-406.45
877
-0.463
<40
-566.20
661
-0.857
<35
-746.20
476
-1.568
<30
-503.70
361
-1.395
<25
-460.25
262
-1.757
<20
-433.75
138
-3.143
<15
-94.75
40
-2.369
<10
-5.25
8
-0.656
FIGURE 5: IS IT TIME FOR THAT ROAD TRIP? Low readings in the index almost guarantee a mediocre return. This data set includes a 50 % rally in the market overall with a 50% loss from its starting point.
>40
>45
>50
>55
>60
>65
>70
2007
94
89
87
83
79
75
71
2008
174
151
129
110
94
83
2009
160
127
95
84
70
2010
207
161
129
107
2011
171
158
135
2012
181
155
2013
220
2014
buy your positions, you lose opportunity and it is possible that you may not get such an attractive level within your desired timeframe. Everyone must pick their own threshold. The table in Figure 5 shows that low readings in the index almost guarantee a mediocre return. This dataset includes a 50% rally in the market overall with a 50% loss from its starting point. There are lots of high- a nd low-volatility periods to study. Even with the rally, it’s clear that you need to wait ti ll index levels are low before you buy. It is certainly true that even in raging bull markets, if the index is low, high positive returns are rare a nd you are more likely to earn meager returns. MAKE IT CLEANER If the market is rallying up and you are not long, you may worry that you will not be able to reap the returns others are seeing. You want to jump in even though the price level (and the index) seems high. The table i n Figure 6 shows you by year how often you get high readings. There are 250 trading days in a year, so if you get, say, 80 trading opportunities, then you are long about one third of the time, which may be sufcient. The table in Figure 7 shows how much money you would have made each year ltered by index level. The aw with this table is that it fails to show you what the market offered as a return during the period. You can see, for example, signicant declines in early 2010 followed by gains, so that for the year, the market and index gave you a positive result. Nevertheless, you should not just blindly use the fuel index. There are a sufcient number of cases where the index was bullish, but the market was in a state of transitioning into a bear market, which was the case in 2010 and 2014. A bear market test is needed so that if the index does break down, it needs to reset to lower levels. As you see weakness i n a market that is in a st rong rally, you may nd yourself getting more bullish, but if it breaks down below a certain threshold, you will have to abandon hope, at lea st for a while. But then again, the markets have a tendency to mean-revert, which is why it’s always a good idea to use stops. Another thing you can do is wait for the index to give you an att ractive >40
>45
>50
>55
>60
>65
>70
2007
18.50
14.50
32.00
51.25
33.25
11.75
15.25
75
2008
-93.25
94.25
58.50
70.75
93.25
120.50
51.00
54
40
2009
278.45
108.45
86.25
96.50
108.00
132.50
165.75
88
72
59
2010
77.50
-38.25
-13.50
-44.50
-78.30
-17.50
14.75
109
81
66
56
2011
120.00
45.25
-67.50
128.50
86.00
132.50
49.50
138
123
106
94
82
2012
131.00
64.75
72.75
134.00
191.25
213.50
172.75
193
167
145
126
105
84
2013
434.50
391.50
335.75
297.25
194.00
179.00
181.50
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 to know just so you can have an idea of how often you need to be l ong to get sufficient returns. 16 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 7: HOW MUCH DID YOU MAKE EACH YEAR? You can see there were sufficient declines during 2010 but you can’t determine how much of a return you made in a specific year.
600 400
reading and then apply a shorter-term (for example, hourly bars) trend-following system that can only buy. If it sees a breakout to the upside, then you enter a long position. If the hourly chart breaks down, you exit and wait for the next opportunity. DON’T FORGET TUNE-UPS
YOUR DAILY
You know where the index stands every day, and with that information, how can you gure out if the index is trending or not? The lters I discussed will not work since they are grouping all outcomes above or below a threshold, and that dataset may include many better or worse conditions than the current one. What you need to do is view the performance within a narrow band around the current level of the index. The most reliable levels where all the points are signicantly above zero occur when the index range midpoints are >= 60 (Figure 8). Each range band is 10 points and the size of each bubble is proportionate to the number of occurrences. I shall resist the temptation here to create a simple trading system using the index. The index can be used just for risk control but allow me t his indulgence. Let’s say you were forced to own the S&P contract. You can never be at but you can own the contract in proportion to the level of the index. The position quantity will be set at index/50 so the average position over 10 years equals close to one—1.03 to be precise. Let’s compare that with the S&P 500. You can see from Figure 9 that there a re still some severe pullbacks. That’s because you must be long through all markets but the drawdown is 40% lower and the total number of points earned is almost three times greater. BOOST
d e n r a E s t n i o P P & S l a t o T
200 0 -200 -400 -600
-20
0
20
40
60
TOP
IT UP WITH FOREX
You may not have a strong feeling for how the euro or the British pound may be affected by an S&P rally, but you know there are some reliable associations between the S&P index and the foreign exchange markets. The Japanese yen has been a place of refuge during periods of western turmoil and the Australian dollar is a commodity producer that outperforms during good economic times or when the S&P rallies. Let’s look at the Australian dollar but adjust for the general direction of the US dollar by dividing by the price of
100
120
Interval Range Midpoint FIGURE 8: LOOKING AT A NARROWER RANGE. The size of each bubble is
proportionate to the number of occurrences. Each range band is 10 points. The most reliable levels where all the points are significantly above zero occur when the index range midpoints are >= 60.
2000 1500
Cum ES
Cum System
1000 500 0 -500 -1000
1 1 1 1 1 1 2 1 2 1 3 1 3 1 3 1 4 1 4 1 5 1 5 1 5 7 0 7 0 8 0 8 0 9 0 9 0 9 1 0 1 0 1 0 0 2 0 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 2 0 2 0 2 0 2 0 2 0 2 0 2 2 / 1 / 6 / 5 / 1 / 3 / 3 / 8 / 7 / / / / 3 / 9 / 0 / 1 / 7 / 7 / 2 / 5 / 4 / 8 / 7 7 8 2 0 / 3 / 2 / 1 / 0 / 0 / 2 / 1 / 0 / 2 / 2 / 1 / 0 / 0 / 2 / 1 / 0 / 2 0 2 2 1 / / / / / 5 0 9 0 2 0 7 1 1 8 1 2 0 5 1 0 0 3 0 7 1 2 0 5 1 0 0 3 0 7 1 2 0 5 0 9 0 2 0 7 1 2 0 0
FIGURE 9: S&P 500 VS. TRADING ONE ES CONTRACT WITH VARYING POSITION SIZES. You can see there are some severe pullbacks. That’s because you
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.
the euro (Figure 11). I do this so I can see the underlying behavior of the Australian dollar without the macro effect. For this, I would use the following rules:
THE OCTANE WITH BONDS
An index that helps project equity returns might also indicate when to buy or reduce bond exposure, since bonds, in t he short run, are extremely negatively correlated to the S&P contract. From Figure 10 you can see t hat the average bond return over this 10-year period is 0.027 points per day. There has been a huge upward tilt in bond prices. Notice how as the index reaches bullish levels, the retur ns on bonds fall precipitously. Even if you only trade bonds, you still can use this index to manage your exposure or duration.
80
1. Buy the A$/EC cross if the index is > 65 2. Short the A$/EC cross if the index is < 35. If the index is between 65 and 35, you wouldn’t take a position. Continued on page 45
18 16 14 12 10 8 6 4 2 0 -2 -4
Filter
Avg Ret
>40
0.032
>50
0.019
>60
0.011
>70
0.006
>80
0.012
>90
-0.004
FIGURE 10: WHAT ABOUT BONDS? The average bond
return over this 10-year period is .027 points per day. Notice how as the index reaches bullish levels the returns on bonds fall precipitously. Even if you only trade bonds, you still can use this index to manage your exposure.
A$/EC
7 0 7 0 8 0 8 0 9 0 9 1 0 1 0 1 1 1 1 1 2 1 2 1 3 1 3 1 3 1 4 1 4 1 5 1 5 0 0 2 0 2 0 0 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 2 0 2 2 2 / / / / / / / / / / / / / / / / / / / 8 4 8 1 6 1 6 9 2 3 8 0 8 0 4 5 1 2 7 0 2 2 1 1 0 2 2 1 0 2 2 1 1 0 3 2 1 1 / / / / / / / / / / / / / / / / / / / 6 2 6 2 6 1 3 9 3 8 2 8 2 8 1 7 1 7 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 1 0 1
FIGURE 11: TRADING THE AUSSIE/EURO CROSS. There’s a relationship between
the S&P500 and just about everything, including currencies. Study those relationships and see how you can take advantage of them. March 2017 • Technical Analysis of STOCKS & COMMODITIES • 17
up advising the rm on how to make it even better. His professional management experience includes both domestic and foreign tours of duty at IBM, Petrie Stores, PriceWaterhouseCoopers, 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 KEVLAR
Get Your Bullet-Proof Vest On
This Butterfy Wears Kevlar Butteries are a well-known options trading strategy. But here’s one that’s a little different.
by John A. Sarkett
In
the history of options tradi ng, Jim Riggio goes “way back.” He started trading more than two decades ago. He was among thinkorswim’s rst 100 clients; trained as an engineer, with degrees in computer science and information management, he admired their advanced platform so much he became a broker there, and wound
18 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
BEHIND
All the while, there was one constant: He was trading options himself, for his own account, and all the while honing, perfecting, and striving to perfect his methods. The passion never subsided through the serpentine path of ups and downs that every veteran trader knows. Capital preservation became his focus and is what makes his approach somewhat different. 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 tions traders, collect time premium (positive theta), I used to think that my short gamma and short vega were just things that I would have to accept. Which I did. Until the implosion of 2008, when I made it my life’s mission to collect theta without, or at least with drastically reduced, gamma and vega risk.” Thus, the Kevlar buttery was born. The name came not from Riggio himself but from a student, who, on grasping its power and efcacy, said,
/ A N Y R I N A B R O H : R N A O L S V I E R K R O W O M L L E N E I T Y / S R I E R T H N C : U E H Y G L A L F L R O E C T / T K U C B O : Y T L S F R R E E T T T T U U H B S
OPTIONS
“Wow, this buttery can survive huge market Profit/Loss by Change in SPX Index Price $ moves ... it’s like the buttery is wearing 90000 +610% T+37 81000 +550% a Kevlar jacket or something.” The name T+19 72000 +490% T+0 stuck. (Kevlar is the near-indestructible 63000 +430% synthetic ber used in helmets and bul 54000 +370% letproof vests.) 45000 +310% Most buttery traders start with short 36000 +250% strikes at-the-money (ATM). Most every 27000 +180% options textbook or trainer depicts the but18000 +120% tery that way. The Kevlar buttery is notably 9000 +61% different. It starts with a below-the-money 0 0% (BTM) buttery that shows negative delta -9000 -61% -18000 -120% but neutral or positive gamma. So in that -27000 -180% sense, it can be viewed as “bea rish.” -36000 -250% But there’s more, much more to the method -45000 -310% than that, and it can generate prots in up markets as well. Its success is based on a profound respect for the destructive capabili - FIGURE 1: LOW IV AND STE EP PUT SKEW. Here you can see that puts well below-the-money are expenties of vega and gamma: “The Kevlar’s 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 nea r zero and drastically lower short vega when He has two distinctly di fferent 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 doesn’t mean the market is not still trying to take my Options. Change the lter 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 tery at Capital Discussions, a new trade education and alert volatility calculation method is reected (such as volatility service featur ing several top mentors he cofounded with op - smile or individual i mplied volatility). tions veteran Tom Nunamaker. To his method, which volatility environment he is in at a given time makes a signicant difference. Once he determines where we are in the volatility universe, he feels condent to HOW HE TRADES IT Riggio’s 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) buttery paired with exible. He explains: “The reason is that the risk, especially a deep in-the-money (ITM, with at least 60 delta) call. In t he 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 highgo home … and start the next trade with 60 to 80 days to volatility environment and normal-to-at 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 buttery (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. Here, the spacing is a right wing that is 75 points above the takes to keep it low. All this seems sound and reasonable enough, but what short stri ke, and the left wing is 100 points lower. If the SPX makes his approach unique is the entry scenar io about which is 2050, then the BWB is put on at 1900/2000/2075. There’s he is quite part icular: 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 it’s easier to trade all one type, for exa laser. ample, all puts, he will employ iron butteries (short put credit 1832.50
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+4.4%
March 2017
2182.50
+6.1%
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2287.50
+11.2%
• Technical Analysis of STOCKS & COMMODITIES • 19
Profit/Loss by Change in SPX Index Price
$ 120K
+240%
110K
T+56
+220%
100K
T+28 T+0
+200%
90K
+180%
80K
+160%
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0K -10K
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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%
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+11.2% +13.0%
FIGURE 2: HIGH IV AND NORMAL-TO-FLAT PUT SKEW. In this scenario, a below-the-money (BTM) put broken wing butterfly is put on. The upper strike is usually 25 points above SPX price. This position has much more negative vega. Here, the spacing is a right wing that is 75 points above the short strike, and the left wing is 100 points lower.
TRADE
spread under a short call credit spread) to generate credits and conserve capital. The Kevlar buttery m itigates risk by having a negative delta and a at T+0 line. He says: “In a market decline, the S&P 500 market price must travel through my prot zone to get to my risk zone. Th is gives the Kevlar a strong defensive position for a ma rket selloff,” he says. Offense sells tickets, he says, but defense wins championships. MANAGING
POSITIONS
While he is fai rly rigid about entry, his adjustments are managed by the options greeks. To lift his T+0 (today’s prot-loss sum), he employs a variety of tools to atten the prot peak and generate credits. These might include “condorizing” his position with additional credit spreads, moving his position up or down, or just adding long puts or calls. Veteran trader that he is, Riggio has a visceral reaction for how fast a prot can turn into a loss in an other wise “brilliant” options strategy, so his rst “adjustment” can be as simple as taking a trade off when it reaches approximately 10% prot, either entirely or by partials. For example, if a buttery has 6 x 12 x 6 contracts, he might take off 2 x 4 x 2. If he feels motivated to stay in a position—which, by the way, is a function of the math, not a “ feeling”—he will look at a large variety of what ifs including but not limited to leaving the position as is, selling calls, selli ng put condors (balanced or unbalanced), adding put or credit vertical s, and more. What are his “rules?” He is not comfortable with the concept of “rules,” per se, and tells why: “It is beyond naive to thi nk that if you can get the perfect set of rules you will conquer the options game. Anyone who learns sound options trading skills a nd who masters risk management methodology should be able to become a protable options trader. “It is all about understanding the tradeoffs when you are making decisions. I could put together a very, very long list 20 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
of rules ... for all the market conditions that I can think of, such as ... price, price trend, speed of price move, greeks (today), greeks (in one week from now), strikes, expiration cycle, days to expiration, implied volatility, skew, term structure, kurtosis, trade congurations, tape reading, knowing when you should be scared, and so on. These factors would all vary for every option structure. For example, if we had an existing broken wing buttery with 100 points left wing vs. 75 right wing ... and when to adjust with a symmetrical 25 wide wing put condor vs. a 25/40 point asymmetrical condor ... and this would be different if the center was 25 vs. 50 points below the current SPX point ... and this would be different if the Brexit vote or US elections were tomorrow ... and this would be different if ... Do you get my point? There are just too many potential ifs.”
SMART
“I could write 100,000 r ules, and the next day, something will happen in the market that I will need to write a nother 20 rules ... and following that, another 30 rules ... and the week after that ... well, you get the pictu re.” For clients, he winnows down this mass of potentiality to a simple, specic recommendation, sent out by email and text as a real-time trade alert. And his platform keeps score with a documented trade record and cumulative equity curve. “We are transparent,” he says simply. Most recently, while this piece was being written, in his current live trade, he elected to do that simplest and easiest adjustment: “This old geezer is going to close the O ct Kevlar, pick up my piggy bank, get a glass of lemonade, go to the bathroom (if I a m going to get out of my rocking chai r, why waste the tr ip), and then go and sit back in my rocki ng chair with my measly 10% prot for the month.” Self-deprecating, humorous, but with decades of options wisdom stuffed into one pithy statement, he says: “I know I’m not smarter than the market.” Which is why he puts on Kevlar garb when he ventures into it. And advises others exactly how to do the sa me. Continued on page 25
Anyone who learns sound options trading skills and who masters risk management methodology should be able to become a profitable options trader.
Too Much Braun
The Grand Illusion Is the economy as strong as it looks? The charts may suggest the economy is strong but the real answer lies between the price bars. Let’s take a peek.
by Tim W. Wood, CPA
A
rising stock market—it gives us a warm, fuzzy feeling; it puts us in a state of complacency because it makes us think that everything is going to be just ne. In reality, that may not be the case. And here’s why.
GETTING TOO INFLATED I believe economic issues began in 20 00 and have only been made worse. The world economy is in a systemic cr isis and we are in a stock market bubble that has resulted from attempts to resuscitate the underlying economy. In spite of equities’ push to a new high in 2007 and again in 2016–2017, I have held all along that the secular bull market pea ked in 2000 along with the underlying economy. The rst attempt at stimulating the economy and resurrecting the secular bull market came in the wake of the decline 22 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
into the 2002 four-year cycle low. Those efforts resulted in what was, at the time, the longest cyclical extension since the inception of the Dow Jones Industrial Average (DJIA) in 1896, which in turn resulted in a banki ng crisis, a commodity bubble, and a housing bubble. Then, when the extended cycle nally began to roll over, the end result was the worst nancial crisis seen since the Great Depression. Yet the response to the worst nancial crisis since the Great Depression was an even more extreme version of the same policies that helped create the problem in the rst place. Those resuscitation efforts have, for the most part, failed to stimulate the economy and have instead created an equity bubble. In 2015, the equity ma rkets began what is sti ll a ginormous topping process. After the initial decline into the August 2015 low, I expected there would be false bottoms and false rallies. Since the topping process rst began in 2015, there have been four intermediate-term advances, with the most recent carrying the market to yet another new high, and there have been three intermediate-term declines with the fourth pending as of January 2017. Admittedly, I did not anticipate the extent or duration of these rallies being what they have
/ 4 S O G N I R G : N S O S E I I C R N R E O R M R E U I N C T S D I L R R H O C : W / E E G L A B L B L U O B C / E K L C B O U T O S R D E : T R T A U E H B S
CYCLES
been. However, the duration of 2300 S&P 500 2200 these rallies has not changed 2100 the fact that the advance out of 2000 1900 the 2009 low has been the most 1800 1700 extended cyclical advance 1600 1500 since 1896. 1400 1300 In spite of the duration of the 1200 1100 overall advance out of the 2009 1000 900 low or the four intermediate4 800 term advances that have fol700 4 4 600 4 lowed in the wake of the August 500 400 4 2015 low, there has still been 300 4 200 no meaningful effect on the Bullish/Price Volume Characteristics Bearish/Price Volume Characteristics 4 100 associated with the Secular Bull Market associated with the Secular Bear Market 0 underlying technical or funda25000 mental data, much less in the 20000 underlying economy. The three 150000 intermediate-term declines 10000 5000 and recoveries in 2015–2016 0 caused great confusion while 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, volume expanded as price rose and contracted on the declines, which is bull ish behavior. The bullish price/ volume relationenormous complacency. 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 report s US economic condence 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 t ime and which I Since the i nception 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 the most extended four-year cycle advances in stock market potentially be revisited. history, the price/volume behavior remains bearish. Thus, in spite of the most coordinated global intervention efforts in WILL THE BUBBLE POP? I’m going to take a moment and step back to look at the the history of the stock ma rket, 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. I’ll rst 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 fourprices 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 ma rket 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 pr ice moved into the extended extended cyclical advance 2007 four-year cycle top. As prices moved down into the 20 09 since the inception of the extended four-year cycle low, you see that volume expanded. Following that low, the bearish volume behavior was further Dow Jones Industrial Average conrmed. The declines into the 2010, 2011, and 2015 lows in 1896. also conrmed this. But then in 2015–2016, as price began going parabolic into those tops, volume continued to shrink, 1984 198 5 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
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 23
right? Wrong! The di fference is that, li ke M2 Velocity the extended rally into the 2007 top, it was not organic. It was manufactured and it lacks the underlying foundation of secular bullish volume. The extended advance into the 2007 top was a ma nufactured, synthetic event that imploded, and while the current advance has stretched further than ever imagined, my belief all along has been that this time will be even worse. Next, I’ll look at the money supply (M2). On the velocity of M2 chart in Figure 2, you can see a divergent top that occurred in conjunction with the 2000 top in equities, which clearly telegraphed the peak i n the underlying economy and 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 ma rket top. These two pieces which clearly telegraphed the peak in the underlying economy. This could suggest a secular bull market top. But what about the continued contraction in M2 velocity that has reached the lowest levels since the inception of data are related. 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 WHAT’S NEXT? were able to positively inuence 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 there’s the uptur n 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 deationary forces surrounding these There’s a continued contraction and the lowest levels since secular tops back in 20 00 that the Money Masters have the inception of this data in 1959. In spite of what economists been ghting ever since. say, my belief is t here has been no economic recovery. In fact, 3. These charts show that the monetary policies in associait 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 characteristics of the market and other technical Labor Force Data data, the bigger picture begins to come into focus. I want to point out that the JPR peaked in 2000, along with the stock market and the initial contra ction of the velocity of M2. Interesting how that works! This is all related. Here too, note that the liquidity campaign associated with the 2002 to 2007 extended four-year cycle did positively inuence this data in that it nally found a bottom in late 2004 and there was an upturn into late 2006. It is also interesting to note here that the peak in late 2006 followed the April 2006 peak in the velocity of M2. Makes sense, doesn’t it? But now look at what has happened in conjunction with the extended four-year cycle advance out FIGURE 3: THE BIGGER PICTURE COMES INTO FOCUS. Job participation rate (JPR) peaked in 2000, along of the 2009 low. It collapsed, which is with the stock market and the initial contraction of the velocity of M2. Note also that the peak in late 2006 folconsistent 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. 220
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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 underlying economy than they were in conjunction with the advance into 2007.
Jurik algorithms deliver low lag, low noise analysis
So not only has there been a diminishing return, but these policies may have failed with regard to the underlying 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 in a massive and unsustainable bubble. In short, it has all gone to equities, which has served as camouage for the underlying economy.
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ACCEPT REALITY
Throughout the extended advance into the 2007 top, reination efforts were only making matters worse. In my opinion, efforts to extend this advance are not only making matters worse, but this time I think it will be far worse than the extension of the previous cycle that led to the 2007 top. This extended advance rst began trying to peak in 2015, and now with the lat est advance following the election, along with the associated complacency and optimism, I feel this is the most dangerous stock market environment since the inception of the DJIA in 1896. It has been a “grand i llusion” and the market has served as camouage for the continued deterioration of the underlying economy. The ongoing evidence that we are in a massive topping process is telling us that the global monetary policies are now failing with respect to the markets. No amount of twisting or manipulati ng of any other data changes or negates this data. The bottom line is that there has been no economic recovery. Like the extended advance into the 2007 four-year cycle top, this entire advance has been a manufacture d event within the context of a secular bear market, and this time, the bubble is even bigger. While most don’t see it, this bubble is very large and we are in a very ugly topping process. I believe the consequences of this extended advance are going to come
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with an extremely heavy price. The post-election advance has generated maximum complacency. Don’t be fooled. Tim Wood is the author of the newsletter Cycles News And Views. He can be reached via his website, cyclesman.com, by email at
[email protected], or by phone at 504 2089781. FURTHER READING Edwards, Robert D., and John Magee [1948]. Technical Analysis of Stock Trends. Wood, Tim [2016]. “The Reckoning,” Technical Analysis of STOCKS & COMMODITIES, Volume 34: March. ‡MetaStock ‡See Editorial Resource Index
OPTIONS
SARKETT/THIS BUTTERFLY WEARS KEVLAR Continued from page 20
John A. Sarkett is the author of Option Wizards: Real Life Success Stories From The Financial Markets And Market Mentors (http://option-wizard.com). He writes frequently for the financial press and has been a contributor to S TOCKS & C OMMODITIES magazine since 1995. Sarkett may be reached at
[email protected]. More on Jim Riggio and veteran options trader and educator Tom Nunamaker can be found at http://capitaldiscussions.com and http://kevlartrade.com.
FURTHER READING Sarkett, John A. [2017]. “A Road Trip With Options Supertraders,” Technical Analysis of STOCKS & COMMODITIES, Volume 35: February. †See Traders’ Glossary for definition
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 25
A Quicker Reaction
Buy & Sell Pressure And A Faster RSI Most of you are familiar with the relative strength index (RSI), but are you taking full advantage of it? Here, we deconstruct the RSI to lead to a more intuitive and symmetrical gauge of buying and selling pressure and a more responsive indicator.
by Tushar S. Chande, PhD
M
any novice and even intermediate t raders have told me over the years that t hey nd the ever-popular relative strength index (RSI) indicator c onfusing. The RSI is an oscil lator plotted on a scale of zero to 100, and is typica lly used as a n overbought/oversold indicator, which means that it is used to signal impending reversals in direction. However, during strong trends, the RSI can remain at “extreme” levels, either high or low, for the duration of the trend, and thus, it’s not precise as an indicator of impending reversals. This is partly due to range compression, which I will discuss later in this article.
DIGGING
DEEPER
Even expert technicians have expressed their concern about the smoothi ng built into the indicator. In brief, calculations begin by separating daily changes into absolute values separated by days on which a market (or stock) closes up on the day or down on the day, so that there 26 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
are two columns of positive numbers, one showing today’s close minus yesterday’s close (changes on up days or zero), and the other featuring yesterday’s close minus today’s close (changes on down days or zero). These two columns of positive numbers are then smoothed using a variation 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 27day 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 0–100 scale.
THE
TROUBLE WITH RANGE COMPRESSION
The complaint arises because the intermediate ratio, relative strength, is calculated using relatively long EMAs, which therefore have a long memory (that is, they need a lot of data to stabilize and are heavily inuenced by old data) and make the RSI practically unresponsive as the length of the lookback period increases. I have previously proposed a solution to this problem via the stochastic RSI or stochRSI. A bigger problem is that because the RSI is plotted on a xed 0–100 scale, as opposed to an open scale with no upper or lower limit, there is massive range compression at the extremes, or the
/ O I D U T S N 2 A O S R : I R D R U O O L M C E D N I N T A S I H T R H R A C : H E C / I G A K I L L H O O C N / A K H : C O C I T H S P R A E R T G T Y U H U B S
INDICATORS
area of the most interest. Visualize the two columns of daily close-to-close changes described earlier as buying pressure or selling pressure. If there is strong selling pressure, the absolute daily close-to-close changes on down days will be much greater than the close-to-close changes on up days. So the ratio of selling pressure to buying pressure could be 10:1 or greater (and vice versa). Imagine a stock that surges on strong earnings, with strong buying over many days as investors follow through. In this case, the proportion of buying to selling pressure, that is, t he ratio of the average of up-day close-to-close changes to the average of the down-day close-to-close changes, could move from 3:1 to 12:1, a 300% increase, and yet the RSI would only shift from 75.0 to 92.31, a mere 23% increase. As a short-term trader, you would rather be alerted to the 300% increase in buying pressure than a 23% increase in RSI. The range compression gets even more extreme as the ratio of buying pressure to selling pressure increases. In defense of the design of the RSI, it is a brilliant and practical solution to the problems of its time, when computers were uncommon and data were plotted by hand. In order to speed up hand calculations, the use of moving averages that required just one row to be ca lculated anew each day was most convenient, even essential. Similarly, the ability to plot RSI data on a xed 0 –100 scale greatly simplied the problem of updating a large number of charts by hand. However, today we can rework the problem to overcome these c omputational or charting challenges.
UNDERSTANDING RSI CALCULATIONS I’ll illustrate the quirks of the RSI calculations using a few simple calculations. First, I show the smoothing factors built into the calculations (see Figure 1). The rst column shows a range of lookback periods ranging from six to 42 days incremented in steps of two days. The smoothing factor corresponding to e ach length of RSI is simply an inverse of the length (see column 2). The equivalent length of the corresponding EMA i s shown in column 3, using the usual formula that the index of the EMA is given by (2/ (L+1)), where L is the length of the average. Clearly, if you want the RSI to respond more quickly to ma rket changes, you can shorten the length, or simply change the type of moving average used to calculate the smoothed quantities used in the calculations. In Figure 2, I illustrat e the range compression feature of RSI calculations by constructing a series of hypothetical values for the up-closes and down-closes EMA. I rst vary t he up-closes EMA from 10 to 1 in steps of 1, while keeping t he down-closes EMA xed at 1 (see columns 1 and 2, and the rst 10 rows in Figure 2). I compute the relative strength (RS) by taki ng the ratio of the values in the rst two columns. The fourth column converts the RS values into the equivalent RSI values using the formula RSI = (1-(1/(1+RS))*100. Note the range compression: When the RS increases from 1:1 to 10:1, the RSI only increases from 50 to 91, approximately. The range compression also works simila rly on the downside. For example, when the
RS decreases from 1 to 0.1, a 10-times drop, the RSI itself drops from 50 to 9 or so. The xed range has two effects: nonlinear range compression, and asymmetric values. First, when the range compression is nonlinear, the greater the difference between the up-closes and down-closes averages, which is precisely when the indicator should be drawing your attention to that stock or market. Second, though the displacement from the center is symmetric, the numeric readout Up-closes EMA
Length of RSI
Smoothing Factor
Effective Length of EMA
6
0.16667
11
8
0.12500
15
10
0.10000
19
12
0.08333
23
14
0.07143
27
16
0.06250
31
18
0.05556
35
20
0.05000
39
22
0.04545
43
24
0.04167
47
26
0.03846
51
28
0.03571
55
30
0.03333
59
32
0.03125
63
34
0.02941
67
36
0.02778
71
38
0.02632
75
40
0.02500
79
42
0.02381
83
FIGURE 1: SMOOTHING BUILT INTO THE RELATIVE STRENGTH INDEX (RSI). The smoothing factor seen in column 2 is an inverse of the length of the RSI.
Down-closes Relative Strength Relative Strength EMA (RS) Index (RSI)
10
1
10.0000
90.91
9
1
9.0000
90.00
8
1
8.0000
88.89
7
1
7.0000
87.50
6
1
6.0000
85.71
5
1
5.0000
83.33
4
1
4.0000
80.00
3
1
3.0000
75.00
2
1
2.0000
66.67
1
1
1.0000
50.00
1
2
0.5000
33.33
1
3
0.3333
25.00
1
4
0.2500
20.00
1
5
0.2000
16.67
1
6
0.1667
14.29
1
7
0.1429
12.50
1
8
0.1250
11.11
1
9
0.1111
10.00
1
10
0.1000
09.09
FIGURE 2: RANGE COMPRESSION IN RSI CALCULATIONS. When the RS increases from 1:1 to 10:1, the RSI only increases from 50 to 91, approximately. When the RS decreases from 1 to 0.1, a 10-times drop, the RSI itself drops from 50 to 9 or so. March 2017 • Technical Analysis of STOCKS & COMMODITIES • 27
Up-closes Down-closes EMA EMA
M O C . S T R A H C K C O T S
Relative Strength
RSI - Relative Chande Buy/Sell 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
7
1
7.0000
87.50
7
6
1
6.0000
85.71
6
5
1
5.0000
83.33
5
4
1
4.0000
80.00
4
3
1
3.0000
75.00
3
2
1
2.0000
66.67
2
1
1
1.0000
50.00
1
1
2
0.5000
33.33
-2
1
3
0.3333
25.00
-3
1
4
0.2500
20.00
-4
1
5
0.2000
16.67
-5
1
6
0.1667
14.29
-6
to selling pressure, that is, buy/sell pressure or BSP. I use the following formulas: If RS < 1, CBSP = -1/RS and If RS >= 1, CBSP = RS. You can just as easily rewrite t he CBSP using the RSI values directly as follows: If RSI < 50, then CBSP = (0.01*RSI-1)/(0.01*RSI), else (RSI >= 50), then CBSP = (0.01*RSI)/(10.01*RSI)
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 is greater—the buying or sell ing pressure. 1 8 0.1250 11.11 -8 In Figure 3 I show how the RSI values can be 1 9 0.1111 10.00 -9 converted into BSP values using the same synthetic 1 10 0.1000 9.09 -10 data as i n Figure 2. First, when you compare columns FIGURE 3: BUY/SELL PRES SURE CONVERTED FROM RSI FIXED SCALE TO OPEN SCALE. 3 and 5, note that BSP is the same as RS when the The open scale tells you instantly the relative magnitudes of the two pressures, and the sign RS is >=1, but is equal to -1/RS when RS is < 1. The tells you which is greater. convenience of this denition 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 rst 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 li ne, when the selling pressure is 10 ti mes the buying pressure, BSP = -10. HANDE BUY S ELL PRESSURE Thus, the open scale instantly tells you the relative magC / (CBSP) I would like to convert the usua l RSI calculations away from nitudes of the two pressures, and the sign tells you which is the xed 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 DD gapped higher, and rallied hard through early 70 50.79 December, ending with an exhaustion gap. In Fig30 10 ure 4 you see a chart of the DD price action along 74 with the 14-day RSI in the upper panel. Observe 72 70 how the RSI values remai ned above 70 for more 68 66 than 45 days as DD trended h igher. 65.42 64 I reproduced the RSI calculations from Figure 62 60 4 in an Excel spreadsheet (see Figure 5) to pro58 56 vide the bridge to a later discussion. The ending 54 value, on December 31, 2015, is 50.79, which is 52 the same in Figure 4. Thus, I can cross-check my 50 48 calculations against a commercial package for 46 completeness. I can now use the RSI calculations 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 in Figure 5 and compare them directly to buy/sell FIGURE 4: BUY/SELL PRESSURE IN DUPONT (DD). Dupont rallied in late 2015 and the RSI pressure calculations (see Figure 6). stayed above 70 for more than 45 days.
28 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
Dupont: 14-day RSI with Wilder’s Smoothing RSI
Up Ref
Wilder’s RSI
100 90 80 70 x e d n I h t g n e r t S e v i t a l e R
60 50 40 30 RSI = 50.79
20 L E C X E T F O S O R C I
Dupont Rally captured via Wilder’s RSI and Chande Buy/Sell Pressure
Dn Ref
Buy/Sell Pressure
120
12
110
n 11 i
) 100 I S R ( 90 x e d 80 n I h t 70 g n e r t 60 S e 50 v i t a l e 40 R s 30 ’ r e d l i 20 W
10
g
h t 10 o o m 9 S r e l i 8 d W t 7 h i w e 6 r u s 5 s e r P 4 l l e S y 3 / u B 2 e d n a 1 h C
RSI Flattening
CBSP Surging
0
10 0
5 5 5 5 5 5 5 5 5 5 5 5 5 5 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / 0 7 4 1 8 4 1 8 5 2 9 6 3 0 3 0 1 2 2 0 1 1 2 0 0 1 2 3 / / / / / / / / / / / / / / 9 0 0 0 0 1 1 1 1 2 2 2 2 2 0 1 1 1 1 1 1 1 1 1 1 1 1 1
M
FIGURE 5: 14-DAY RSI WITH WILDER’S SMOOTHING. Here, the RSI calculations were reproduced in an Excel spreadsheet. The RSI value of 50.79 on December 31, 2015 is the same as in Figure 4.
The rapid acceleration in buying pressure is more intu itively obvious in Figure 6, even as the RSI values begin to atten out, topping out above 90 for BSP > 10, as can be expected from the calculations in Figure 3. I’ll now briey revisit the internals of RSI smoothing. Wilder’s formulation does not quite follow the usual EMA formula. For example, for a 14-day RSI, it adds 1/14 of the new value to 13/14 of old value, instead of adding 2/15 of the new value to 13/15 of the old value to compute the updated averages. This subtle change slows down the RSI computations. I compared the RSI values during the DD rally using the t wo different smoothing schemes in Figure 7. The “proper” EMA formulation, denoted by “standard EMA smoothing” in Figure 7, responds more quickly than the Wilder formulation, which
FIGURE 6: WILDER’S RSI VS. BUY/SELL PRESSURE. The values are consistent with those in Figure 3. The buying pressure was 10 times the selling pressure (values above 10) with RSI greater than 90 just before DD flattened out in mid-November. The acceleration in CBSP values makes the buying pressure more obvious than the flattening out seen in RSI values.
should be expected since I am using a larger fraction of the incoming data (0.13 vs. 0.07) to update the new value for the moving averages used to calculate the relative strength.
THE
SPILL IN KIMBERLY CLARK
The shares of Kimberly Clark (KMB) had a bit of a spill in late 2016. These defensive stocks have been following the bond market lower, after bonds peaked in the immediate aftermath of the “Brexit” scare. I show in Figure 8 how the selling pressure reached -4, with the RSI in the range below 20, as is expected from Figure 3. The CBSP instantly communicates selling pressure four times the buying pressure, whereas the RSI readout is merely an oversold condition below 30. Thus, when you compare the pressure of buying
Dupont: RSI with Wilder’s vs. Standard EMA Smoothing RSI Standard EMA Smoothing
0
5 5 5 5 5 5 5 5 5 5 5 5 5 5 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / 0 7 4 1 8 4 1 8 5 2 9 6 3 0 3 0 1 2 2 0 1 1 2 0 0 1 2 3 / / / / / / / / / / / / / / 9 0 0 0 0 1 1 1 1 2 2 2 2 2 0 1 1 1 1 1 1 1 1 1 1 1 1 1
Kimberly Clark: RSI vs. CBSP (1:4 Selling Pressure)
Wilder’s RSI
80
120
RSI
Up Ref
Dn Ref
CBSP
3
70
2
60
1
50
0
40
-1
30
-2
20
-3
10
-4
0
-5
100 ) I S R ( x e d n I
h t g n e r t S e v i t a l e R
80
60
40
20
0 5 5 5 5 5 5 5 5 5 5 5 5 5 5 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / 0 7 1 8 1 8 5 2 9 6 3 0 3 0 1 4 2 2 0 4 1 1 2 0 0 1 2 3 / / / / / / / / / / / / / / 9 0 0 0 0 1 1 1 1 2 2 2 2 2 0 1 1 1 1 1 1 1 1 1 1 1 1 1
FIGURE 7: WILDER’S RSI VS. STANDARD EMA SMOOTHING. The RSI calculation using the standard EMA formula reacts faster because it uses a larger proportion of new data to update it s internal moving averages. The more responsive RSI can be quite attractive to short-term traders.
) I S R ( x e d n I h t g n e r t S e v i t a l e R
6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 1 0 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 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 2 / / / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 6 / 0 1 2 3 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 9 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
FIGURE 8: RSI CA LCULATION AND CBSP. The selling pressure here is four t imes the buying pressure, giving a CBSP reading of -4, intuitively clarif ying that the stock is under significant selling pressure. The RSI readout at about 20 merely shows an oversold condition. Thus, the CBSP gives symmetrical r eadings (4:1 or 1:4, that is, +4 or -4) for the intensity of buying or selling pressure. March 2017 • Technical Analysis of STOCKS & COMMODITIES • 29
) s e l c r i c n e p o h t i w h p a r G ( e r u s s e r P l l e S / y u B e d n a h C
NFLX: RSI with Wilder’s Smoothing and Standard EMA Smoothing Standard EMA RSI
RSI Wilder Smoothing
100
h t g n e r t S e v i t a l e R
Standard EMA CBSP g n i h t o o m s l a n r e t n i t n e r e f f i d h t i w e r u s s e r P l l e S / y u B e d n a h C
90 ) I S R ( x e d n I
Buy/Sell Pressure with Wilder vs. Standard EMA Smoothing
UP Ref
80 70 60 50 40 30 20 10 0
6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 0 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 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 2 / / / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 0 1 2 3 0 0 0 / 0 / 0 / 0 / 0 / 0 / 0 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 2 / 2 / 2 / 2 / 2 / 2 / / / / 9 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 0
FIGURE 9: PRICE JUMPS AND RESPONSE TIME. The 20% or so jump in NFLX in a single day was heavily damped in the RSI calculations using the Wil der smoothing formula. However, using the standard exponential moving average formula led to a faster response from the resulting RSI.
The open scale instantly tells you the relative magnitudes of the buying and selling pressures, and the sign tells you which is greater, making it a more intuitive formulation of buying and selling pressure, and closer to the natural price action. or selling, the CBSP gives a more intuitive readout of which side is dominating and by how much.
A SURGE IN NETFLIX Traders and investors rewarded Netix (NFLX) with a 20% or so jump in stock price when the company’s performance exceeded expectations in October 2016. The sudden one-day jump in price shows the lags due to the smoothing built into RSI calculations. I rst compared the standa rd 14-day Wilder RSI calculations to the RSI calculat ions using a standard 14day EMA (see Figure 9). It is clear that the Wilder smoothing built into the RSI is less responsive than the usual denition of an EMA. The corresponding buy/sell pressure calculations can be seen in Figure 10. Once again, the calculations using the regular EMA formula respond much more quickly. This intuitively shows that the buying pressure is six times greater than selling pressure. This is easier to absorb than just a n RSI reading 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 discretionar y 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
Wilder Smoothing
7
6
5
4
3
2
1
0
6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 6 1 0 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 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 0 2 2 / / / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9 / 0 / 1 / 2 / 3 / 4 / 5 / 0 1 2 3 0 0 0 / 0 / 0 / 0 / 0 / 0 / 0 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 1 / 2 / 2 / 2 / 2 / 2 / 2 / / / / 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
FIGURE 10: BUY/SELL PRESSURE WITH WILDER VS. STANDARD EMA SMOOTHING. The Chande buy/sell pressure (CBSP) calculati ons using the regular exponential average definitions responded more quickly to the one-day jump in NFLX than the CSBP calculati ons 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 symmetric, open-scale variant that instantly summarizes the relative magnitudes of buying or sell ing pressure. Remember that because the core calculations are closely related, the “shape” of the variations will look alike, though the numerical readouts will differ. Tushar Chande, PhD, MBA, has two decades of experience trading the futures markets as a CTA and hedge fund head of research. He is the developer of numerous widely used original technical indicators such as VIDYA, CMO, and AROON. He is the author or coauthor of several books on technical analysis. His website, ETFmeter.com, offers trend analysis of more than 1,200 ETFs, stocks, and international indexes, and buy/sell pressure data. Users can build and rebalance risk-managed ETF portfolios.
FURTHER READING Chande, Tushar, and Stanley Kroll [1993]. “Stochastic RSI And Dynamic Momentum Index,” Technical Analysis of STOCKS & COMMODITIES, Volume 11: May. Chande, Tushar [2001]. Beyond Technical Analysis, 2d ed., John Wiley & Sons. , and Stanley Kroll [1994]. The New Technical Trader, John Wiley & Sons. [2016]. “When Is Berkshire Hathaway Stock Good Value?” Technical Analysis of STOCKS & COMMODITIES, Volume 34: Bonus Issue. ‡StockCharts.com ‡See Editorial Resource Index
FUTURES FOR YOU INSIDE THE FUTURES WORLD Want to nd 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. S he 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
[email protected] or via www.DeCarleyTrading.com. Selected questions will appear in a future issue of S&C.
ES OPTIONS Why trade ES options, and not the SPX or SPY options?
I’ve been asked on multiple occasions why I recommend S&P 500 options trades using the emini S&P futures options (ES) traded on the Chicago Mercantile Exchange (CME) rather than equity products such as the SPX or SPY. The truth is, I am a futures and options broker who deals solely in futures contracts and options on futures contracts. But besides the fact that options on futures are in my comfort zone and are the “bread and butter” of my business, there are some compelling reasons to trade emini stock index options and bypass the equity market versions.
simple: Just because the stock exchanges are closed doesn’t mean nancial markets around the world—and, therefore, emini S&P 500 futures prices—aren’t moving.
Carley Garner
report each individual trade to the IRS. Instead, he receives a 1099 with a lump sum of prot or loss. That single gure is reported on the trader’s taxes.
Lower barriers to ent ry and access to Preferable ta x treatment option-selling strategies Options on futures traders enjoy a Most equity brokers require their clients 60/40% blend between long-term and to apply separately for access to trade short-term capital gains rates on all trades options. Further, being granted the ability regardless of how long they were held or to sell options is generally reserved for which particular instruments are used. those with sizable speculative accounts. This is a signicant advantage for active For instance, most stockbrokers seem traders because most stock products to want at least $100,000 in a trading require a trade be held for more than account before option-selling strategies a year to be eligible for the discounted are a possibility (although some brokers long-term capital gains rate. will allow it in a $50,000 account). In any case, traders are expected to put up at least ve gures to trade short options Traders who trade Around-the-clock m arket access and spreads in the stock market. Futures options on futures stand options traders, on the other hand, are The primary argument for trading emini S&P 500 options versus the stock market granted cheap and easy access to short to potentially get more version, SPX, is that the futures options and options spread trading. For bang for their buck when options trade 23 hours per day. Accordingly, it is instance, my brokerage service allows they are right in their possible to exit them at any time of the day options spread trading with as little as speculations. or night, with the exception of the daily $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 insta nce, on stock products treated in this manner. on futures. election night, traders holding long SPX I’m not a tax expert, nor am I an equity puts wouldn’t have been able to exit t heir 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 acwould have had the opportunity to lock 1256 provision. You’ll need to consult count size. This means that traders who in a prot 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 benet for futures options traders side of the trade. In other words, portforesight 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. It’s 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 you’re a scalper, an int raday trader, or a longer-term trader, binary options can provide several types of trading opportunities and can work in any type of market condition. What are they and how can you trade them? Find out here.
by Gail Mercer
Y
ou have probably heard the ter m binary options, but what are they really? They’re different from traditional options and if you aren’t all that familiar with them, now’s your chance to get to know them better. Before jumping into all the different opportunities they provide, I’ll start with a review of what binary options are.
32 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
WHAT
ARE THEY?
While there are three binary options providers (Canton LP, CME, and Nadex) that are designated by the Commodity Futures Trading Commission (CFTC) as contract markets in the US, in this ar ticle, I’ll use the Nadex binary options since they offer several choices when it comes to expirations and markets (futures, commodities, and forex markets). Binary options are short-term expiration contracts that provide a limited risk and limited payout environment for traders. The maximum payout on any binary option is $100. Risk is always limited to the price paid on entry. If the binary option indicative price expires in-the-money (ITM), the full payout is received ($100). The actual prot is $100 minus price paid on entr y.
K C O T S R E T T U H S / M O C . L E X I P W A R
OPTIONS
The binary option consists of a strike statement that shows the following:
A B
• instrument • price statement • expiration date and time.
> 1.2688
Sell -
Buy 6.00
> 1.2678
Sell 1.75
Buy 8.00
> 1.2668
The binary option ladder chart in Figure 1 identies the following information:
Sell 8.00
Buy 14.25
> 1.2658
Sell 18.00
Buy 24.50
> 1.2648
• Point A—Instrument and expiration time • Point B—Strikes closest to price for the specied time period (6 am–8 am EST). On t he GBPUSD, there are always nine strikes offered for the two-hour expiration • Point C—Indicative price, which is used as the expiration • Point D—Date and time axis. CHOOSING
C 1.26391
Sell 32.25
Buy 38.75
> 1.2638
Sell 49.00
Buy 55.50
> 1.2628
Sell 65.25
Buy 71.75
> 1.2618
Sell 78.75 12:00
16:00
20:00
Dec 14
D
04:00
Buy 85.00
08:00 expiry
FIGURE 1: BINARY OPTION LADDER, GBPUSD. On this binary option ladder chart of the GBPUSD, you see the instrument, price statement, expiration date, and expiration time.
RISK LEVELS
A trader with a bias to the upside on the GBPUSD believes the binary option statement will be true at expiration. If the trader believes the statement will be true at expiration, then he clicks on the blue button to buy. The risk is limited to the price identied on the blue button (unless the trader modies the price using a limit order). Using Figure 1, the long opportunities with risk and prot potential are:
the trader believes the statement will be false at expiration, then he clicks on the red button to sell. The risk is limited to the maximum payout minus the price shown on the red button (unless the trader modies the price using a limit order). Using the earlier example, the binary short opportunities are: • The > 1.2658 strike is considered DITM because price is trading at least two strikes under it. Risk is limited to $82.00 ($100 minus $18.00). The prot potential would be $18.00.
• The > 1.2618 strike is the deep ITM (DITM) option, as price is trading at least two strikes above this level. The risk is $85 with a prot potential of $15 ($100 minus $85).
• The > 1.2648 strike is considered ITM because price is trading at least one strike under it. Risk is limited to $67.75 ($100 minus $32.25). The prot potential would be $32.25.
• The > 1.2628 strike is the ITM option, as price is trading at least one strike above this strike. The risk is $71.75 and the prot potential is $28.25 ($100 minus $71.75).
• The > 1.2638 strike is the ATM because price is currently trading at this strike level. Risk is limited to $51.00 ($100 minus $49.00). The prot potential would be $49.00.
• The > 1.2638 strike is the at-the-money (ATM) option, as price is currently trading at this level. The risk is $55.50 strike and the prot potential is $44.50 ($100 minus $55.50).
• The > 1.2628 strike is the OTM because price is trading above this strike level. Risk is limited to $34.75 ($100 minus $65.25). The prot potential would be $65.25.
• The > 1.2648 stri ke is the out-of-the-money (OTM) option, as price is currently trading below this strike level. The risk on t his option is $38.75 and the prot potential is $61.25 ($100 minus $38.75). • The > 1.2658 strike (also OTM). The risk is limited to $24.50 and the prot potential is $75.50 ($100 minus $24.50).
• The > 1.2618 strike (also OTM). Risk $21.25 ($100 minus $78.75). The prot potential would be $78.75.
When trading binary options, traders can never lose more than what they paid on entry.
A trader with a bias to t he 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 expirations available at any given time, the trader could also have chosen additional two-hour binaries, as well as daily expiration, since Nadex offers multiple daily expirations on the forex pairs. For example, there is also a 7 am, 11 am, 3 pm, 7 pm, and 11 pm daily expiration, providing traders with even more opportunities. TECHNICAL
ANALYSIS AND
BINARY OPTIONS
they paid on entry. In this case, if the trader entered the ve long positions described earlier using only the two-hour binary options from 6 am–8 am and trading only one contract each, the results would be what you see in the t able in Figure 3. Of course, the trader could have entered a single binary option or any multiple of the binary options you see in Figure 3 plus any of the daily or weekly options that were offered at the time. Binary options are also great for trendSlow Stochastic ing markets because the trader can simply build positions th roughout the day, using different option strikes as well as weekly expirations that end on Friday. And if markets are moving sideways, traders can 22:00 23:00 12/14 01:00 02:00 03:00 04:00 05:00 06:00 limit their trades to either ITM or ATM FIGURE 2: DIVERGENCES BET WEEN INDICATOR strikes. GBPUSD - 15 min
Technical analysis in the simplest of terms is a mathematical approach to creating visual tools for forecasting the direction of prices using historical data points. It is this forecasting ability of technical analysis, combined with the power of limiting risk, that makes binary options ideal for technical analysts. Take the case AND PRICE. When you look at this chart of the of divergences between indicator and price GBPUSD with the slow stochastic indicator, you see that price was making lower lows while the LEAN TOWARD SIMPLE as an example. The chart of the GBPUSD in Figure 2 slow stochastic was making higher highs. This When trading binary options, keep these divergence indicates that an upside move is likely indicates that a position to the upside was two points in mind: and you could take a position that supports an more likely because as price was making upside price movement. lower lows, the slow stochastic was making • For long positions, the indicative price higher lows—also 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 conrmation 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, mentrend (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 developprice 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 binar y options futures, forex, and binar y 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 binar y options, traders can never lose more than what tradershelpdesk.com. FURTHER
Strike ( GBPUSD )
Risk ( $)
1.2618
85.00
15.00
1.2628
71.75
1.2638
READING
Net Profit ( $)
ROI (%)
1.80
13.20
16
Mercer, Gail [2016]. “Choosing A Binary Option Provider,” Technical
28.25
1.80
26.45
37
Analysis of STOCKS & COMMODI-
55.50
44.50
1.80
42.70
77
1.2648
38.75
61.25
1.80
59.45
153
1.2658
24.50
75.50
1.80
73.70
300
275.50
224.50
9.00
215.50
78*
totals
Gross Profit ( $) Exchange Fee ( $)
FIGURE 3: TRADING THE T WO-HOUR BINARY OPTIONS FROM 6 AM–8 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
, Volume 34: November.
TIES
‡NADEX †See Traders’ Glossary for denition ‡See Editorial Resource Index
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, ema il him at
[email protected], 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 A DOLLAR MADE When I present on topics such as “trade some and hold some,” as was the sub ject of my column in this magazine last month, I have invariably been asked, “Well, what about stop-losses?” One of the benets of spread trading is the distribution of capital over a range, by chosen methodology, allowing a dollar-cost-averaging approach to hedged trading. Not having to be right on a single bet provides a reasonable level of comfort. One of the problems with spread trading is that which provides comfort also creates anxiety when the layers have been applied and things are not going swimmingly, in that you nd yourself swimming against the current. Anyone who has traded pairs or equity spreads of any kind has experienced the symbols in that spread drifting apart from each other. This presents an opportunity that is even better than your original starting point. Your plan may have included this foresight through running each potential scenario ahead of time and planning your future trades. In previous columns, I have spent quite a bit of time on this and suggested this as a process, method, and discipline. The philosophy of spread trading would be to have capital available, that the bet size would be in keeping with logical risk management formulas, and that you would capture that window of opportunity as the spread moves to outlier regions. By denition, the mean-reverting opportunity would only improve as the spread continues farther from the main distribution areas. This brings up two questions.
1. Why would anyone want to stop out a unit or layer of capital after putting it on under such advantageous conditions? 2. Does a pair trade need or require that you plan for and utilize a stop-loss? The answer is actually … yes … no … it depends. It depends on what the position size is relative to your capital and the statistica l edge. The position size might be so small that a stop-loss seems unwarranted.
Anyone who has traded pairs or equity spreads of any kind has experienced the symbols in that spread drifting apart from each other. This presents an opportunity that is even better than your original starting point. • Would you use xed stops, trailing stops, time-based stops, or are you responding to any new information, or any change in the validity of the trade? The general rule with leverage would be to utilize some form of stop-losses. So we have a quandary in spread trading—that stretched-out price, which provides a great opportunity to get in for the potential prot, is also ashing red lights of warning of exponential potential losses.
What we desire in mean-reverting trades is like the rst line of the song “Spinning Wheel” by Blood, Sweat & Tears: “What goes up, must come down.” But something that needs to be considered is from the second line: “Spinning wheel got to go round.” Applied to pairs or spread trading, that line would say to me: “Is this a oneoff, or single-opportunity trade, or is it compoundable? If it is a trade that can be repeated frequently, then it is treated differently than a t rade you have identied for this particular moment in time that might never present itself again. Traders would be less likely to require a stop-loss with pattern-based spreads that have a signicant statistical opportunity to work it over a specied range, by keeping capital sliced into layers and distributing that up to their maximum planned-for capital. This is as we have shared in the past in this column—harvesting t he noise. Back to the “hook” of this month’s column: A dollar saved becomes a dollar made. I touched on it in the February 2017 issue when I wrote, “Let’s discuss a technique for managing a pair going against you.” I went on to explain the approach: Using the last in, rst out (LIFO) accounting method for your pair, subtract a layer to reduce the losses of a pair trending against you by making the effort to reestablish that pair at a much better price. Use all your skills and indicators to place that bet when conditions are suitable. In this case, a dollar saved will become that dollar made when and if the spread travels once again in the direction of your bias. You may nd it is warranted to remove all layers Continued on page 45
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 35
INTERVIEW
Patience Is A Virtue
You don’t have to be an aggressive trader to make it as a n 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 didn’t spend a single day working at a trading desk for a nancial rm, although the thought did cross his mind. McMaster even went on to get a master’s degree in applied nance and investment, but admits that didn’t 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 ve 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. S TOCKS & C OMMODITIES Editor Jayanthi Gopalakrishnan communicated with Gavin McMaster via email in January 2017 to nd out more about his options trading journey.
Gavin, tell us a little bit about yourself and how you got interested in the nancial markets. My earliest memory about the nancial markets is from primary school—I think you call it elementary school in the US—and a ctional story my teacher told. It was about an investor who bought a stock that went from $1 to $999 and he was greedy and refused to sell. Sure enough, the stock fell back down to zero and this ctional investor was back to where he started. From then on, I was fascinated with the nancial markets, so it is no surprise that I ended up in this industry. My parents were also a big factor. They bought me $2,000 worth of some telecommunications shares in the mid1990s. I was around 13 or 14 at the time. I remember checking the newspaper each day to see how the shares had per formed the previous day. From there I started watching other stocks each day and really developed a fascination for the stock market. I wanted to be a stock broker when I grew up because I thought that was the
only job available having to do with nancial markets. And did you end up becoming a stock broker or did you turn to something else? Once I got a bit older, I realized I didn’t want to become a stock broker. They are just gloried salesmen. I didn’t want to be pushing stocks on people in return for a commission, so I decided to go at it on my own. You’re a self-directed trader but you’re also a self-taught options trader. Can you tell us how you started learning to trade options? I rst learned about options in 2004 from a small book I got from the Wall Street Journal called Guide To Understanding Money And Investing. It had the typical basic info on stocks, bonds, mutual funds, and indexes. But it also had a section on options. I always knew people could make money when the markets went down, but up until then, I didn’t really know how it was done. I knew you could short a stock, but I also knew that was difcult
36 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
Having a written trading plan is not only important, it’s impossible to succeed without one. to do and could be risky. So when I rst learned about options, I was hooked. What was it about options that you liked so much? I liked t he exibility. When I was rst learning about options, I read a booklet that described 26 core strategies. There was so much exibility in the way you could trade. You could do bullish, bear ish, neutral, synthetics, ratio spreads, and volatility trades. I was like a kid in a candy store learning all these different ideas. Trading stocks is so boring in comparison because you can only be long, short, or in cash. Not a lot of exibility there. I read a countless number of books and started trading in 2004. And then in 2007 I started trading credit spreads and iron condors. The ability to generate income without having to pick the direction of a
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There is no substitute for experience and the only way to get that is to get in the market and make some real-money trades. You learn from your mistakes.
stock appealed to me. At that point I went back to school and completed a bachelor’s degree in nancial markets, then a master’s in applied nance a nd investment. In one of the master’s courses, there was a subject that covered options. Reading through the course material, I realized I already knew everything in the course through my own reading and research. What led to the decision to go back to school? I had a real thirst for knowledge and also wanted to get some more qualica tions under my belt. I don’t regret it, but I don’t think getting a master’s has really helped me that much, either. The program of courses was great for getting some qualications behind me, but it didn’t teach me anything about trading. It taught the theory, but theory is nothing until you put it into practice and have real money on the line. Why do you think that is? There is only so much you can learn from a book. There is no substitute for experience and the only way to get t hat is to get in the market and make some real-money trades. You learn from your mistakes. I paid my fair share in “tuition” to the market via losing trades. In my rst options trade, I bought a put on a retail stock. The only reason I chose that stock and that put option was because it was cheap. That trade cost me only $200. Needless to say, the trade was a bust and I lost 100% on that one. I also had some big losses in 2008–2009 as the market crashed. I made very amateur trades, didn’t manage risk, and didn’t have a proper trading plan. I was “winging it”
thinking that I knew more than I actually did. I didn’t understand how important a written trading plan is. I gured I didn’t need it, as I could keep everything in my head. I’ve since realized that having a written-down trad ing plan is not only important, but it’s impossible to succeed without one.
Who were your mentors or people you looked up to while you were learning? Tony Sizemore had the biggest inuence on my trading. Actually, I rst learned about him in an article in this magazine [see “Sizing Up For Success” in the further reading section at end], and I remember that some of the concepts he talked about just blew my mind. It really opened up a whole new world to me. I was a member of his trading room for over a year and that really accelerated my learning curve. As you were tra ding options, what are some things you came across that you may not have learned about in books you read or from people you lear ned from? One of the most important metrics I follow is the concept of delta dollars. No one else really seems to talk about it. It’s simply the position delta multiplied by the underlying price. It helps me know the dollar exposure I have at any given time. I nd it a really useful number in terms of deciding when to adjust op tions trades. Also, Sizemore is big on “managing by the greeks,” and this has inuenced
38 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
my trading as well. Having rules around delta/theta ratios and vega/theta ratios is very important in managing risk. How are these ratios related to risk? The greeks and their ratios tell me what my exposure is to price and vola tility. If those exposures get outside my comfort zone, it’s an indication that I need to cut risk. What mistakes taught you the most? One particular mistake sticks out in my mind. I had a position in NDX that was too large for my portfolio size. I was stubborn, though, and didn’t think the market could continue moving upwards, since it was already pretty extended. The next morning, the Fed announced more QE (quantitative easing) and the Nasdaq opened about 2% higher. Un fortunately, I was leaving for vacation that day, so I was scrambling, trying to sort out this trade while my wife was packing for me. I should have just closed the trade then and there, but I adjusted it and kept it open. This was a Friday and I was stressed the whole day while we were traveling because I couldn’t really check the markets. I also wouldn’t have access to my ac count on the following Monday, so I was stressed the entire weekend and it really ruined our weekend away. My wife was very understanding about it but I could tell she was disappointed. From that experience, I learned not to let my exposure get too big, and never have open trades when going on vacation. Well, small ones might be okay! When you look back, what changes did you make to your trading that led you to become the trader you are today? There are a couple of things that come to mind. One is learning to be patient. Once I learned that you don’t have to be in the markets all the time, I became a much better trader. Rather than trying to force things, I now wait for my perfect setups. I actually really enjoy those times when I’m out of the markets because I can completely relax, and if stocks tank, it doesn’t affect me and it gives me an opportunity to take
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? I’m denitely more technical than fundamental. I have a watchlist and each weekend I’ll check short-term and long-term charts. I don’t trade directionally very often, but when I do, I’m more of a mean-reversion trader than a trend trader. For an options trade, I’ll check a 12-month chart of implied volatility to see where the underlying sits currently compared to the recent past. I really like using Bollinger Bands to see if an underlying is undergoing contraction or expansion. If a stock has had a long period of price contraction, I like to get long vega and hope that it makes a big move and vice versa.
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What do you trade—options on equities, futures, indexes? I trade options on equities and i ndexes. Mostly, I’ll just trade the indexes. That’s because I don’t like the risk of a stock making a big move after earnings or an unexpected news item, unless I’m trad ing long volatility. But I tend to be more short volatility. How many trades, on aver age, do you do in a week? I only place about two to three trades per week. I prefer to trade less often but with bigger size. My theory is that two to three big trades are much easier to adjust than 20 to 30 smaller trades if
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things go pear-shaped. When you say “pear-shaped,” what do you mean? Ha-ha, I think that’s a British expression. It just means when things go wrong/bad.
I don’t trade directionally very often, but when I do, I’m more of a meanreversion trader than a trend trader.
might go over a certain timeframe and also what volatility might do. From there I have six core strategies that I use and I’ll choose the most appropriate one.
What variables do you consider before placing a trade? Other than the technical factors, I’ll When you consider trading look at strike placement, position size, something, how do you decide the greeks, days to expiry, prot target, what strategy to apply? stop-loss, and I’ll have a plan in place I’ll take a look at the charts for adjustments. and also volatility. Based on what I see, I’ll 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
The main characteristics I think are necessary are patience, discipline, and the desire to succeed. My core strategies are iron condors, trapdoors (which are a variation on the condor that I developed), butteries, diagonals, strangles, and the wheel. I think of the wheel as covered calls on steroids. In a nutshell, the wheel is a systematic way to trade covered calls but you do it as part of a long-term strategy. In fact, I’ve described the strategy and others, such as trapdoors, on my blog at optionstradingiq.com. I separate my capital into trading capital and long-term capital. The wheel is a great long-term trade, so I can put that on and not think about it too much. For the trading capital, I generally want to be pretty neutral. I nd directional trading can be difcult. Condors and trapdoors are great for that. The trapdoor is similar to a condor but moves a lot slower and requires less maintenance and less adjustments. However, I don’t like having these on when the market has had a strong run up. That’s where diagonals and the bearish buttery come in. So the strategies kind of complement each other nicely. What type of risk management strate gies do you apply? I have a number of rules based on the delta dollars metric and making sure my exposure doesn’t get above a certain level in relation to my capital. I also have other rules regarding the greeks, both in terms of individual
positions and my portfolio as a whole. Adding in some long volatility trades when the VIX is low is another strategy that helps avoid large drawdowns in the event of a sharp selloff.
What led you to teach others to trade options? I’ve always enjoyed teaching others. Even from some of my early jobs as a kid, I always felt comfortable training new staff and it’s something that comes naturally to me. I also get a real buzz when I explain somethi ng to a trader and I can see the light bulb go off. A lot of traders have told me I have a knack for taking difcult-to-understand concepts and breaking them down into easy-todigest chunks. Trading can be a lonely business and I’ve met so many great people through teaching options, and I love chatting with other traders over email, Skype, and online. None of my friends trade, so teaching options has allowed me to develop an amazing network of traders that I talk to regularly. What are some common misconceptions new traders have about trading options? Probably the main one is expectations about returns. I get a lot of email s along the lines of, “Is it possible to make 10% per month?” I tell them, if you’re aiming for a massive return, you have to take on a massive amount of risk. That’s just Finance 101. People need to be realistic. Most beginners will not be successful at rst. They will probably make a lot of mistakes.
Warren Buffett averages about 15– 20% per year, so if a beginner expects to make more than that, they are doing better than Buffett and most hedge funds. How likely is that for a begi nner? Not very. What is necessary for someone to become a successful options trader? The main characteristics I think are necessary are patience, discipline, and desire. Patience to wait for the right setups, discipline to have a plan and stick to it, and desire, because if you don’t have a burning desire to succeed, you won’t make it through the hard times, and there will be hard times. FURTHER READING
McMaster, Gavin [2014]. Bullsh*t-Free Guide To Option Volatility: Making Sense Of Market Mayhem, IQ Finan-
cial Services, LLC. [2013]. Bullsh*t-Free Guide To Butter y Spreads: Your Ulti mate Guide To Buttery Spreads Plus 7 Unusual Variations, IQ Financial
Services, LLC. [2014]. 37 Quickre Lessons In Trading Options: 10 Years Of Trad ing Experience Compacted Into Easy To Digest Lessons, IQ Financial
Services, LLC. Morris, Kenneth M., and Virginia B. Morris [2004]. The Wall Street Journal Guide to Understanding Money & Investing, 3d edition, Lightbulb
Press and Dow Jones & Co. Sarkett, John A. [2009]. “Sizing Up For Success,” Technical Analysis of STOCKS & COMMODITIES, Volume 27: December. †See Traders’ Glossary for denition
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40 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
Explore Your Options Got a question about opti ons? Tom Gentile started his trading career on the oor of the American Stock Exchange in 1994. He has appeared on many nancial TV and radio shows, as well as hosting a weekly talk show himself, and has coauthored 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 … WHICH IS BEST? Many people ask me this question about debit and credit spreads: “I hear one makes money and the other costs money. Is that true?” In a way, that is correct, but it’s not as cut-and-dried as you may think. Credit means you are generating a credit to the account. Technically, you could say the credit or money brought in to the account is money made, but realize that this money must remain tied up until the trade is either closed or expiration happens. The credit received to the account isn’t money you can take right now and go buy birthday gifts with, because the trade is still open. Consider money credited to the account li ke money being held in escrow. Debit means you have incurred a debt. You spent money to open the position. The money you spent is your cost and is the most amount of money you will have at risk on the trade. With both option strategies, you are predening your risk and predening your max prot potential on the trade. This is different from the straight call or put buyer who has more prot potential but less of a probability of success than the spread trader. The question becomes, which one 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 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. In Figure 1 you see details of a call debit spread . The option you buy is the
long leg and the one you sell is the short leg. You would “open” both options at the same time on the same order ticket and your broker should charge you only one commission, as this is one spread, not two separate options trades. You would sell-to-open t he short leg or the February 17, 2017 $1,530 call for $47.65 (all prices are based off the mid-price shown). You don’t want to end up with a naked call position with substantial r isk and you also want to hedge/ reduce risk so you would buy-to-open the long leg or the February 17, 2017
With both debit and credit spread strategies, you are predefining your risk and predefining your max profit potential on the trade. $1,525 call for $50.35. The difference in premiums is $2.70 ($50.35 - $47.65 = $2.70). This is your max risk/cost in the trade. The most a spread option trade of this nature can make is the amount of the spread or difference between the strikes. In this case, the strikes are $5 wide so
the most you could make is $5.00 per contract. The $5 potential prot is offset by the cost of the spread trade, which is the difference in the premiums already calculated at $2.70. The max reward potential for this call debit spread is $2.30. For that to happen, PCLN must be above the short leg stri ke price of $1,530 at expiration. With PCLN in-the-money (ITM) at expiration, it is likely the execution of the two strikes will take place where the markets buy the stock from you at $1,530. The account should execute your buying PCLN at $1,525, making that $5 per contract offset by the $2.70, leaving the prot of $2.30 all on a percontract basis in the account. It should happen without the actual purchase and sale of the amount to buy and sell shares taking place so that no requirements of all that capital and commissions will take place. Recognize PCLN is already above the short leg strike. As long as it stays above $1,530, this trade should be able to realize max prot potential. I will now show you an example of a put credit spread on PCLN. The goal of this trade is the same in that you want to be protable. You can anticipate PCLN Continued on page 44
M O C . S L O O T N O I T P O S M O T . W W W
FIGURE 1: PCLN FEBRUARY 1530/1525 CALL DEBIT SPREAD. The strikes are $5 wi de so the most you could make is $5.00 per contract. The $ 5 potential profit is offset by the cost of the spread trade, which i s the difference 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 1422 Delgany Street, Suite 400 Denver, CO 80202 Phone: 312 262-1289 Fax: 312 329-9888 Internet: www.ninjatrader.com Requirements: Minimum requirements are Windows Vista (SP2) w/platform update, Windows 7, 8, or 10, Windows Server 2008 w/platform update, Windows Server 2008 R2 or later; 1 gigahertz (GHz) or faster 32-bit or 64-bit processor; 2 GB RAM; Microsoft. NET Framework 4.5; screen resolution of 1024x768; DirectX10 compatible graphics card. Product: Trading platform for active equity, futures, and forex traders. Price: Always free use for advanced charting, strategy backtesting, and strategy simulation. For live trading i n your brokerage account, purchase it for $999 (or four monthly payments of $299); lease it for $600 annually, $330 semiannually, or $180 quarterly; free through a NinjaTrader brokerage account. by Jayanthi Gopalakrishnan
ast month in par t 1, I reviewed some of the many features of NinjaTrader 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 rst part, there are so many features available in NT8 that it’s impossible to cover all its features in a review. My objective here is to scratch the surface enough to reveal to you the powerfulness, efciency, a nd exibility of NT8. The platform will meet the needs of active traders, whether you’re a long-term or short-term trader, and whether you trade equities, futures, options, or forex. There’s something in it for everyone and the nice thing is you can take advantage of the free trial to nd out more about the platform.
L
DEVELOPING STRATEGIES One feature that packs a punch to the NT8 platform is NinjaScript. For programming novices, it may take some time to master but once you do, it opens up a world of innite possibilities. NinjaScript is based on the C# programming language, which makes it very versatile. You access NinjaScript via the NinjaScript editor. NT8 has a lot more .NET plug-ins than previous versions did. On the right-hand side of the window you’ll see the explorer panel, which lists all the code that is currently available to users. You’ll notice it’s organized into several folders to make everything easy to nd. In Figure 1 you see an example of the NinjaScript editor. I selected the simple moving average crossover strategy, and the code is displayed in the ScriptEditor window. If you open up the folders listed in the explorer window, you’ll see that you have a number of code sets to choose from. If you still prefer to create your own script, you can do that as well. All you have to do is right-click on any of the indicators listed in the explorer window and select new strategy, or you can open up a new strategy builder window and
start building your own strategy. As with all windows in NT8, you can have different tabs along the bottom, which gives you the ability to work on different scripts. In NT8, it almost seems as though you have no limits in what you can do with NinjaScript. It goes well beyond creating trading strategies and gives you the opportunity to create custom bar types, chart types, custom drawing tools, import types for importing historical data, your own optimizer engines, and even Super DOM columns, among other things. You can also integrate NinjaScript with Visual Studio. This allows you to debug NinjaScript objects while they’re running, and that means you can test your programs right then and there. If you’re a programmer, you’ll know this is a big bonus. If you’ve never written code or done any programming but want to give it a go, you can use the Strategy Builder, which walks you through developing your own strategies. It takes a while to get the hang of it but the nice thing is that tech support is readily available via support forums, the help desk, and online tutorials.
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 you’ve 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 nd 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 you’d like to perform, that is, standard, optimizat ion, walk-forward optimization, or multiobjective optimization. You also select a strategy, strategy parameters, data series, timeframe, and so on. Once you’ve selected all the parameters, hit the run button. When the test is complete you’ll be able to see the performance results of your strategy. For example, Figure 2 displays an analysis of the moving average crossover system applied to the March emini futures contract using the % analysis option, which is just one of the many different ways you can analyze the performance of your strategy. You may prefer to view the performance results graphically, and as you may have guessed, there are different ways to graphically view strategy performance results. In the bottom half of the StrategyAnalyzer window in Figure 2, the maximum drawdown is displayed graphically. And you have the ability to create your own performance metrics using NinjaScript. Here’s where you see how thoughtful the technology behind NT8 is. One of the drawbacks of backtesting in general is that the results are not necessarily realistic since commissions, lls, and slippage aren’t factored in. But in NT8 under setup in the settings panel, you can choose to include commissions, whether you want conservative or liberal order lls, and factor in some slippage. I also want to bring your attention to the break at EOD option that is available in the settings panel. If this is selected, it means the bar wi ll end at the close. If it’s not selected, the bar will continue to form beyond the close until the bar ends. Some traders will need to know when the market closed, especially if their strategy is based on the closing price. Other s may, depending on what type of strategy t hey are developing, prefer to wait till t he bar
FIGURE 2: ST RATEGY ANALYZER. There are many options when it comes to backtesting your strategy and 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.
completes even if it’s after the close. Here again, you see how NT8 caters to the needs of all types of traders.
ADVANCED
TRADE
MANAGEMENT
the basic order entry parameters, you can set your stop-losses, your prot targets (you can set several), and stop strategies. And yes, you have the ability to create a custom stop strategy where you can set your auto breakeven points and auto trailing stops. You can save your custom stop strategy as a template and apply it to any order you want to place. There are several other options for creating your custom ATM such as auto chase, which allows you to dene your chase limits with options such as selecting your target chase, chase if touched, and your chase limit. There’s also the option of selecting a stop limit for a stop-loss, market if touched for prot, and shadow strategy. Shadow strategy is a method of simulating an ATM and
Now that you have a strategy that has been backtested and are happy with its performance, you’re now ready to place your trades. NinjaTrader supports several online brokers and through them you can place trades automatically, semiautomatically, or any number of different ways. NT8 has made great strides in their Advanced Trade Management (ATM) feature to make trading through the platform much easier and more efcient than before. Managing trades is an important and necessary task for all traders and, once again, NT8 has incorporated tremendous flexibility when it comes to trade management. ATM can be accessed through the order entry window. You can create your custom ATM strategy from the dropdown menu available on FIGURE 3: CUSTOM ATM STRATEGY. There’s a ton of flexibility when it comes to managing your positions at the time you place them and after a position is open. the ATM strategy You can set your stop-losses, profit targets, and stop strategy. You have the ability option (Figure 3). to create a custom stop strategy where you can set your auto breakeven points From here, besides and auto trailing stops. March 2017 • Technical Analysis of STOCKS & COMMODITIES • 43
being able to forward-test it. Once you select your parameters, typically, you’re going to enforce these at the time you place your order. But what if you only have a split second to place a trade? When you’re in such a situation, NT8 has a solution for you. It allows you to apply an ATM to an open and unprotected position. Once you create an ATM, you save it as a template. To apply the ATM, go to the control center, then to positions, right-click on the open position, and select apply ATM strategy. Another feature worth mentioning is the alerts feature. In previous versions of NT you needed to program the alerts, but in NT8 there’s an alert feature that allows you to set up conditions and actions. You can access this from the chart window and set more than one condition. So if a
condition is met you can create an action, which can be either in the form of a sound or a popup. You can also share the alert via social media, and submit an entry or exit order tied to the alert.
Managing trades is an important and necessary task for all traders, and NT8 has incorporated tremendous flexibility when it comes to trade management.
JUST THE TIP OF THE ICEBERG Jayanthi Gopalakrishnan is Editor of As you may have guessed by now, NT8 S TOCKS & C OMMODITIES . may appear to be similar to its previous iteration but really there’s more to it than FURTHER READING meets the eye. One of the unique char- Gopalakrishnan, Jayanthi [2017]. “NinjaTrader 8, part 1,” product review, acteristics of NT8 is the stellar support Technical Analysis of STOCKS & COMbehind the product. NinjaTrader listened MODITIES, Volume 35: February. to their customers and redeveloped their platform based on what customers told ‡NinjaTrader them they need and want. The result is ‡See Editorial Resource Index a trading platform with a lot of thought behind it and with something that meets the needs of any type of trader.
Explore Your Options GENTILE Continued from page 41
moving higher just like in the cal l debit spread.The primary distinction between the two is that you are generating a credit into the account of a specic amount versus incurring a cost or having an outlay of capital to start. The option you buy is the long leg and the one you sell is the short leg. You would open both options at the same time on the same order ticket and your broker should charge you only one commission as this is one spread, not two separate option trades. See Figure 2 for an example of a put credit spread. You would sell-to-open the short leg or the February 17, 2017 $1,530 put for $42.00 (all prices are based off the midprice shown). You don’t want to end up with a naked put position with substantial risk and you also want to hedge/reduce risk so you would buy-to-open the long leg or the February 17, 2017 $1,525 put for $39.80. The difference in premiums is $2.20 ($42.00 - $39.80 = $2.20). This i s your max prot potential in the trade. Another distinction of the credit spread versus the debit spread is that as long as PCLN is higher than the short leg stri ke
FIGURE 2: PCLN FEBRUARY 1530/1525 PUT CREDIT SPREAD. Here, the difference in premiums is $2.20 ($42.00 - $ 39.80 = $2.20). This is your max profit potential in the trade.
price of $1530, things should work out for the best for this trade. There is no need to have a transaction or execution of the options. Think about it. If PCLN is above $1,530 at expirat ion, would anyone need to exercise their right to put you to stock or make you buy it at $1,530 when they can sell it to t he open market for a higher price? Not likely. Therefore, you would not have to have the account exercise the right to put the stock to anyone or sell it for $1,525. Both options expire and the account then gets to realize that credit amount of $2.20 per contract. The credit and the debit from a risk-toreward standpoint is basically the same. That is why you will hear some say there really isn’t a difference. When they say that, it is from the risk-to-reward view of
44 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
when both spreads use the same strikes and expiration. The debit spread I discussed can potentially earn $2.30 per contract and the credit spread can potentially earn $2.20 per contract. This means the risk for both is close to the same as well. Other than that, the debit spread tends to need a slight or moderate directional move more often than the credit spread does. So when you are looking at spreading your risk, ask yourself which one makes the most sense for your personality. All things equal, there’s not much difference except whether or not you hold the money or pay the money for the spread. In the end, it’s about risk and reward once the exit is made.
Q&A FRIESEN Continued from page 35
except your original core layer, which you maintai n, using it for information. Then reestablish the capital when appropriate, or occasionally, you may nd you have to exit the core layer as well, as there is often a new driver or catalyst that is affecting one or both stocks of your pair. Allow me to expand on this subject. This procedure is a form of stop-loss but also is in line with “trade some, hold some.” In pairs trading for a multilayer approach, we use LIFO. If you put on three layers, you would take off the last layer in a protable situation rst. Or when you need to start reducing position, the same rules apply. Money has been saved. Capital has been shelved. This capital can be redeployed. Here’s an example. If you put on a layer at 1.00, 2.00, and 3.75 and realized there were forces pushing it farther out, you could take off the 3.75 layer at, say, 4.00 and wait. Book that 0.25 loss on that layer. Later, the ducks could line up for you to reestablish. Your spread has deected off 5.00 and is on its way back down. You take the trade at 4.75 going with that retracement. It reaches 4.00 and seems stable. You are going through news during this time and see a pertinent piece of information that slightly increases risk—hence, the reason the spread went out. Of course, the spread went out before the news was
posted and when the news came out, the spread started its retracement. With the increased risk you are now aware of, you decide to take off the 4.75 layer at 4.00, as it seemed to stabilize there. Next, the pair goes back out to 4.50, and you see a new range developing. You put on your trade at 4.50 and then it drops to 3.75. Let’s add it up. You are still holding your original two layers and still view the spread to have future mean-reverting value. You lost $0.25 on the third layer,
Once a range gets broken, it often trades in a new range, returning to predictable patterns. then reestablished that layer to make $0.75, and then took another roll of production to make yet another 0.75. You are protable on the overall management of the third layer now by 1.25. The trading of the new range could continue for days, weeks, or months. In a perfect world, the spread comes back down and you eventually prot on the layer at 2.00 and then the 1.00. Remember LIFO. What could happen, or what often happens to traders, especially the ones who have no management plan for layers after they established them, is they add, sit, and stare at the screen, only to capitulate at the worst possible times. This will also happen for traders who
have not set a maximum allocation of capital. It is a different experience for those who proactively manage risk, are willing to reduce systematically, and still be committed to the original plan, working it with discipline. In my experience with equity pairs, once a range gets broken due to a catalyst, it often trades in a new range, returning to predictable patterns. It may be months before it returns to where it came from. It’s tragic that many traders abandon the pair and make nothing from all the activity. After taking all that pain, they aren’t committed to gain. A one-off pair trade may look different than the distribution over a range. That type of pair may receive only one allocation of capital, and the trade is for a particular expectation. It considers the risk, reward, probabilities (expected value formula), and has a time duration. On this type of trade, many traders risk 1.00 to make 3.00 or greater. A pair or spread structure like this mimics a single-stock trade in terms of directional implications. Traditional xed stops and trailing stops could be utilized. The trader would have need of pair trading tools in order to monitor and manage positions in t his way. Risk management is a priority for any type of trader, and intelligent planning with complete rules can make a signicant difference to any trader in the outcomes and the bottom line.
TRADING STRATEGY
EVANS / S&P FUEL GAUGE Continued from page 17
Having this information gives you a tremendous advantage even though there are many other variables that affect such currency cross rates. AND YOU HAVE A FULL TANK
This type of trade governs many, if not all, market relationships. 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
positions when the S&P 500 is at poor levels. Keep an eye on that S&P gauge and when it has risen to an at tractive level, put on those risk-on positions and plan your next vacation. Chris Evans is an independent research provider. He has worked as a global macro portfolio manager for various hedge funds in London and New York. He currently offers fuel gauge updates and a weekly research blog to subscribers. He may be reached via his website at www.paratradesystems.com.
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 45
Comparison of REIT ETFs (As of December 20, 2016)
With low expense ratios, tax efficiency, and instant liquidity, REIT ETFs offer investors a high level of dividend income and capital appreciation potential.
Ticker Symbol
VNQ
IYR
ICF
RWR
XLRE
Inception Date
9/23/2004
6/12/2000
1/29/2001
4/23/2001
10/8/2015
Total Assets
$32.8B
$3.91B
$3.47B
$3.30 B
$2.37B
Net Expense Ratio
0.12%
0.44%
0.35%
0.25%
0.14%
30-day SEC Yield
4.04%
4.21%
3.50%
4.42%
4.22%
147
126
30
100
29
3-Yr.Return
45.05%
38.85%
48.79%
46.54%
N.A.
MASONSON / THE REALITY OF REITS
Benchmark
RMZ
REI
RMP
REI
RE Select
Continued from page 7
Avg. Daily Volume
5.14M
9.40M
426,000
377,000
2.64M
0.80
0.82
0.77
0.81
1.41
No. of Holdings
Equity Beta
index has 32 REITs. Thus, the creation of REIT ETFs was a simple matter of selecting from this universe or additional exchange listings. The t op 10 REITs by market capitalization are listed in Figure 1. REIT ETF
M O C . F T E . W W W , M O C . B D F T E : E C R U O S
FIGURE 2: COMPARING THE LARGEST REIT ETFS. Five similar ETFs are compared here. VNQ is the leader of the pack in terms of assets under management, the number of holdings, and the lowest expense ratio.
CHOICES
ETFs brought a new dimension to REIT dist ribution that has broadened their appeal to investors and traders. There are now over 30 US-listed ETF REITs. With low expense ratios, tax efciency, and instant liquidity, REIT ETFs offer investors a high level of dividend income and capital appreciation potential. Based on the recent change in the GICS classication mentioned earlier, State Street Global Advisors’ Financial Select SPDR (XLF) removed the REITs in that portfolio. The new SPDR sector was called the Real Estat e Select SPDR (XLRE) that holds 29 REITs and real estate management and development companies. There are now 11 sector SPDR ETFs. REIT ETFs range from pure US real estate to global real estate, developed markets, and US mortgages. Most REITs have a fairly concentrated portfolio. The top four ETF R EITs have nearly $42 billion in assets under management. They invest over 95% of their money in commercial, special ized, and residential
properties. Specialized REITs can have investments in land, prisons, data centers, movie theatres, a nd casinos. The Vanguard REIT Index Fund (VNQ) has assets of $32.5 billion, accounting for 77% of the assets of the top four issuers. Other smaller REIT ETFs focus on particular niches such as small cap, global super dividend, equal-weight, Asia, global quality, and long-term care, among others. Figure 2 compares the top REIT ETFs by asset size. They include Vanguard REIT Index (VNQ); iShares Cohen & Steers REIT (ICF); iShares US Real Estate ETF (IY R); SPDR Dow Jones REIT (RWR); and Real Estate Select Sector SPDR Fund (XLRE). Clearly, VNQ is the behemoth in size. IYR has t he highest daily trading volume at 9.4 million shares while RWR has the lowest volume at 377,000 shares, but offers the highest yield. ICF and the new XLRE have only 30 and 29 holdings, respectively. ICF has the lowest beta but the highest threeyear return at 48.79% which is a desirable combination of characteristics. Interestingly, XLRE had the highest beta at 1.41 but did not have the highest return. Probably the small
M O C . S T R A H C K C O T S
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 the beta.
For more comprehensive information on REI Ts in general, I recommend a recently published book titled The Intelligent REIT Investor. Based on the REIT performance over the last 16 years, investors and traders should denitely consider placing PERFORMANCE COMPARISON 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 ETF’s website and look at December 21, 2016 are KBWY (+28.40%), SRET (+21.82%), the top 10 REIT holdings. Obtain complete nancial infor MORT (+20.64%) and REM (+19.75%). This compares to the mation including credit rating, quarterly and annual reports, ve ETFs mentioned earlier: VNQ (+7.74%), IYR (+6.71%), press releases, and other critica l information. Also, check out RWR (+5.83%), ICF (4.34%), and XLRE (+3.05%). So even the ETF’s Morningstar rating to know what you are buying. when investing in REITs, segments of the REIT market out- And don’t forget to bring up 10-year, ve-year, and one-year perform at different times. Using relative strength analysis on charts with a few moving averages, MACD, and RSI indicathe above-mentioned website can assist investors in nding 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 Intelligent REIT Investor: How To Build Wealth With Real (excluding XLRE because of its short life) from September Estate Investment Trusts, Wiley. 29, 2004 (earliest common date) through December 29, 2016. VNQ (red color) led the way up with a 167.29% gain, followed Masonson, Leslie N. [2017]. “ETF Factor-Based Investing,” Technical Analysis of STOCKS & COMMODITIES, Volume by ICF (pin k) up 164.14%, then RWR (green) at 150.99%, and nally 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 didn’t come STOCKS & COMMODITIES, Volume 34: September. public until September 23, 2004 compared to the other ET Fs • www.etf.co m that had three to four years’ lead time to garner assets. • www.etfscreen.com For active traders looking to daytrade REITs with leverage, • www.etfdb.co m there are four ETFs available. Direxion introduced leveraged • www.REIT.com bull and bear real estate ETFs in July 2009. They are Direxion • www.vanguard.com Daily Real Estate Bull 3x Shares (DRN) and Direxion Daily • us.spders.com Real Estate Bear 3x Shares (DRV). Both have expense ratios • www.iShares.com/Low-Cost/ETFs of 0.95%. ProShares offers double-leverage ETFs with ticker • www.statestreetspdrs.com/SPDRs symbols URE and SRS, bullish and bearish, respectively. • www.wiley.co m Traders are cautioned to fully understand how to use these vehicles and understand all the r isks before using them. Check the websites of these ETF providers for more information. ‡StockCharts.com
FUTURES FOR YOU GARNER a net risk level, and then levies a margin requirement accordingly. Stock options traders might or might not be granted portfolio margining by their broker but those who are generally have in excess of $100,000 in their trading account.
or against you. But the reality is, options on futures traders stand to potentially get more bang for their buck when they are right in their speculations. That’s because emini S&P futures options are written against an already leveraged product. Naturally, the options are generally more expensive but they are priced that way for a reason—they can really move!
More leverage We all know that leverage is a doubleedged sword in that it can work for you
Mo’ better Trading SPX or SPY options is convenient for those with substantial capital
Continued from page 31
but that doesn’t mean they are the best “option.” The emini S&P futures options give you the ability to take action during the overnight tradi ng session, which could be a game changer. Plus, the ease of market access for smaller traders opens the door to trading strategies that were once reserved for the “big boys.”
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 47
TRADING ON MOMENTUM
Golden Cross Breakouts A “golden cross” on a chart is typically dened 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.
by Ken Calhoun
Step 2: You may enter your trade anytime after this crossover signal is seen.
henever you are looki ng for swing trading brea kout entries, it helps to use the same signals that institutional traders follow. One of the most popular patterns is the “golden cross,” in which a 50-period simple moving average (SMA) line crosses above a 200-period SMA. In this month’s column, you will see how to trade this useful breakout swing trading pattern.
Step 3: As long as both SMA lines remain uncrossed in a n uptrend, you keep your position open. Close your position once a trailing stop of two points or more is taken out, as seen on December 13, 2016 at $59 per share. Alternatively, you could use a trailing stop at the 50 SMA level, especially for longer-term swing or position trades. (In the chart in Figure 1, that would be $54.)
W
SWING TRADING THE GOLDEN CROSS ENTRY When the 50-period SMA breaks above the 200-period SMA, it signies a major short-term trend reversal. This can help identify swing trading brea kout entries when combined with price action patterns such as bullish cups, ascending triangles, and increasing volume. It is important to note that golden crosses, like most technical trading patterns, should not be used in isolation. Instead, you should combine them with other breakout entry signals.
L A N G I S e
Step 1: Look for a 90-day daily candlestick chart in which a 50-period SMA line crosses above a 200-period SMA li ne. In the chart of Spirit Aerosystems Holdings, Inc. (SPR) in Figure 1, you see this occurred on October 20, 2016.
INSIGHTS: WHY THIS TECHNIQUE WORKS The golden cross is part icularly effective because it combines the shorter-term 50 SMA momentum signal with the longerterm major 200 SMA t rendline. This combination provides a breakout conrmation signal because it uses both short- and long-term trendlines working together.
TRADE MANAGEMENT TIPS
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 t rading ranges. Here’s how you can start using this strategy with your swing You can see t hat this cha rt has nea rly 20 points of range ($43 trades: to $61 on a 90-day char t). Price action also follows a classic 45-degree angle breakout trend pattern. Further, note how cleanly dened the trend is—it is not a choppy, uncertain chart. The more up-and-down oscillations a chart has, the tougher it is to trade protably. The cleaner, more i n-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 instruments. You will often see strong upside price action following golden crosses, FIGURE 1: TRADING USING THE GOLDEN CROSS. Here you enter a swing trade when the 50-period simple because institutional traders use this same moving average (SMA) crosses above the 200-period SMA. Note that the exit takes place after the two-point pattern to put on large block trades. trailing stop is hit.
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. He is a UCLA alumnus and is the founder of TradeMastery. com, an educational resource site for active traders.
FURTHER READING Mustapha, Azeez [2016]. “Golden Cross And Death Cross,” Technical Analysis of STOCKS & COMMODITIES, Volume 34: September. See our Traders’ Tips section beginning on page 50 for commentar y on implementation of Calhoun’s technique in various technical
At-the-Mo ney—An option whose strike price
is nearest the cur rent price of the underlying deliverable. Black-Sch oles Option Pricing Model—A model developed to estimate the market value of option contracts. Bollinger Bands—Developed by John Bollinger. Bollinger Bands widen during increased volatility and contract in decreased volatility, and when broken, are an indication that the trend is powerful and may continue in that direction. Buttery Spread —A sideways market strategy using all calls or puts, designed to prot from a stock trading in a specic range. Calendar Spread —Also known as a time spread or horizontal spread, calendar spreads exploit differences in time value between options. Call—A contract that gives the buyer of the option the right but not the obligation to take delivery of the underlying security at a specic price within a certain time. Condor—Essentially, a buttery spread with two different strikes that make up the body of the option. Covered Call—Selling a call option while holding an equivalent in the underlying tradable. Covered Write—Writing a call against a long position in the underlying stock. By receiving a premium, the writer i ntends to realize additional return on the underlying common stock or gain some element of protection (limited to the amount of the premium less t ransaction costs) from a decline in the value of that underlying stock. Credit Spread —The difference in value of two options, where the value of the one sold exceeds the value of the one purchased. Debit Spread —The difference in value of two options, where the value of the long position exceeds the value of the short position. Delta—The amount by which the price of an
Use the golden cross on 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. analysis programs. Accompanying program code can be found in the Traders’ Tips area at Traders.com.
option changes for every dollar move in the underlying instrument. Delta-Hedged —An options strategy that protects an option against small price changes in the option's underlying instrument. These hedges are constructed by taki ng a position in the underlying instrument that is equal in magnitude but opposite in sign (+/-) to the option's delta. Delta Neutral—This is an "options/options" or "options/underlying instrument" position constructed so that it is relatively insensitive to the price movement of the underlying instruments. This is arranged by selecting a calculated ratio of offsetting short and long positions. Delta Position—A measure of option price vs. the underlying futures contract or stock price. Gamma—The degree by which the delta changes with respect to changes in the underlying instrument’s price. Greeks—A loose term encapsulating a set of risk variables used by options traders. Historical Volatility—How much contract price has uctuated over a period of time in the past; usually calculated by tak ing a standard deviation of pr ice changes over a time period. Implied Volatility—The volatility computed using the actual market prices of an option contract and one of a number of pricing models. For example, if the market price of an option rises without a change in the price of the underlying stock or future, implied volatility will have risen. In-the-Mo ney (ITM)—A call option whose strike price is lower than the stock or future's price, or a put option whose strike price is higher than the underlying stock or future's price. For example, when a commodity price is $500, a call option with a strike price of $400 is considered in-the-money. Iron Butterfy—The iron buttery spread is a limited risk, limited prot trading strategy
Near-the-Mon ey—An option with a strike
price close to the current price of the underlying tradable. Out-of-the-Money (OTM)—A call option whose exercise (strike) price is above the current market price of the underlying security or futures contract. For example, if a commodity price is $500, then a call option purchased for a strike price of $550 is considered out-of-the-money. Premium—The price a buyer pays to an option writer for granting an option contract. Put —A contract to sell a specied amount of a stock or commodity at an agreed time at the stated exercise price. Straddle—The purchase or sale of an equivalent number of puts and calls on an underlying stock with the same exercise price and expiration date. Strangle—The purchase or sale of an equivalent number of puts and calls on an underlying stock with the same expiration dat e but a different exercise price. Usually, the put has a low strike price and the call has a higher strike price. Strike Price—The price per unit at which the holder of an option may receive or deliver the underlying unit; also known as the exercise price. Vega—The amount by which the price of an option changes when the volatility changes. Vertical Spread —A stock option spread based on simultaneous purchase and sale of options on the same underlying stock with the same expiration months but di fferent strike prices. Volatility — A measure of a stock’s tendency to move up and down in price, based on its daily price history over the last 12 months. Volatility Index — A widely used measure of market risk. Sometimes referred to as the “investor fear gauge.” Zet a—The percentage change in an options price per 1% change in implied volatility.
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 49
TRADING
ONMOMENTUM
Golden Cross Breakouts A “golden cross” on a chart is typically dened a swhen the Step 1:Lookfora90-daydailycandlestickchartinwhicha 50-day moving average crossesabove the 200-day moving 50-periodSMAlinecrossesabovea200-periodSMAline. average, seen asa bullish sign. In thismont hly column on In the chart ofSpirit AerosystemsHoldings, Inc. (SPR)in t r a d i n gb r e a k o u t s ,t h i s p r o f e s s i o n a lt r a d e r s h o w s h o wy o uFigure 1,you see thisoccurred on October20, 2016. c a nu s et h i s p a t t e r na s a n e n t r ys i g n a lf o r s w i n gt r a d e s .
by KenCalhoun
Step 2: You may enteryourtrade anytime afterthiscrossoversignalisseen.
heneveryouarelookingforswingtrading breakout entries,ithelpstous ethesamesignalsthatinst itutional tradersfollow.Oneofthemostpopularpatternsisthe “goldencross,”inwhicha50-periodsimplemoving average (SMA)line crossesabove a 200-period SMA. In this month’scolumn,youwillseehowtotrade thisusefulbreakout swingtradingpattern.
Step 3: Aslong asboth SMAlinesremain uncrossed in an uptrend,youkeepyourpositionopen. Closeyourposition once a trailing stop oftwo pointsormore istaken out, as seen on December13,2016 at $59pershare. Alternatively ,youcouldusea trailingstopatthe50SMA level,especiallyforlonger-termswingorpositiontrades. (In the chart in Figure 1,that wouldbe $54.)
W
SWING TRADING THE GOLDEN CROSS ENTRY
INSIGHTS:W HY THIS TECHNIQUEWORKS
When the 50-period SMA breaks above the 200-period SMA,itsigniesamajorshort-termtrendreversal.Thiscan helpidentifyswingtradingbreakoutentrieswhencombined with price action patternssuch as bullish cups, ascending triangles, and increasing volume.It isimportant to note that goldencrosses,likemost technicaltradingpatterns,should not be used in isolation. Instead, you should combine them withotherbreakoutentrysignals.
Thegoldencrossisparticularlyeffectivebecauseit combines theshorter-term50SMAmomentumsignal withthelongertermmajor200 SMAtrendline.Thiscombinationprovidesa breakoutconrmationsignalbecauseitusesbothshort-and long-termtrendlinesworkingtogether.
STEP-BY-STEP ACTIONPLAN Here’showyoucanstartusingthis strategywithyourswing trades:
48 •
•
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&C
TRADE MANAGEMENT TIPS Oneofthe keystousingmovingaveragesignalssuccessfully, aswith most ofthe breakout patternsyoulearn about in this column,istovisuallyscanforchartswithwidetradingranges. You can see that thischart hasnearly 20 pointsofrange ($43 to $61 on a 90-day chart). Pr ice action also followsa classic 45-degreeanglebreakouttrendpattern. Further,notehowcleanlydenedthe trend is—it isnot a choppy, uncertain chart.The more up-and-down oscilla tionsa chart has, the tougherit isto trade protably.Thecleaner,more in-focusthe chart is,the easierit isto trade, asyou can see in Figure 1. Aswith all ofour professional swing and intraday charts, it isbest to use this strategywithstocksandETFspricedin the $20–$70 pershare range, because these chartstend to have stronger, more sustainabletrend sthatyoucantrade.This strategy should not be used withcheap, riskypennystocksorstock spricedunder $10 pershare, due to the high risk and choppinessofthesepoortradinginstruments.Youwilloftensee strongupside price action followinggolden crosses, becauseinstitutionaltradersusethissame pattern to put onlarge block trades.
For this month’s Traders’ Tips, the focus is Ken Calhoun’s article in this issue, “Golden Cross Breakouts.” Here, we present the February 2017 Traders’ Tips code with possible implementations in various software. The code for the following Traders’ Tips selections is posted here:
• Traders.com
Home–S&C Magazine
Traders’ Tips The Traders’ Tips section is provided to help readers implement 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 In “Golden Cross Breakouts” in this issue, author Ken Calhoun describes his methodology for trading using the popular chart pattern commonly known as the golden cross. He defnes the golden cross as a 50-period simple moving average crossing above a 200-period simple moving average. The author suggests using this indicator in conjunction with other price-action patterns. The TradeStation platform has many built-in indicators that can be evaluated along with the golden cross. Here, we are providing TradeStation EasyLanguage code for a golden cross strategy based on the author’s concepts. We have also included an indicator that can be used in the TradeStation Scanner application to help identify trading opportunities. Indicator: Golden Cross Breakouts // TASC MAR 2017 // Golden Cross Breakouts // Ken Calhoun inputs: FastLength( 50 ), SlowLength( 200 ), MaxBarsSinceCross( 10 ), MinPercentRange( 25 ) ; variables: FastAvgValue( 0 ), SlowAvgValue( 0 ), BarsSinceCross( 0 ), PercentRange( 0 ) ; FastAvgValue = Average( Close, FastLength ) ; SlowAvgValue = Average( Close, SlowLength ) ; PercentRange = 100 * ( Highest( High, FastLength ) Lowest( Low, FastLength ) )/ Close ; if FastAvgValue > SlowAvgValue then BarsSinceCross += 1 else BarsSinceCross = 0 ; Plot1( BarsSinceCross ) ; 50 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 1: TRADESTATION SCANNER. Here, the golden cross breakout strategy i s
applied to a daily chart of Blackstone Group LP along with a TradeStation Scanner results list of candidate symbols.
if BarsSinceCross > 0 and BarsSinceCross <= MaxBarsSinceCross and PercentRange >= MinPercentRange then Alert ; Strategy: Golden Cross Breakouts // TASC MAR 2017 // Golden Cross Breakouts // Ken Calhoun inputs: FastLength( 50 ), SlowLength( 200 ), TrailAmountDollars( 2 ), BreakoutLookBack( 20 ), VolumeMultRequired( 1.5 ) ; variables: FastAvgValue( 0 ), SlowAvgValue( 0 ), BarVolume( 0 ), AvgVolume( 0 ), BreakOutPrice( 0 ), EntryOK( false ), MP( 0 ), TT( 0 ) ; MP = MarketPosition ; TT = TotalTrades ; FastAvgValue = Average( Close, FastLength ) ; SlowAvgValue = Average( Close, SlowLength ) ; if BarType >= 2 and BarType < 5 then BarVolume = Volume else BarVolume = Ticks ; AvgVolume = Average( BarVolume, FastLength ) ; if FastAvgValue crosses over SlowAvgValue then begin BreakOutPrice = Highest( High, BreakoutLookBack ) ; EntryOK = true ;
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://community.tradestation.com/Discussions/Topic.aspx?Topic_ ID=147651. The ELD lename is “TASC_MAR2017.ELD.” For more information about EasyLanguage in general, please see http://www.tradestation.com/EL-FAQ. A sample chart is shown in Figure 1. This article is for informational purposes. No type of trading or investment recommendation, advice, or strategy is being made, given, or in any manner provided by TradeStation Securities or its afliates. —Doug McCrary TradeStation Securities, Inc. www.TradeStation.com
F METASTOCK: MARCH 2017 TRADERS’ TIPS
CODE Ken Calhoun’s article in this issue, “Golden Cross Breakouts,” presents a trading system based on a popular pattern. The MetaStock formulas that implement the buy and sell signals for the pattern are given here: Buy signal Cross( Mov( C, 50, S), Mov( C, 200, S) )
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 last 10 days. The column properties show the golden cross condition and the condition for price being between $20 and $70.
We used the new scan columns and enhanced formula language in version 17 to scan for stocks between $20 and $70 where the 50-day simple moving average has crossed up through the 200-day moving average within the last 10 days. The formula for the golden cross uses the new “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. The sample char t in Figure 2 shows the golden cross (point 1) that occur red six days previous. Using the simulated trading features in TC2000, we entered a long position of 100 shares of FOX at $29.01 and set a trailing stop at the 50-day moving average (point 2). You can try the simulated trading yourself at www. TC2000.com. —Patrick Argo Worden Brothers, Inc. www.TC2000.com
Sell signal bsig:= Cross( Mov( C, 50, S), Mov( C, 200, S) ); 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:
—William Golson MetaStock Technical Support www.metastock.com
F TC2000:
MARCH 2017 TRADERS’ TIPS CODE The golden cross breakout strategy described by Ken Calhoun in his column in this issue titled “Golden Cross Breakouts” can be easily applied in TC2000 version 17 using the new EasyScan columns and enhanced custom formula language.
MARCH 2017 TRADERS’ TIPS CODE For this month’s Traders’ Tip, we’ve provided the study GoldenCrossBkout.efs based on the formula described in Ken Calhoun’s 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. The eSignal study contains formula parameters that may be congured through the edit chart window (right-click on the chart and select “edit chart”). A sample chart is shown in Figure 3. To discuss this study or download a complete copy of March 2017 • Technical Analysis of STOCKS & COMMODITIES • 51
FIGURE 3: eSIGNAL. Here is an example of the GoldenCrossBreakout study plot-
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 Aerosystems (SPR). Based on Calhoun’s 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 strategy on thinkorswim charts start calculating the trade from this point. We have also added the prebuilt TrailingStopLX strategy to help chartists understand about taking prots or protecting capital. See the article in this issue for more details on the strategy. —thinkorswim A division of TD Ameritrade, Inc. www.thinkorswim.com
ted on a daily chart of Spirit AeroSystems Holdings (SPR).
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 script (EFS) is also available for copying & pasting from the STOCKS & C OMMODITIES website at Traders.com in the Traders’ Tips area. —Eric Lippert eSignal, an Interactive Data company 800 779-6555, www.eSignal.com
F THINKORSWIM:
MARCH 2017 TRADERS’ TIPS CODE In “Golden Cross Breakouts” by Ken Calhoun in this issue, we get a lesson on a classic market condition with some in-depth
F WEALTH-LAB: MARCH 2017 TRADERS’ TIPS CODE
The golden cross system for swing trading described by Ken Calhoun in his article in this issue, “Golden Cross Breakouts,” can be recreated in Wealth-Lab entirely from the building blocks known as rules in a drag-and-drop manner. No coding is required. Figure 5 illustrates the necessary conditions and the order in which they should be stacked. When you combine the rules as shown in Figure 5, the system will exit with a dolla rbased trai ling exit or after an opposite event—the crossunder of 50-day and 200-day moving averages (MAs). To add more interactivity, click a nearby parameter to expose it as a parameter slider. This way, its value can be changed by dragging the slider on the bottom-left part of 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
FIGURE 5: 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
FIGURE 6: 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 different 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. A sample chart implementation is shown in Figure 6. —Eugene, Wealth-Lab team www.wealth-lab.com
FIGURE 7: AMIBROKER. Entry and exit points are shown with arrows on a daily
candlestick chart of SPR (Spirit Aerosystems) with 50/200 day moving averages, replicating the chart from Ken Calhoun’s article in this issue.
F NEUROSHELL
F AMIBROKER:
MARCH 2017 TRADERS’ TIPS CODE In “Golden Cross Breakouts” in this issue, author Ken Calhoun shows a simple swing trade strategy based on the golden cross pattern, which is 50-period simple moving average (SMA) crossing over a 200-period SMA. A ready-to-use AmiBroker formula is presented here that replicates the chart shown in the article with the moving averages and trading system with the golden cross entry and two-point trailing stop. A sample chart is shown in Figure 7. AmiBroker code:
TRADER: MARCH 2017 TRADERS’ TIPS CODE A golden cross breakout trading system such as the one described by Ken Calhoun in “Golden Cross Breakouts” in this issue can be easily implemented in NeuroShell Trader. Simply select new trading strategy from the insert menu and enter the following in the appropriate locations of the trading strategy wizard: BUY LONG CONDITIONS: [all of which must be true] Avg Crossover Above (Close, 50, 200) LONG TRAILING STOP PRICES: TrailPricePnts( Trading Strategy, 2)
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 www.amibroker.com
FIGURE 8: NEUROSHELL TRADER. Here is a sample NeuroShell Trader chart
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 & COMMODITIES 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,
[email protected] www.neuroshell.com
F AIQ: MARCH 2017 TRADERS’ TIPS CODE The AIQ code based on Ken Calhoun’s article in this issue, “Golden Cross Breakouts,” can be found at www.TradersEdgeSystems.com/traderstips.htm. I tested the author’s system using the NASDAQ 100 list of stocks from the year 2000 through 1/11/2017. I also coded an alternative exit that held positions much longer. Figure 9 shows the author’s system and exit, and Figure 10 shows the same golden cross entry but with my alternative exit. My alternative exit has the following rules:
FIGURE 9: AIQ. Here are sample summary test results for the strategy descri bed in
Ken Calhoun’s article in this issue.
1) Sell when the 50-day moving average crosses through the 200-day moving average, or 2) Sell using a prot-protect type of trailing stop set to trigger when prot is greater t han or equal to 15%, then exit if prot drops to 1% (do not let a prot of X% turn into a loss). The alternative exit signicantly 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: len1 is 50. len2 is 200. stopamt is 2. minPrice is 5. maxPrice is 70. SMA1 is simpleavg([close],len1). SMA2 is simpleavg([close],len2). GoldenCrossUp if SMA1 > SMA2 and valrule(SMA1
SMA2. PriceOK if simpleavg([close],10) >=minPrice and simpleavg([close],10)<=70. Buy if Golden and PriceOK. 54 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 10: AIQ. Here are sample summary test results for the same entries as in
Figure 9 for the golden cross strategy but using my alternative exit rules.
Sell if Golden=0 or [close] < {Position High Price}-stopamt. Buy1 if Golden and PriceOK. Sell1 if Golden=0. !and use built-in prot protect[1,15]
Again, the code and EDS le can be downloaded from www. TradersEdgeSystems.com/traderstips.htm. —Richard Denning [email protected] for AIQ Systems
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.
F TRADERSSTUDIO:
MARCH 2017 TRADERS’ TIPS CODE The TradersStudio code based on Ken Calhoun’s article in this issue, “Golden Cross Breakouts,” can be found at www. TradersEdgeSystems.com/traderstips.htm. The following code le is provided in the download:
FIGURE 12: NINJATRADER. The GoldenCrossBreakout strategy displays the long
entry for the crossing of the 50 SMA over the 200 SMA on the SPR daily chart for October 2016.
F NINJATRADER:
System: GOLDEN_X —A system that buys on golden cross up and sells on golden cross down.
Figure 11 shows the equity curve trading 200 shares of each of the NASDAQ 100 list of stocks from March 2000 through June 2016. I did not use the two-point trailing stop for this test. The code is shown here: 'GOLDEN CROSS BREAKOUTS 'Author: Ken Calhoun, TASC March 2017 'Coded by: Richard Denning, 1/8/17 'www.TradersEdgeSystems.com Sub GOLDEN_X(len1, len2, stopamt, minPrice, maxPrice) 'INPUTS: 'len1 = 50 'len2 = 200 'stopamt = 2 'minPrice = 20 'maxPrice = 70 Dim SMA1 As BarArray Dim SMA2 As BarArray Dim Golden,PriceOK SMA1 = Average(C,len1) SMA2 = Average(C,len2) Golden = SMA1 > SMA2 PriceOK = Average(TSCLose,10)>=minPrice And Average(TSCLose,10)<=maxPrice If Golden And PriceOK Then Buy("LE",1,"",Market,Day) If Golden=0 Then ExitLong("LX","",1,"",Market,Day) 'If C < (Highest(C,BarsSinceEntry,0))-stopamt Then ExitLong("LX stop","",1,"",Market,Day) End Sub
MARCH 2017 TRADERS’ TIPS CODE The golden cross breakout strategy, as discussed in “Golden Cross Breakouts” by Ken Calhoun in this issue, is available for download at the following links for NinjaTrader 8 and NinjaTrader 7:
NinjaTrader 8: www.ninjatrader.com/SC/March2017SCNT8.zip NinjaTrader 7: www.ninjatrader.com/SC/March2017SCNT7.zip Once the le is downloaded, you can import the strategy into NinjaTader 8 from within the Control Center by selecting Tools Import NinjaScript Add-On and then selecting the downloaded le for NinjaTrader 8. To import into NinjaTrader 7, from within the Control Center window, select the menu File Utilities Import NinjaScript and select the downloaded le. You can review the strategy’s source code in NinjaTrader 8 by selecting the menu New NinjaScript Editor Strategies from within the Control Center window and selecting the GoldenCrossBreakout le. You can review the strategy’s source code i n NinjaTrader 7 by selecti ng the menu Tools Edit NinjaScript Strategy from within the Control Center window and selecting the GoldenCrossBreakout le. NinjaScript uses compiled DLLs that run native, not interpreted, which provides you with the highest performance possible. A sample chart implementing the strategy is shown in Figure 12. →
→
→
→
→
→
→
→
—Raymond Deux & Patrick Hodges NinjaTrader, LLC www.ninjatrader.com
—Richard Denning [email protected] 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 Calhoun’s column in this issue, “Golden Cross Breakouts.” In the article, Calhoun proposes that this classical technical analysis setup be used in conjunction with other lters, such as rising volume, to better identify trends with the potential 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 rewall 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
In this trading simulation, we buy at the open of the next bar. The price hits our two-point trailing stop on 12/13/2016 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) magazine website at www.Traders.com in the March 2017 COVER Traders’ Tips area) is set up to process 2,500 bars, or just BUY ELSEIF HASX(MAVE(#PERIOD1),MAVE(#PERIOD2),DOWN) short of 10 years of historical data. SELL The transaction summary tab shown in Figure 15 shows SHORT 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) bit. Gotta love those trail ing stops! NEXT 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 [email protected] nearly the highest bar on the chart, and things moved downwww.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 SUGGESTIONS explains the workings of a simple trend-following trading 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 nd 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 nd any. Thus, you should expect to scan quite a few securi • A mechanism to scan across this symbol universe and ties to nd one. ag symbols showing a golden cross signal in the last But when you do nd one, it can provide an interesting several days. This may be a very small number of symride, as demonstrated by the Spirit Aerosystems Holdings exbols much of the time ample given in Figure 1 of Calhoun’s 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 art icle. 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. INDICATORTYPE TOOL DISPLAYSTYLE 2LINES PLOTSTYLE LINE RGB(255,0,0) PLOTSTYLE2 LINE RGB(0,255,0) SHOWEQUITYCURVE
Continued on page 62
56 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
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TDAmeritrade.com/tradefinder
WEBSITES
StockCharts.com
02, 37
StockCharts.com
PUBLICATIONS
Stocks & Commodities
63
Store.Traders.com, Traders.com
Stocks & Commodities
63
Store.Traders.com, Traders.com
SOFTWARE
Jurik Research
25
jurikres.com, tinyurl.com/jurik-online
EDITORIAL RESOURCE INDEX National Association of Real Estate Investment Trusts (reit.com/nareit) . . . etfdb.com . . . . . . . . . . . . . . . . . StockCharts.com . . . . . . . . . . . . MetaStock . . . . . . . . . . . . . . . . . Microsoft Excel . . . . . . . . . . . . . . NADEX (nadex.com) . . . . . . . . . . TomsOptionTools.com . . . . . . . . . NinjaTrader . . . . . . . . . . . . . . . . eSignal (Interactive Data) . . . . . . . . . . TradeStation . . . . . . . . . . . . . . . TC2000 (Worden Brothers, Inc) . . . . . . . thinkorswim . . . . . . . . . . . . . . . .
. . 07 . . 46 . . 46 . . 23 . . 27
Wealth-Lab . . . . . . . . . . . . . . . . AmiBroker . . . . . . . . . . . . . . . . . Neuroshell Trader (Ward Systems Group) AIQ . . . . . . . . . . . . . . . . . . . . . TradersStudio . . . . . . . . . . . . . . . Updata . . . . . . . . . . . . . . . . . . .
. . 52 . . 53 . . 53 . . 54 . . 55 . . 56
. . 33 . . 41 . . 42 . . 48 . . 50 . . 51 . . 52
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March 2017
• Technical Analysis of STOCKS & COMMODITIES • 57
FUTURES LIQUIDITY rading liquidity is often overlooked as a key technical measurement in the analysis and selection of commodity futures. The following explains how to read the futures liquidity chart pub lished by Technical Analysis of STOCKS & COMMODITIES every month.
T
COMMODITY
very high volumes. The greatest number of dots indicates the greatest activity; futures with one or no dots show little activity and are therefore less desirable for speculators. Courtesy of CBOT
FUTURES
The futures liquidity chart shown be low is intended to rank publicly traded futures contracts in order of liquidity. Relative contract liquidity is indicated by the number of dots on the right-hand side of the chart. This liquidity ranking is produced by multiplying contract point value times the maximum conceivable price motion (based on the past three years’ historical data) times the contract’s open interest times a factor (usually 1 to 4) for low or
three-year period. Thus, all numbers in this column have an equal dollar value. Columns indicating percent margin and effective percent margin provide a helpful comparison for traders who wish to place their margin money ef ciently. The effective percent margin is determined by dividing the margin value ($) by the three-year price range of contract dollar value, and then multiply ing by one hundred.
STOCKS
All futures listed are weighted equally under “contracts to trade for equal dollar prot.” This is done by multiplying contract value times the maximum possible change in price observed in the last
Trading liquidity has a signicant ef fect on the change in price of a security. Theoretically, trading activity can serve as a proxy for trading liquidity and equals the total volume for a given period expressed as a percentage of the total number of shares outstanding. This value can be thought of as the turnover rate of a rm’s shares outstanding.
Trading Liquidity: Futures Commodity Futures
Exchange
% Margin
Effective % Margin
Contracts to Trade for Equal
Relative Contract Liquidity
Dollar Proft
S&P 500 E-Mini (Mar ‘17) 10-Year T-Note (Mar ‘17) Crude Oil WTI (Mar ‘17) Russell 2000 Mini (Mar ‘17) 5-Year T-Note (Mar ‘17) Ultra T-Bond (Mar ‘17) T-Bond (Mar ‘17) Euro FX (Mar ‘17) Gasoline RBOB (Mar ‘17) Natural Gas (Mar ‘17) Nasdaq 100 E-Mini (Mar ‘17) Soybeans (Mar ‘17) ULSD NY Harbor (Mar ‘17) British Pound (Mar ‘17) 2-Year T-Note (Mar ‘17) Eurodollar (Dec ‘17) Corn (Mar ‘17) Gold (Feb ‘17) Dow Indu 30 E-Mini (Mar ‘17) Japanese Yen (Mar ‘17) High Grade Copper (Mar ‘17) S&P Midcap E-Mini (Mar ‘17) Silver (Mar ‘17) Sugar #11 (Mar ‘17) Wheat (Mar ‘17) Live Cattle (Apr ‘17) Soybean Meal (Mar ‘17) Australian Dollar (Mar ‘17) Canadian Dollar (Mar ‘17) Lean Hogs (Apr ‘17) Mexican Peso (Mar ‘17) Coffee (Mar ‘17) Cotton #2 (Mar ‘17) Hard Red Wheat (Mar ‘17) U.S. Dollar Index (Mar ‘17) Cocoa (Mar ‘17) Crude Oil Brent (F) (Mar ‘17) Feeder Cattle (Mar ‘17) Platinum (Apr ‘17) Soybean Oil (Mar ‘17) Swiss Franc (Mar ‘17) 30-Day Fed Funds (Apr ‘17) Brazilian Real (Feb ‘17) New Zealand Dollar (Mar ‘17) Palladium (Mar ‘17)
GBLX CBOT NYMEX ICEUS CBOT CBOT CBOT CME NYMEX NYMEX GBLX CBOT NYMEX CME CBOT CME CBOT COMEX CBOTM CME COMEX GBLX COMEX ICEUS CBOT CME CBOT CME CME CME CME ICEUS ICEUS KCBT ICEUS ICEUS NYMEX CME NYMEX CBOT CME CBOT CME CME NYMEX
4.6 1.3 6 4.7 0.8 3.9 2.9 2.7 7.1 7.7 4.3 5 6 5 0.3 0.1 5.4 5.5 4.2 4.5 3.7 4.3 7.5 8.1 5.2 4.2 5.8 2.9 2.5 4.7 8.3 6.3 5.4 4.5 2 8.3 6 5.7 5.4 3.8 3.2 0.1 8.7 3.5 5.2
18.6 15.3 5.8 14.5 17.6 17.7 15.8 9.1 6.9 8.2 12.6 11 6.3 13.9 15.7 10.4 12.9 33.9 17.9 30.1 13.1 14.8 24.5 16.2 7.1 9.3 11.9 11.6 11 5.2 12.3 13.3 16.9 4.8 9.4 14.8 5.4 6.4 9.9 13.3 14 10.1 19.4 16.7 13.5
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2 7 1 2 13 2 2 2 1 2 2 3 1 2 18 20 9 3 3 4 4 1 3 6 4 3 4 4 4 3 4 2 6 3 3 6 1 1 3 12 2 25 5 4 2
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ers’ Resource database at our website to nd the websites of the exchanges handling your tradable, then go to the site to get the specics of the trading vehicle. Better yet, get several equivalent products at several exchanges and be sure your broker can direct your business to the venue of your choice.
LI NK S
TRADERS’ RESOURCE AT TRADERS. COM In addition to our listing of exchanges at Traders.com, you’ll also nd listings of other trading-related products and services such as software, publications, courses and seminars, brokerages, data service s, trading systems, and more. We hope this will help you learn about products to help in your trading endeavors. To reach the Traders’ Resource area of our website, just click on the Traders’ Resource lin k from Traders.com. Then follow the category link for exchanges, or use the search feature to nd products or services with specic attributes in this or other categories.
The information in Traders’Resource is the most accurate at the time of posting and is subject to change. Because the vendors posting to Traders’ Resource are responsible for their own listing, Technical Analysis, Inc. declines any and all liability for any representations made by the businesses and individuals listed. Nor can Technical Analysis, Inc. endorse any business or individual listed on Traders’ Resource. Technical Analysis, Inc. makes no warranties, express or implied, as to the accuracy and reliability of claims herein. You agree to release Technical Analysis, Inc., together with its respective employees, agents, officers, directors and shareholders, from any and all liability and obligations whatsoever in connection with or arising from your use of Traders’ Resource. If at any time you are not happy with the information posted to Traders’ Resource or object to any material within Traders’ Resource, your sole remedy is to cease using it. This list is updated frequently. If you are aware of a business that should be listed, please email us at [email protected].
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 that you want to follow and how often, after placing a trade, have you deviated from that plan? Emotions can wreak havoc on our trading lives and there’s nothing you can do to make them disappear. The rst step toward combating them is to be aware of the existence of emotions.
by Claudio Demb
I
am tempted to start with the end and give away the punch line. So here it goes: Psychology is destiny. I agree that it sounds very categorical, and whether or not this is true doesn’t really matter. You still have to go through the motions. As a good friend of mine often said, “Not everything is psychological.” I know that what he said is true, but to be fair, he had to learn to deal with his emotional issues in order to become a good t rader. WHAT DOES IT REALLY TAKE? If not everything is psychological, then what are the other
60 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
necessary elements to become a successful t rader? To answer this question could lead into a long academic discussion. You could say that the psychological lens is a very powerful element, but right in this statement l ies the rst problem. We can reference a psychological “lens,” but do you act ually see your emotions or do you feel them? You don’t see your emotions. You feel them, and that can be a problem when it comes to trading. But that doesn’t mean emotions are all bad. It is much easier to see things that are concrete or tangible. Numbers are an example of something that is concrete. Feelings are extremely important, but since you cannot see them, it can be difcult to understand and accept them. It is not unusual for people to believe they have control over their actions. They can speak clearly about their methods and tra ding plans. But when feelings kick up in high gear, it is very possible to do something totally different, sometimes even 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 is some invisible force that takes over, uninvited, that helps us to depart from our plan.
K C O T S R E T T U H S / L A N O I S S E F O R P D S E
AT THE CLOSE
NOT ALL IS LOST Just because emotions are intangible, it doesn’t mean you are helpless. There’s hope. With practice, pat ience, help, and time you can get a handle on your emotions. Taking the step to being aware of what is going on and even anticipating what you might feel as the trade unfolds is an indication that you are on the right track. It’s a sign that you are no longer blinded by your feelings. 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 won’t be much use since every person is unique. The twists and turns that one trader takes will not apply to those of another trader. But there are some key ingredients such as time, commitment, trust, hard work, and exposure to vulnerabilities that affect all of us.
We think we know, we believe we have a solid plan, but there is some invisible force that takes over, uninvited, that helps us to depart from our plan.
tory signals. Before you know it, you are underwater and you need to think fast. You were bullish and dead sure about your long position, but the ma rket is telling you the opposite. Who are you going to listen to?
WHAT YOU SEE KNOW WHAT YOU’RE DEALING WITH I will now shift gears and move on to a more concrete, easy- In situations like these, you need an innate abil ity 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 won’t 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. It’s not less will not sufce. 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. It’s 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, it’s almost seductive, but that is just an illusion. The reality is t hat it is very difcult. So passion is Claudio Demb has been an independent trader and investor for over 20 years. He is a practicing psychiatrist and lives one of the must-haves to be a succe ssful trader. You also need some smar ts with numbers. It’s not that you with his family in Brookline, MA. He may be reached via need to be a mathematical wi zard, but you need to have some email at [email protected]. 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 Inuence Your Tradwilling to sit down and work at it. You need mental exibility, ing,” Technical Analysis of STOCKS & COMMODITIES, almost like having the agility of a wild an imal. That may sound Volume 35: January. esoteric but just think about this for a moment: Say you’re trading with your best trading idea a nd it is getting contradic-
Sneak preview... Trading The Open
Harmony and PATH
by Adam Ryan
by Patrick Hughes
The open of any trading day sets the tone for the rest of the trading day. Here’s how you can take advantage of the volatility of the open to generate profits from it.
When learning technical analysis, traders tend to look for perfection instead of looking at how perfection is created. Here’s a technique that could give you a deeper insight into the relationship between time and price.
Trading Elliott Waves Using A Top-Down Approach by Mircea Dologa
When applying Elliott wave counts to your charts, one of the challenges is knowing which trend to use. Here is an approach that could help you identify which to use. 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 ve or six deat h cross signals buried in the data used to create my list of sample transactions. The spreadsheet le 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 le link (“GoldenCrossBreakout.xlsm”), then • Select “save as” to place a copy of the spreadsheet le on your hard drive.
—Ron McAllister Excel and VBA programmer [email protected]
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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