Saturday, January 24, 2015

Active-Trader - Anatomy of a Trade

Welcome back, Active Traders.  We had a perfect storm of market action this past week.

After many months of dropping hints, the European Central Bank or ECB announced a massive amount of Quantitative Easing - where they basically create billions of Euros out of thin air and buy up all types of debt securities.  This has the effect of driving up the prices of those securities, and driving down the yields, which forces money into stocks.

Europe as a culture (particularly Germany) has strong cultural biases against this type of action with generational memory of hyper-inflation leading up to prior world wars.  But with the US economy firing on all cylinders,  the dollar rallying and oil prices plunging, they could no longer deny that it was working.  So they followed the path of the US Fed who completed a round of QE late last year.

The markets loved this of course and it sparked a huge rally across the board, particularly in Europe and Emerging Market Equities.  By comparison, international equity ETF's EFA and EEM are up 0.85% and 3.74% respectively versus DIA and SPY which are both down on the year. Emerging Markets have a lot of catching up to do after several years of under-performance.

Now let's go from the macro level down to the micro and look at an individual trade able - Netflix. NFLX reported earnings on Tuesday and I approached in my standard fashion - selling an iron condor outside the expected move.  Specifically, I sold the 302.5/305 385/387.5 iron condor for a credit of 1.03, max loss of 1.47. This trade had a skewed risk to reward ratio, but since its outside the expected move, has better than even chance of going max profit.

What happened next was unexpected, NFLX surprised to the upside and exceeded the expected move.  In no time at all the stock was trading at 390 and my condor was a max loss situation.  I did not immediately reverse my position however, somewhat skeptical that this move outside the expected move would last.

Well the stock did nothing but trade up, and it settled close to 415 and hung out there for a while. But it edged ever higher and I finally got long and bought the next Friday 410 call at 15.6.  The stock moved steadily higher and closed the day in the 428 area.  I went out long expecting a pop up into the open the next day.  We didn't get it, but I ended up closing the call out for $19 so I took a decent profit on it.

Friday came around and the stock attempted a sell-off, but it didn't materialize and the stock quickly recovered the 430 area and hung out.  I was expecting the 432 area to be resistance since there's the 261% fire line at 432.47 or thereabouts.  The stock traded up and then back down and headed ever higher.  So I went long the next Friday 420 call for a debit of $15 and flipped it out later in the day for $20.  So with a profit of 3.4 on the other trade and 5 on this is a total of 8.4 profit not counting commissions overall I came out ahead on this trade in a lemons to lemonade fashion

Now let's examine how John Carter traded it.

He started off with an iron butterfly, selling the at-the-money 345 puts and calls, and buying the 300 put and the 390 call as protection.  Overall, the trade had a max gain of about $4000 and a max loss of about $5000.

Carter had the same outcome as me, a max loss on the initial trade.  But what he did next is what makes the difference, so read on.

Next, to make up for the loss, he sold 15 of the 395/400 put credit spread for a credit of 1.2 bring in a total of $1530 to make up some of the 5K loss.  Next, he bought 10 of the next Friday 405 calls at 14.20 and sold 5 of the 425 calls and the 430 calls against it. Those options basically doubled and he made over 10K on that trade and easily wiped out the initial loss.   Although as the stock moved higher, he would have had to scramble to buy back the 425 and 430 calls at a loss since the stock rallied into the close Friday.

The real take away is how Carter handles adversity.  His initial idea failed, but he traded around that and managed to come out ahead.  In my case, I was afraid of compounding one losing trade with another.  It took me about 25 points of price movement (from 390 to 415) before I finally changed directions, while Carter did it much sooner.  In either case, Carter's ability to build a position as the price action evolved (and in the middle of trade) is what gave him an advantage.

But clearly part of Carter is rubbing off since I am:

1) Selling premium to bring in income
2) Buying Delta 0.7 puts and above for directional positions
3) Giving myself the give of time and buying the next week options for longs while selling this week's premium for shorts.

I've come a long way, but it still feels like baby steps.

Have a great week ahead.

Saturday, January 17, 2015

Active-Trader - Free Fib Lines indicator

Welcome back, Active Traders and Wealth Builders.

After many, many hours of work, I am pleased to present the FibLines indicator for TradeStation v9.5 at no charge to members of my blog.

This is a pretty major accomplishment considering that last year at this time, the Voodoo lines indicator was a complete mystery.  Of course, I could have spent the $1000 to buy the indicator plus $50 a month thereafter to use it.  But as you know, I'm not that kind of guy and don't believe in paying for indicators, at least not nearly that much.

So go ahead and download the file and follow the directions in the document to install it on your system.  Here are the highlights:

- Requires TradeStation v9.5 or above.

As I mentioned in last week's post, support for Thinkorswim is not going to happen due to limitations in that platform.  Note that I use Thinkorswim to draw the lines initially, and I can share for any symbol at your request.

- Lines appear identically in all time frames from monthly down to intraday.

- Includes support for over 130 stocks including DIA, IWN, QQQ and most members of the Dow-30 and the Nasdaq 100.  I also threw in a few favorites, PANW, BABA and GPRO.

Not included at this time is:

- A method to deliver support for new symbols over the Internet.  As of now, the symbol data is hard-coded into the DLL, so you will need to download a new DLL file to support more symbols.

- Support for Futures or Currencies since I don't trade those.  I'm not adverse to adding support for these if there is a demand for it.

As for my future plans, I may turn this into a paid service with support a much larger number of symbols.  Left to be determined is if there is enough demand for this indicator and what people may be willing to pay for it.  So give it a try and let me know your feedback.

Saturday, January 10, 2015

Active-Trader - 2015 Week 1

Welcome back, Active Traders.

I am back from a week in sunny Cape Coral, FL.  Before you get too jealous. I was with my in-laws.  So what was I doing with all that free time on my hands?  Coding the Fib Lines indicator of course!

One question you might be asking is, does this indicator really help with trading?  Its a very relevant question since one of my resolutions for 2015 is to trade less.  In other words, don't take a trade unless the setup is so obvious you could explain the setup to someone who knows nothing about trading.  And with all these lines on the chart, some of them are bound to be meaningful and others are not.  How do you know which is which?  The answer is you never know for sure.  But sometimes when the signs appear, you have to act.

And along those lines, take a look at CBOE. As you know I have been a fan of this stock and long since my post CME back in December of 2014.  I was able to get some shares and stay long and ride a nice breakout.  This past week, I noticed the stock slammed into the 223.6% treeline and seemed to hit an invisible ceiling.

So I took the opportunity to take profits and since then the stock has pulled back almost $1. I don't expect the bull case is over in these shares, and I will reload on the long side if we can get a pullback to the 193.6% tree line just under $65 per share.

As for what else has been accomplished, I found (and coded in the DLL) the fib levels for the Dow-30 stocks.  Next step is to locate the Fib lines levels for the Nasdaq 100 and perhaps the SP-100. I would like to supply those Fib line levels when I release the indicator to members of my Yahoo group (for free of course).

As for ongoing challenges, I don't believe I will be able code the indicator for Thinkorswim.  As it turns out, the Think script environment has some serious limitations that I did not anticipate as follows:
  • No ability to input data from the outside world except for simple parameters to the study.
  • No file input or output, no ability to call Windows DLL files like in TradeStation
  • Once you plot a value in ThinkScript, the price chart is scaled to always include the plot, which is pretty much a deal killer for Fib Lines in Think script which are very often out of view based on the time frame and Zoom level selected.
All this is pretty ironic considering I use Thinkorswim to discover the Fib line levels just to transfer them over the Windows DLL to include them into Tradestation.  Why don't I just do everything in Thinkorswim you might ask?  Because I prefer the programability of the TradeStation environment as well as the $1 pricing I for a trade of 100 shares or one option contract in Tradestation.

Overall, it has been a good start to 2015 and I started off the year with a good rest and a good running start of the Fib Lines indicator. I am feeling pretty good about my prospects and content to just watch events unfold and wait for great trading setups to occur.

So go ahead and relax and don't feel any pressure to act.  Let the market doing the talking and don't make any moves until your market declares itself one way or the other.  Don't guess, react.

And have a great week ahead.

Sunday, January 4, 2015

Active-Trader - Trading Plan 2015

Welcome back Active Traders and Wealth Builders.

The end of the year and beginning of a new one is an excellent time to reflect on what we are doing and why.  Where finance meets human behavior is a very interesting and often overlooked area of the human experience.  And for all the work I do to build and maintain my wealth, I overlook this area myself.  So in this post, I'm going to lay out my trading and investing plan for 2015 so here goes.


The overall objective of my trading plan is to deliver performance which achieves 75% of the annual return of the SP-500 with 50% or less of the peak-to-trough draw down. I also want to extract between 5% and 10% of the value of my account from the market each year as a result of active trading and opportunistic investing.


You might read this and say – aren’t you underachieving? If you don’t want to beat the market why even bother to make a plan? Why not just put 100% of your cash into the SP-500 and let it ride? Isn’t that guaranteed to deliver a better result over time? The answer is yes – but with a higher risk. Recall that the market can and does go down. Back in 2008, the market was down 50% from the top. Back in 1929, the market was down about 90% from the top to the bottom. Since I have been trading and investing for many years – and I am well on the way to financial independence – the last thing I want to do is lose my hard-earned gains. And as a result, I am willing to sacrifice some upside to avoid the chances of a wipe out.

Asset Allocation

CategoryAllocationKey TickersOver or Under
Broad US Stocks40%DIA, SPY, IWN-8%
Select US Sectors20%XLE, XLU, XLB, USO-7%
International10%EEM, EFA+3%
Active Trading and Trend Following20%AAPL, FB, CME, CBOE-10%

Looking at this, I am underweight in every category except for cash.  Its no wonder my performance is so ho-hum.  So clearly I'm no market wizard, so what about active trading?

Back in my younger days, I believed that I could program my way to financial independence. So I got my hands on SuperCharts (predecessor to today's TradeStation) and tried to program just about every stock trading strategy I could imagine. After a lot of struggle and observation, I discovered this simple truth: The trading system being used doesn't matter nearly as much as the performance of the underlying asset.

Put another way, a buy and hold strategy on a top-performing asset beats just about any given trading system on any given chart. In other words, its doesn't matter so much what system you trade, but what symbol you trade it against. That doesn't mean I don't believe in specific setups, I do and I'll get to those below. What it does mean it that it makes sense to find the best performing stocks and stick with those. And here is how to find them:
  • Stocks with excellent fundamentals and a reasonable valuation.  My favorites are those where the 5 year earnings growth rate is greater than the PE.
  • Stocks on the right side of a developing and ramping longer story
  • Stocks with meet the above criteria and are breaking out to new all-time highs
You can find more on how to identify those stocks in my post New High, Low PE, High Growth. That screen criteria constitutes the bulk of my entries.  Here are some specific setups I use to supplement that core strategy and bring in some extra cash:

Elephant Bar Breakout 

This happens when a stock breaks out to a new all-time high on huge volume and typically along with some underlying fundamental or news development.   Its best to enter these stocks late in the day (say between 3:30 and 4:00) on the day they break out .  Don’t wait until 2-3 days after the break out, instead remember these key words from Jesse Livermore:

I become a buyer when a stock breaks out to a high in price action after having a normal reaction.

In other words, don't buy a stock after it has made 8 straight new all-time highs.  Wait for the stock to clear resistance and move into all-time high territory then go long!  For an example, see Cigna (CI) on 10/30/2014.

Post Earnings Crash and Gap Fill

This happens when a stock with excellent fundamentals and prospects comes out with earnings and gets severely punished for no good reason.  Look at Qualcomm (QCOM) on 7/23/2014 and again on 11/5/2014.  The stock got crushed for 3-5 days after earnings then retraces.  These sell off's can be a good opportunity to buy some stock or sell puts. Take profits as the stock retraces.

Playing Defense

2014 has shown some great trading opportunities where the broad markets setup for a fall and get smashed. As the markets get increasingly traded by algorithms, its seems like the market has gotten more directional. I'm finding that it makes sense to hedge a certain part of the portfolio to extract alpha or minimize losses.  I will buy short ETF’s (in my 401K Rollover) or just go “Short Against the Box” ETF’s in my taxable account. I do so because I don’t want to close out my longs and pay capital gains taxes. Instead, I want to just minimize the pain during the downdraft. I have more work to do on this category of trade and would like to develop some setups which can identified and traded using TradeStation.

Special Situations

These are hard to define and I can’t really quantify exactly what I’m talking about here. But I know them when I see them. What else can I say.

Selling Premium into Earnings

I have been doing these trades for the past 2 years in small (1-2) lots and I find them to be an overall reliable way to make money. For an explanation, see here. I also like these trades because the ones which fail often turn into excellent directional trades in the direction that they failed. You know I have been doing a lot of work on Fib lines. Where to they fit into the larger scheme of things? Recall that Fib Lines – or no other Technical Indicator constitutes a Holy Grail . Instead, they provide clues to where price action may pause at resistance on the way up, at support on the way down. I plan to release the Fib Lines – plus levels on key stocks and ETF’s in early January 2015. So stay tuned for that.

That's all for now, have a great 2015!

Thursday, January 1, 2015

Active-Trader - 2014 Wrap-Up

Welcome back and Happy New Year to my loyal blog readers!

Happy Birthday wishes are also in order since as of today, this blog is officially 5 years old!

Five years is a long period of time to do something for which you don't get paid - and probably never will.  But in my case, the work is its own reward.  And I will continue to share the best of what works in trading and finance with the sole purpose of  making you successful.

Looking back over the prior 5 years, my net worth has roughly doubled over that time period.  Much of that success is due to a rising stock market.  If I can continue that performance over the next 10 years,  I will be well positioned to live happily ever after.

As for performance, 2014 was an average year and I put in about 6.6% in my taxable account and about 7.5% in my retirement account.  I didn't do nearly as well in my active trading accounts in both ThinkorSwim and TradeStation.  But I will continue to work on that and more to come on that topic in my 2015 trading plan post which is scheduled for this upcoming weekend.

As for design and analysis, my biggest accomplishment for 2014 was unraveling the Voodoo Lines indicator. Also, I have made excellent progress on the my version of the indicator for TradeStation which I call Fib Lines.  Look for a post on that in the first few weeks of 2015.

Overall, it was an excellent year and (thanks to an incredibly accommodating US Federal Reserve) a great time to be an investor.

So hear is my opportunity to wish you and your family a happy, healthy, productive and profitable 2015!