Active-Trader - The Gap, Freeze and Slip

Welcome back Active Traders.

If you have been following my blog for any length of time, you know I am a fan of day-trading delta 7 or higher options on big, popular high-priced stocks. And a key part of this strategy is to limit losses to $100 or 1 point when trading a single lot.  These are pretty tight parameters for an option trade since a delta 0.7 option will move 70 cents for each $1 move in the underlying.  This means that a move of about $1.30 in underlying will cause a stop-out in this type of position.   And that's nothing for a high priced stock such as GOOG or AAPL.

Add on top of that the fact that the bid-ask spread for these options can be 1 point or more, and its easy to see how this strategy can make me easy meat for the market makers.  That said, I have had a pretty decent record thus far and my $1 stop loss has resulted in a loss of at most $130 or $150 on a 1 point stop.

Well all that changed this past Tuesday when was trading the GOOG 895 call which I entered on Tuesday at 18 with a target of 20.5 and a stop-loss of 17.   I watched the stock shortly after entry and at one point I was up about 1.2 or $120 or so within a few minutes.  At this point, there was nothing left to do but just sit back and let the trade play out.  GOOG had briefly tagged $920 on Monday and I figured a retest could be in the cards.

A few minutes later, GOOG pulled back to just about break-even, then gapped down about $2.2 or $2.5 points.  At first, it seemed like a bad tick, and the options did not immediately follow. Instead, they sort of froze and waiting to see if the price in the underlying were just a bad tick or what.  I expected the options to catch up within a few seconds, but instead they just froze.   And I sat there watching the price bounce around, have traded well below my stop price yet the option prices were not updating, nor was I stopped out of my position.

Now this is the type of moment when time just stops as a trader.  You are in a position, and you have a stop, but the market is not letting you out.  And it moments like this when you hearken back to the all the fine print in the account agreement when you sign off on the fact that you can incur financial losses based on failures in technology, servers, the Internet, bla, bla bla.  I get all that, but the market maker has an obligation to maintain a fair and orderly market on the underlying if its trading right?

Well all this went on for 2 or 3 minutes but seemed like an eternity. Tradstation continued to update quotes, but a slower pace than usual.  Its hard to say whether the slowness was real or imagined, but it seemed clear that either the market makers were not updating their quotes, or the Tradestation stop server was hung.  Some time after that, the options caught up, and I was stopped out at $15.70, a full 2.3 points instead of the 1.0 point stop I planned upon.

At this point it occurred to me that stops are just a promise, and promises are not always kept.  It's not that we can't trust the Options Clearing Corporation.  Its more that the options market maker can cease to make a market at any time based on their inability to price the underlying.  And this could happen in a a flash-crash or other adverse market situation. It could also happen if trading in the underlying is halted based on news pending or any number of other unexpected events. It doesn't happen often, but its part of doing business in the wild world of financial markets.

All this makes the case for doing a more time-based methods of trading such as credit spreads, condors and other trades which benefit from Theta decay. I have come a long way in my journey as a trader,  but in many ways, I'm just getting started.

Enjoy your weekend and get some rest.

Meta-Trader - Fading the Gap

Welcome back traders.

In this post, let's delve into John Carter's excellent book Mastering the Trade.  It was interesting to find out that this book contains many ideas which can be tested programmatically.  And I find that to be more than a bit ironic since John Carter himself doesn't do any automated trading.  But he does follow defined setups, and this was the first one in the book and it goes like this:

- Use this system on the broad market indices, either the stock index futures or the broad market ETFs such as SPY or DIA.  I tested it against DIA which is the ETF for the Dow Jones Industrial Average.

- When the market opens with a gap greater than 10 Dow points and less than 70 Dow points,  fade the gap.  In other words, if the market gaps up, sell short and if the market gaps down, go long.

- Close the trade when the gap is closed (as in the example on the left) otherwise close at the end of the current day at the market price.

- Stop loss is 50 Dow points, however John Carter recommends a stop at 1.0 to 1.5 times the gap size.  I didn't find the results to be much different when using Carter's formula versus a fixed stop.

Coding this system took some trial and error but I have to say its a complete pleasure to work in this environment versus Meta-Trader. TradeStation by default will evaluate systems once per bar.  When I tested it against the hourly bars, it would not enter a position until 10:30 AM.  So I ran it against the 5-minute bars and TradeStation had no problem pulling up and executing the system against 5-minute bars for the past several years.  This was a major relief vs Meta-Trader where you could not trust the results of 5-minute bars due to the bar interpolation issue.  Also, getting reliable data inside MT4 is a challenge to say the least. What an amazing tool TradeStation is and I am so glad to be done with MT4!

Code for the system is pretty simple and looks like this:

{* Index Gap Fade down *)

var: bool GapDn(false);
var: double DistanceInPoints(0.0);

{* Did we gap down?*}
GapDn = Open < CloseD(1);

{* How big was the gap, will always be positive *}
DistanceInPoints = closeD(1) - Open;

{* Greater than 10 and less than 70 Dow Points and 9:35 AM *}
if GapDn and DistanceInPoints > 0.1 and DistanceInPoints < 0.7 and time = 0935 then Buy ( "FadeGapDn" ) at next bar at market;

{* Stop a stop of 50 dollars, we are trading 100 shares *}
SetStopLoss(50.0);

Results for the system are shown in the table in percentage return of invested capital. 

- For the past 8 years, returns ranged between -0.55 and +1.16% per year. 

- Against the entire 7+ year test period, the system returned 2.56% with about -0.38% drawdown.

- Percentage profitable was just over 63% showing the system definitely does have a positive statistical bias

JC references an analysis where he shows that gaps are less likely to fill on Mondays than other days of the week and some other conditions (last day of the month etc) which I did not include in my analysis.

One weakness of this system that it loses money on days where the market gaps up and does not look back.  Since the stock market has a positive bias over time and certainly over the test period, the system fights the trend in that respect.  We can see that in the results where buying the gap down makes twice as much overall as shorting the gap up.

Overall results from this system are not stellar.  To make a living in active trading, we want to make about 1% per day on our assets at risk. But this system is just one of many tools in our arsenal of money making techniques.

I will upload the TradeStation code to my Yahoo Group and notify the list.

Have a great weekend and week ahead.

Meta-Trader - Just go with it

Welcome back Meta-Traders.

It was another spectacular week in the stock market with Dow Jones Industrials breaching 15,000 for the first time.  Taking a look at the daily chart of SPY, we had new, all-time highs on 5 of the 6 previous trading days. And it all started with a gap to the upside after better-than-expected jobs numbers last Friday.

To say the markets are extended at this point it putting it mildly with the SPY way above the 8, 20 and 200 day moving averages.  Everyone expects a pullback, but we are not getting it.  John Carter recently advised that in situations like this, you don't want to fight the action, you just want go with it until it stops.  Its the kind of simple mindset that comes so naturally to JC that at the same time would cause the head to pop-off of someone who is trying to view the markets from a complely rational perspective.  And since we are managing swing or day trades one at a time, nothing should happen in any one day that causes much financial damage ensuring that will be around to capture the money-making opportunities when they arise.

And speaking of opportunities, we had a beautiful breakout in Regeneron (REGN) this past Friday.  I was watching the markets in the first 30 minutes of the day and spotted a breakout.  Checking the daily timeframe, this was a clear breach of the recent trading range that formed as the stock based between the 255 and 265 area.   I picked up a half-size long position at the 266 level right at the orange bar shown in the chart on the right. From there the stock screamed upward.

I was able to point this out to the other traders on the Simpler Options trading room and some other traders got on board and even John Carter put a position on (believe it was 270-280 call debit spread) as the stock reached the 270 area.  The stock made it as high as 274 then based for the remainder of the day and closed at 273.57.  I went out long the stock in both my cash and retirement accounts and I am going to try and stick with it until $300 which I think is an entirely reasonable target from here.  The logic being that if a stock makes it to $270, why not $300 since its the next big round number.

I also took a similar half-size long position in Biogen Idec (BIIB) at about the 211.5 area.  This was close to the bottom of a recent consolidation and I expect the stock will get back into the 220 area next week.  Some members of the Simpler Options Trading room consider BIIB to be an "Elephant" with much higher price levels expected ahead.

As for development work,  I have started to code TradeStation strategies for some of the swing trading setups mentioned in John Carter's excellent book Mastering the Trade.  More to come on that when I'm ready to share.

Enjoy your weekend and be sure to do something special for the Mother's in your life since Sunday is Mother's day.

Looking back, so far 2013 has been an incredible year in the markets. There's no way of telling how long it will continue. So for now, we're just going to go with it.

Meta-Trader - Apple Trendline Break

Welcome back Meta-Traders.

 

It was another spectacular week in the markets.  Gains were broad and across the board with SPY +2.1%,  DIA +1.82% but QQQ leading the pack up +3.78% for the week.   We also had healthy gains in Europe and Emerging Markets with EEM +3.39% as the ECB finally dropping interest rates for the first time since July of 2012. 

Those who subscribe the "Sell in May and go away" theory missed a monster rally on Friday May 3rd.

 

But the big story was AAPL where we finally had a break of a huge 8-month trend line set from the top at 700 set back in September of 2012.  This came on some big fundamental developments which i'll cover below. 

But first, why do we care?  We care because AAPL has a larger capitalization of any stock in the US Market.  So AAPL has a huge impact on the markets themselves.  We also care because AAPL is such a big point mover, about 30 points this past week and the week prior.  So we can make good money trading delta .7 options on this stock. 

And we care about this move because history has shown that trend line breaks often signal the beginning of long-term shifts in price action.  There's a tendency to think that you have to be super-smart to make money in the markets, that to have to be looking at something that nobody else is looking at.  I would argue the opposite - that the big money is make on the big, obvious changes in character like this one here.

Well at this point, the stock is clearly extended, having gone straight up almost 10 days straight.  So I am  not saying that AAPL is a screaming buy here.  Its just that we have clearly switched from STFR (Sell the F'ing Rally) to BTFD (Buy the F'ing Dip) in John Carter parlance.  Now what fundamental developments have occurred here that we need to know about?

Well on Tuesday afternoon, AAPL released earnings along with a number of moves to redistribute part of its huge cash horde to shareholders.  In fact, at the beginning of the conference call, you could here the relief in Tim Cook's voice that he was finally bowing to some of the relentless pressure he has been under to do something about the 40% loss of Market Cap the stock has seen in a mere 7 months.  Here's what they came up with:

• Increased repurchase authorization to 60 B by the end of 2015.  With a current capitalization of 418 B, that will reduce the number of outstanding shares by 14%, thus increasing the per share performance of the business for existing stockholders. 
• Increased the dividend 15% to $3.05 per share per quarter
• Accessed the debt markets in the largest single corporate debt offering in history borrowing 17 billion dollars!
  

This last item is pretty significant since AAPL has traditionally avoided financial engineering of any sort, and almost ignored its huge cash position and instead, focused on just making great products.  With this move, AAPL is borrowing at record low interest rates to retire stock and avoid having to pay taxes on income earned overseas.  They are clearly listening to their shareholders, and activist investors. 

I would not consider buying the debt, since it pays only slightly better than US Treasury securities.  And I am not a debt investor anyway.  What it does say is that APPL thinks they can provide a better rate of return on the capital borrowed from these investors than they are paying them to borrow it.  Phrased another way, they are selling puts on the cash to the bond investors and buying calls on their own stock.  Which side of that trade would you take?

As for the stock, its going to have a long road back to the all-time highs at $700.  For active trading, I also have an eye on Google (GOOG) which on Friday took out its all-time closing high.

That's enough for today.  Go forth and enjoy the fruits of your labors.  And enjoy your weekend.

Meta-Trader - The Earnings Miss

Welcome back, Meta-Traders.

As you know by now, I am mostly a stock trader.  And nothing strikes fear into the heart of the long-side stock holder than the dreaded earnings report.  This is the single most important news event for any individual stock.  And it comes just 4 times per year just as surely as the rotation of the Sun, Moon and the Earth which governs most of our other natural cycles.

What makes the earnings report so important is that it is so rare.  There are about 250 trading days per year in the stock market and only 4 of them are earnings days for any single stock.  That means an earnings day is a 4/250 event or put another way only occurs about 1.6% of the time.  And that spells opportunity for the astute trader in a few ways as follows:

1) The Earnings Miss - This happens when a stock with good fundamentals and a good chart etc releases earnings which don't live up to expectations.  This is especially common when the stock had a big run-up into earnings, see below for that.  In any case, the stock is unduly punished and sells off hard in a manner disproportionate to the rest of the market.  In the above case, IBM sold about 5% on the earnings news which was way beyond the fraction of 1% move in the general market.

Anyway, the Earning Miss provides a buying opportunity for the astute trader, as long the earnings news does not contain any substantial fundamental developments affecting the company.  This means you should read the earnings report and/or listen to the earnings conference call before forming your opinion.  You don't need to have an MBA or understand what is meant by SG&A.  Just listen to the call, read the news and form your opinion, its not that hard.  In my case, I decided to buy IBM at the blue bar above and I am sticking with it for a gap fill up to about 207.  That may seem like a big move, but remember, IBM is a Dow-30 stock with really good management the indexers have to buy it.  They have no choice.

2) The Run-Up into Earnings - This happens when a great stock with great fundamentals runs up into earnings. Case in point is Amerisource Bergen (ABC).   This stock has solid fundamentals, 5-year earnings growth of almost 20%, PE of about 19% and a yield of 1.6%.  Its always encouraging to see a stock with a 5-year earnings growth rate greater than the PE.  Cramer says you can pay a multiple of up to 2X the PE, so stocks in this situation are undervalued and can rise substantially from here.

All that being said the earnings date can make or break the play. In the case of ABC, I bought into the run-up ahead of earnings and sold right into the rally at about $56.70 the day before earnings came out. The earnings were not bad, just not stellar and that was enough to knock the stock down and I re-loaded at the blue bar above.  Sure the stock can drop from here - and it did in my case.  But you have to have conviction in the story based on your own research.  If you don't have conviction, don't take the trade.

3) The Sell-Off into Earnings - This happens when a stock with pretty good fundamentals sells of before earnings in anticipation of bad news.  Once the new comes out, sometimes the news was not quite as bad as expected and the stock rallies..  Case in point in my favorite Health Care cost containment play HMS Systems symbol HMSY.

Check out the daily chart of HMSY.  The stock recently sold off hard on the daily chart from a high of 31 and change all the way down to about the mid 22's.  I almost sold the stock ahead of earnings because it looked so bad.  But listening the earnings call,
I understood that the earnings miss - which was predicted and realized - was based on short term uncertainties related to adoption of government-reimbursed health care contracts which is the core of the long-term story behind this company.  Net result was a buying opportunity and I bought on the blue bar shown above.

Granted I could be totally wrong on all of the above plays.  The stock market could go into the toilet based on terrorism macro or other unexpected factors leading to a big loss of my principal.  But we are in a major bull market and learning and understanding the fundamental factors behind you investments give you conviction to stick with the story or even buy when the charts look bad.

Okay, I'll get off my soap-box now.  Enjoy your weekend.

Meta-Trader - $TICK, $TIKI and $TRIN

Welcome back Meta-Traders.

This past week was a bit rough in the markets for your humble blog author.  The market was down big 3 of the 5 days and the 2 intervening up days barely made up for the down days.  As you know, I'm mostly a long-side player so I took a hit.  It was more like just giving back some recently gains which is not at all unexpected after all this bullishness we have had lately.

Last week's "continuation trade" in LNKD was a bust and I ended up giving up the entire premium over just over 7 bucks paid.  Loss control was poor on this trade as I wanted to exit with a stop around 5 for a max loss of 2 or about $200.  But instead, I let it go to zero and lesson learned for long option trades is to always have a stop loss pointed selected ahead of time and stick with it.  John Carter points out in his excellent book Mastering the Trade, that managing exits is the difference between amateurs and professionals in this business.

On the positive side, I did okay with the "Morning Scalp" trade in my TradeStation account where I seem to be holding myself to a much tighter standards.  I did one trade on Tuesday in the AAPL 430 puts and was stopped for a 1 point loss.  I did another trade on Friday in the AAPL 410 puts where I bought for $9.87 and sold for $12 a few minutes later.  Had I held onto that trade until later in the day, I could have sold it for $18 and made $800 instead of $200.  In any case, I continue to hold gains my TradeStation account which is up about +11.2% for the year edging out the S&P by about 2 points.

As for personal development, I got through the chapter on "Reading Market Internals" in Mastering the Trade and found out some really interesting ways to interpret intraday action.   In the past, I found myself often reacting to price action alone, just to buy at the top tick of the day and wondering why I was left holding the bag.  Read on for a quick recap of these 3 intraday indicators available in TradeStation.

$TICK

Ticks summarize the number of stocks on the NYSE increasing in price versus those decreasing in price.  The number typically ranges between -600 and +600 with occasional spikes to -800 or +800.  Very rarely we see moves to -1000 or +1000.   Extreme readings in either direction indicate that buying or selling has reached extremes and can be used either to prematurely close long or short positions which are in the wrong direction, or to exit positions in the right direction at a profit.

One cool feature of TradeStation is that you can setup audio alerts when ticks reach extreme values.  In my case, I setup the "Cash Register" sound when ticks reach +800 and the submarine "Dive Horn" when ticks reach -800.  Ticks also give you a clue as to overall market strength or weakness.  For example, if ticks spend most of their time above 0 with occasional spikes above +800, that is positive for the markets overall.  Looking at the graph above, which was Friday's action, it was pretty much a mixed bag but slightly positive with a few +800 readings.

For another example, look at the graph on the left which was Monday, April 15, 2013.  Note how Ticks spent most of their time in the lower half of the chart with a few excursions below the -800 mark.  +800 was not reached until the last few 15-minute bars of the day, probably not until about after 2PM EST.

$TIKI

TICK is the same thing as the Ticks, but only for the 30 stocks in the Dow Jones Industrial Average.  As such, its values will range from -30 to +30.  John Carter sets audio alerts on these at -30, -28, -26, +26, +28 and +30.  These levels corresponds to levels at which program trades are being executed which would simultaneously push down (or up) all 30 Dow-30 stocks at the same instant.  Program trades are not the primary driver of price action, but can result in short term moves one way or the other. John Carter uses TIKI as a "heads up" only, but leaves the actual signal to the Ticks.

$TRIN

TRIN is probably the most confusing of these 3 indicators.  Its also known as the ARMS index named after its founder Richard Arms and is calculated as follows:

(advancing issues/declining issues) / (advancing volume/declining volume)

In other words, this is a ratio of a ratio and ranges between 0.5 .. 4..  Lower numbers mean bullish markets and higher numbers mean bearish markets.

Hubert has some rules regarding TRIN based on the closing values such that if TRIN closes at high values indicating extreme bullishness, he will go short into the close expecting a lower open the next day.  Conversely, if the TRIN closes at low values for the day indicating extreme bearishness, he will go long to the close expecting a higher open the next day.  I don't have the exact parameters for this setup, so I will hold off on that for a future post.

That's all of for now, enjoy your weekend and good trading.

Meta-Traders - 2 Trading Setups

Welcome back, Meta-Traders.

It was another spectacular week of trading with my net worth hitting new highs several times during this past week.  The Dow Jones Industrial Average made new closing highs every day of the week but Monday and the SP-500 made new all-time closing highs on Wednesday and Thursday and gave some back on Friday.

One thing I have learned from being associated with John Carter is that good traders have a library of setups in their arsenal.  And they simply scan the markets at the key times and look for these setups.  Here, I will give you 2 setups that worked for me this past week along with some examples.

The Morning Scalp

This trade is done with options and on fast moving, high priced stocks.  I do these in my TradeStation account only since you have to be very nimble and profits could come and go in the time it takes to hit the refresh button on the browser when accessing your web-based broker.  Here's what to look for:

Set your charts to a 5-minute time frame and watch the first 5-minute bar of the day.  Be careful if there is a price gap between yesterday's close and today's open.  In the above case (which was GOOG on Wednesday), there was no price gap. Also note the first bar of the day was a large, green bar or in Oliver Velez Parlance, a "bull elephant" bar, so the bulls are clearly in charge.

Next, find the cheapest option you can find with a delta of 0.7 or above.  Use the closest expiration date you can find since you will be in and out of this trade in minutes.  In the above case, I chose GOOG 130412C765 which was the weekly 765 calls.

Next, wait for the pullback which a counter-trend move caused by profit taking by all the professional traders who take the other side of the opening price action.  Set a limit order inside the spread and wait for a fill.  Don't chase the price action and put in a market order since this increases your chances of being fresh meat for the market makers.  In my case I was filled on the GOOG 765 call at limit of 16.

Once filled, put in your stop loss order.  I chose a stop of $1 or $100 and was going for a take profit of $2 or better. Once the trade is on, only 2 things can happen, either you get stopped out, or you take your profit.  On the above trade, I came within $10 of being stopped out, just before the price reversed and headed higher, so I lucked out somewhat.

I did this trade 3 times this week:

GOOG 790 puts where I risked $100 and made $200

GOOG 765 calls where I risked $100 and made $300

REGN 200 calls where I risked $100 and lost $100.

This last one was a learning experience since the bid-ask spread on the REGN weekly calls was nearly $100.  I put my limit order in at 12 and got a good fill.  I put my stop order in and got stopped out almost immediately since the $100 was nearly the spread itself!  So be careful with less-liquid options and stick with the popular, highly liquid stocks such as APPL, GOOG, PCLN etc.  Either that or use a larger stop loss.

One last thing - if you get stopped out, stand up and high-five yourself because you followed your plan.  If you take profits, don't celebrate since (thank you John Carter) "Euphoria is the worst kind of stupid."

The Closing Continuation

This trade is done in the last 30 minutes of the day.  Set your charts to daily time frame and look for a stock which has had a big day to the upside, preferably into new high territory.  In my case this week I picked  CELG- Celgene which had a huge week along with a number of other large biotechs, BIIB, CELG, AMGN and REGN.

Anyway, check out the price action on this big green bar in the middle of the chart.  This was on Wednesday when the SP-500 had a huge day and CELG had about a 5 point move from about $116 up to about $120 and closed the day at $120.90.

In this case, I chose the CELG April 120 calls at a limit of $2.  In one account, I fat fingered the order and paid the market price of $2.10.  In the other account, I entered it properly and was filled at a limit of $2 even and held them into the close.

For this trade, we are looking for continuation of the prior days move, preferably with an opening gap in our favor.   Fortunately in this case I got it and was able to sell the contract for $3.10 on one account, and about $3.50 in the other account.  That's about a 50% gain in less than 24 hours and not bad for a day's work!

For a final example, take a look at the LNKD - Linked-in daily chart.  This stock had a huge day on Friday and closed at a new all-time high clearing the prior all-time high at $185.14.   I went into the weekend long the April 180 calls at $7.  I'm looking for a quick gap up on Monday morning and if all goes well, I will close the contracts for about $10.  Watch the open of LNKD on Monday and we'll see what happens!

That's all for now.  Enjoy your weekend, spend some time with your loved ones and get some rest.