Archive for the ‘Trend Following’ Category
The biggest question I have received today from everyone, new traders, friends, family, even my wife is “What will happen to the stock market if Obama wins?’ or “If Romney wins will the market rally?”
How should we trade the election results? …..Don’t.
Do not let the results color your trading, trade price action, trade the chart, trade your system. Continue to manage risk and stay disciplined. Take your entries and exits just like you have always done inside a winning methodology.
If Obama wins and the market gaps under support tomorrow and begins a downtrend for multiple days then it may be time to go short. If Romney wins and we gap up tomorrow and the market starts to trend upwards then it may be time to go long. If the election is too close to call then…trade the chart, trade what is actually happening not your own opinion of what should happen. The answers to how to trade the price action should be based on your methodology and the time frame you trade on not who wins the election.
Everybody wants a prediction but no one has a crystal ball, the best traders I know trade the price action not their own predictions.
Since the whole world is waiting on Apple earnings I felt I had no choice but to tell my blog readers how I see it. I have good news and I have bad news, which would you like first? Okay I will give them both to you straight.
The bad news is that no one can give you the right ‘advice’ on what to do, the good news is that you can have a plan before hand. If you are a long term investor with a rock solid $800 price target in 2013 you should hold, if you are a day trader you should not be involved at all, if you are a position trader it would be wise to start new positions after earnings and go in flat, if you are an option trader you can structure a trade that fits your beliefs, long, short, bet on volatility or against volatility, etc. My position will be NONE I will be IN CASH because one of my rules is not to trade through earnings due to the risk. My #1 priority is risk management not profits.
The bad news for bulls is that earnings may not meet expectations due to the older product line for that quarter the good news is that it is already priced in both in projections and the price hence the sell off.
The bad news is that Apple is already very over owned by institutions and investors, the good news is that it will be whether they hold or sell that will drive the price higher or lower.
The bad news for bulls is that Apple is perceived as too big to continue growing the good news is that it is already priced in with a decreasing P/E multiple.
The bad news is that if the earnings are the least bit disappointing the stock could fall quickly to the 200 day or even lose it, the good news is that it will be a buying opportunity at a bounce off the 200 day or a retaking of it later if it does roll over.
The bad news for bulls is that the many think Apple is done and can not continue to grow and compete, the good news is that is not how monster stocks generally go out, they go out on a euphoric blaze of glory where everyone loves them as they go lower.
The good news for bears is that Apple is under distribution an in danger of losing its key 200 day level, the bad news for Apple bears is that at a 14 P/E, $100 billion in cash, and the hottest products and infrastructure cloud in the world it will have great difficulty truly ‘crashing’. True parabolic crashes come off P/Es of 40-100 during euphoric bull markets not during market corrections. And I am not a value investor I am a chart reader, but common sense dictates how to define reasonable price levels from historical data.
The bad news is that Apple has trouble making and distributing products fast enough, the good news is that every company wants that ‘problem’.
The bad news is that many have tons of gloomy reasons why Apple is in trouble and doomed to fall from here, the good news is that it is nothing I have not heard since 2007 and before. Apple continues to break all the rules about what is possible. SO FAR….
My trading plan is to wait until after earnings and play the trend that emerges tomorrow with weekly options to limit my downside but capture the trend in either direction. If we fall to the 200 day and rebound I will be long with a bounce off of it (IDEAL) if we lose the 200 day I will be short while we are under it, if we gap up and break to the upside and hold I will go long tomorrow morning.
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” -George Soros
One element of trading that is over looked as traders chase hot stocks, trends, and chart patterns is the importance of taking trades that have the potential to be big wins OR small losses. Big losses will kill your account quickly and small wins will do little to pay for those losses. Our trades have to be asymmetric where our downside is carefully planned and managed but our upside is open ended. This is a crucial element for trading success and has to be understood and planned for.
The risk/reward ratio is used by more experienced traders to compare the expected profits of a trade to the amount of money risked to capture the profits. This ratio is calculated mathematically by dividing the amount of profit the trader expects to have made when the position is closed (the reward) by the amount the trader could lose if price moves in the unprofitable direction and the trader is stopped out.
A big secret that many rich traders know that new traders do not is that the winning percentage for even the best traders is only about 50%-60% one type of trading edge comes in having bigger winners than losers. A great formula to use is a 3:1 risk/reward ratio, with this ratio a trader is risking $100 to make $300. If 100 shares of stock are bought for $100 a share and the stop is at $99 then the stock should only be purchased if it is probable that the stock could run to $103. At a $103 share price profits could be taken or ideally if it runs to $104 a trailing stop could be set at $103 to give the stock an opportunity to be an even bigger winner. After ten trades your account could look like this:
Profit $1,000 with only a 50% win rate!
However if you allow losers to run hoping they will come back and take profits quickly while they are there you can get into trouble fast.
Lost $500 even with an 80% win rate!
Other ways to measure the ratio:
In trades you can also plan to cut your losses if the stock drops 5% while taking entries on stocks that can run 15% of more.
Another way to measure a 3:1 ratio is that you can risk 1% of your trading capital for the possibility of making 3% of your trading capital in profits.
Remember that you can cut losses even shorter if you are proven wrong before your stop is hit, but at the same time you have to allow enough room for normal fluctuations and volatility in your stop and use position sizing that you are comfortable with for your trading account size. I also recommend you to allow winners to run as far as possible, you never know when you could have a huge win with the right entry and trend.
First know how much you will risk on any one trade then do not enter a trade where the upside is not at least two or three times your risk of loss.
Charts are my best mentors and moving averages are my best teachers.
Entering into Monday Morning I am long Apple with an in the money $610 strike weekly call option but I am hedged with an out of the money $620 weekly put. Like me many traders see indecision with that doji candlestick laying right on the 100 day ema support line. This is the first time all year I have implemented a hedge and not been in a purely directional trade. But, with this option play structure I will capture the full upside of a possible bounce and run with Apple into earnings but my losses are capped to only a few hundred dollars if Apple does rollover under the 100 day ema and 100 day sma and falls towards the 200 day sma at $575 next week. From looking at the chart my belief is that the lowest we will go is the 100 day sma at about $622 that is the probable support area. The resistance level on the upside is at the 5 day ema of $636.55, if we have trouble getting over that line intra-day then it is a good place to take profits on bounces. If we break and close above the 5 day ema then that is my sign to get long with a possible change in trend into earnings. From chart history it looks like this is now a dangerous place to be short and a short covering rally could happen at any moment along with positions being taken by funds for longer term investments at this attractive price point for a value play with a 15 P/E ratio. In the long term time frame this stock is still in an uptrend and at its support level. This is the crossroads, the bottom of the uptrend or the top of a new downtrend. My bet is slanted to the upside.
I will be long with no hedge with a close above the 5 day ema $636ish currently but this target moves fast.I will ride the long until earnings if it stays above the 5 day ema.
I will hold my put option and go solely short by selling my call option with a close below the 100 day ema targeting the 200 day as the next chance to get long.
Every new trader loves to focus on entries, hot stocks, what to buy, what stock might double, and how long they want to hold their stock. Stops are a very neglected subject with new traders, the best shot many new traders give to an exit strategy is either a price target or a quick scalp to lock in small profits. The problems with these plans are many. Price targets can both cause traders to hold through large losses because they had an upside target but no down side stop due to over confidence in their own opinion. Price targets can also cause a trader to mess huge moves by cutting winners short. If this year I had a price target on Apple of $600 when it was $390 I would have missed over $100 more in price appreciation as it kept going first to $644 and after a correction to $700+. In a trending market let a stock run as far as it will wait for a reaction to sell and lock in profits.You need big winners to pay for all your small losers regardless of your winning percentage or time frame.
One dynamic of stop losses is the percentage of your account you risk per trade. I will risk 1% of my trading account per trade in an attempt to make a 3% return on my account. With this ratio I can lose 6% with six losing trades but make 12% with four wining trades. So on average I am profitable out of every 10 trades. Of course there will be times when I have 10 losers or winners in a row, this is just how trading works but you want to use stops to limit your risk per trade so be careful with position sizing so your stops are not too tight and you give the trade some room to breath. In volatile markets you should cut losses quicker and take profits faster due to the speed of change maybe a half% risk of capital per trade and take profits at 1 and half% or 2% profits. If your trading account is $50,000 then the 1% I am talking about is $500 and 3% is $1500. The percentage is of your trading capital not the movement of the stock.
When you are in your favorite stock when do you sell for a profit? And when do you get back in once you are out? One short term indicator I use to get out of a trend trade is the 5 day exponential moving average, when a stock is in a trend making new highs above this line it is a high momentum uptrend, below it is a possible loss of momentum. Watching how a stock closes the day is the best way to really read the final word by traders on the trend. I use a close below this line as a signal to take profits, staying beneath this line is a signal to me the momentum may be changing and it could be time to play the short side until the stock reaches support at high value moving averages like the 21 day ema, 50 day sma, or 100 day ema these areas are where bounces happen many times.If these levels are lost it is the signal to stay short. You have to know where you are getting out before you get into any trade.
“If you diversify, control your risk, and go with the trend, it just has to work.” -Larry Hite.
We often hear of trading with an edge, but how do we know for sure we have an edge in our trading? How do we know that the odds are in our favor and that the more we trade the more our accounts should grow as we play our edge over and over? Are we really the casino and not the gambler or are our short term winning the result of luck?
One edge is in trading entry points in chart patterns that historically play out as a winning trade more times than a losing trade. Even taking entries that play out as winners only 60% to 70% of the time is much better odds than a random 50/50 entry point. The key is to do your homework and know the odds of each entry from specific chart patterns. Cups with Handles, candles sticks, and triangles are just some of these patterns. Thomas Bulkowski has done some amazing work around quantifying these patterns.
Another edge is in the use of historical price action back testing using software and historical price data along with technical indicators to see how a system would have done over an extended period of time across multiple markets. Moving averages and breakouts in different time frames are used many times to see what the equity curve looks like if the system was followed. This is the realm of the mechanical system trader. Price history gives the edge. Programming knowledge required.
Another edge is to trade a method that has been proven historically as a winning one. The method should have rules on what to buy based on fundamental or technical criteria , when to buy, how much to risk per trade, when to exit at a loss or when to exit to lock in profits. One example of such a method is the CAN SLIM system by William O’Neil while the system is very robust it is more of an investing system than a trading system due to the time frames of the recommended buying and holding of stocks.
Technical Analysis applied correctly can give a trader an edge. By trading what the chart is saying with support, resistance, trend lines and volume it will give a trader an edge over someone who enters randomly or based on opinions.
Experienced discretionary traders can be their own edge through intuition which is developed through market experience and exposure to market behavior and what makes and loses money over many years of trading. Successful discretionary traders are like seasoned athletes who began to just know what to do in different circumstances based on past experience and learning through repetitive action. They are also like professional poker players that can instantly size up the odds of their hand and the possible actions of their competitors.
An Emotional Edge can be gained by traders who make buy and sell signals based on systems and methods instead of fear and greed, they can step in and buy in a bear market when a reversal begins with a new trend upwards with out being clouded by fear and they can allow winners to run in a bull market not selling to soon out of fear of giving back profits. Traders not affected by their ego can sell quickly when they are wrong to avoid taking a bigger loss than is necessary. Much of trading is a mind game and do not underestimate the edge of having the discipline to follow your trading plan instead of your own fear and greed over taking you during market hours.
Asymmetric Risk Edge is really THE edge that produces profits in the long term. The only way to make money in the long term is to have all your winners be bigger than all your losers. This can only happen by cutting losers short and letting winners run or having a very big win percentage. A good ground rule is to only take trades that can profit $3 for every $1 at risk. Only risk $1,000 if you believe you can make $3,000 on a specific trade. Of course a day trader with a 60% win rate may be able to get by with a $2 profit for a $1 risk if they stay disciplined in cutting losses and a trend following may have amazing returns with only a 30% win rate if there wins are 5 to 10 times their risk.
#1 Trader Know Thyself.
The first step the trader must under go is know about themselves.
Do you love the action of day trading or would you prefer holding positions for long period of times letting a trade play out? You must pick a style that fits your personality, position trading, trend following, option plays.,day trading, growth investing, CAN SLIM, momentum trading, break out trading, chart pattern recognition, or the Darvas method.
#2 Pick a market
Will you trade stocks, options, futures, commodities, bonds, or currencies?
#3 How aggressive will you be?
Understanding your level of risk correlates to your level of returns how much will you risk per trade? Do you have a large portfolio and want to risk a conservative 1% of capital pr trade? 2%? Will you be aggressive and risk 3% or more per trade? Are you willing to go all in on trades with some speculative money and understand that big bets can cause you to lose your whole account? Do you want to make 15%, 25%, or 50% a year? Are you willing to take the draw downs associated with that level of risk?
#4 Doing the work
Do you understand that trading is a profession like any other and requires the same level of reading, studying, and learning as any other. Like other professions you will not make money at the beginning you will instead pay in time, education, and losses of capital. Trading is the hardest easy money you will ever make. If you want to trade you will be required to study charts, read books, maybe get coaching, have a mentor, do research, and maybe attend some educational seminars.
#5 Learn to lose
In trading you have to get use to being wrong about half the time. While traders will have streaks when they are right 10 or 20 times in a row they will also be wrong 10 times in a row on many occasions. Very few other fields have successful professionals that are wrong as much except entrepreneurs and professional gamblers. Trading is sort of like baseball batting averages where your runs batted in and home runs off set your strike outs.
#6 Master YOUR method
In trading it is more important to be a master of your method than a jack of all trades and master of none. You need a winning method that you believe in that you can trade with faith.
#7 Trading environment
Half of your success will be determined by knowing what kind of trading environment you are in. Bull market, bear market, volatile, or range bound. Also the instruments you use to execute your trading will determine your success. Your market has to fit your style. Trend traders can’t trade a flat blue chip stock and most swing traders can’t successfully trade a strongly trending currency.
This morning one of the best short play stocks of the year gapped up on earnings and provided a new opportunity for beat up longs to get out with their shirts and bears a chance to get short at a much better entry price. I took the entry and went short with put options as the trend reversed in the morning and the daily candlestick became uglier and uglier as the day went on. Besides the poor RIMM bulls that bought at the open the stock seemed to find no buyers above $8 as it plunged quickly from the double digit increase it had built in after hours and pre-market trading. As the day went on the daily candlestick on the chart looked familiar to me. Where had I seen the same exact candlestick before? Ah, good old Groupon was the one. My Groupon short early in the year became one of my biggest winners of 2012 (I played this in April). RIMM gapped above the 50 day today, Groupon also gapped above the 50 day in mid May but quickly returned to earth (See Charts below). There are simply no fundamental earnings drivers to sustain such absurd moves back up from the abyss. Sucking less than expected on earnings just does not create enough momentum to catapult a stock back into an up trend. This is why I am short RIMM and why I shorted GRPN in April. I use weekly in the money puts of course so if these stocks do have a take over rumor or some company buys them out my losses are limited to the price of the contract, selling short has an unlimited upside, put option losses are capped. It is important to know this.
Who is Dan Zanger?
Dan Zanger is the modern day version of the legender trader Nicolas Darvas.
His mother Elaine loved the stock market and Dan would often watch the business channel with her. One day in 1978 Dan saw a stock explode across the ticker tape at the bottom of the screen hitting $1. He made his first purchase and sold the stock a few weeks later at over $3. From that sale on, he was hooked on the action of the market tape.
By the time Dan grew up and went to work he was carrying a quote trek with him to stay up on stock prices on his jobs in Beverly Hills as an independent contractor building swimming pools. Obviously his love for the markets drove him to study and discover what really worked and made money.
He attended a seminar led by William O’Neil and this was a major turning point in his ability to select winning stocks. Dan studied chart patterns 25 to 30 hours per week learning to select stocks that would make big moves, before they moved. As technology and internet stocks took center stage in the stock market in 1997, Dan began to see powerful moves underway. He sold his Porsche for approximately 11,000 dollars to have the necessary capital to jump fully into the market. Over the next year, he parlayed the $11,000 into $18 million with the knowledge acquired over two decades of playing the market and re-reading the works of William J. O’Neil. With this success, Dan was able to become a full time trader and leave contracting behind.
He recommended Darvas’ strategy and told traders that the Darvas System is, “widely used and followed today by the best traders in the world, and still this breakout method is little understood by most…”
Zanger is still a big advocate of Darvas’ teachings and he tells traders that applying the Darvas method will “yield fortunes beyond the reader’s wildest dreams.”
Dan Zanger holds the world record for one-year stock market portfolio appreciation, gaining over 29,000%. In about two years, he turned $11,000 into $42 million.
Zanger was listed by Trader Monthly magazine as one of the top 100 traders in the world with an annual income of $25 million!
Dan Zanger is on twitter @DanZanger
Here are some great videos where he discusses his methods:
Apple appears to currently be at a crossroads after today. The Foxconn riot and the 5 million iPhone 5 ‘s sold did not inspire more longs to come in. The stock grew more volatile and could not find its way. The 5 day ema which acts as support in the strongest up trends became resistance today. That level was sold into. There was a bounce as the price approached the 21 day ema in the morning. The price was able to rally back to the 10 day sma late in the afternoon only to find more sellers. I was stopped out of my stock option position but I am looking to get long again if I get an opportunity at the 21 day ema, or if we rally over the 5 day ema. I am watching this price action closely. This is still the stock to own, this is where consumer dollars are flowing. If we lose the 21 day, I would love to be long at the 50 day sma.