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Life in the Fast Lane

It’s perhaps one of the greatest guitar riffs in the history of rock and roll. You know the one. The little ditty that intros and is intermittently revisited throughout the Eagles’ hit “Life in the Fast Lane.” (And, yes. I realize you’ll now have this earworm running through your head for the next three hours. I’m sorry, or you’re welcome.) That catchy little lick can make you a better option trader. Let me explain.

Training for Option Traders and Rockstars

If you’ve ever taken a crack at learning guitar, you know you’ve got to loosen up those fingers. Get ’em moving. The best musicians all have their routines. As this story goes, one night Eagles guitarist Joe Walsh was in his dressing room warming up for a show. He had this, well, series of notes basically that were really hard to play in this particular order. So, he’d play the bit over and over to warm up. As he was playing it this night, Don Henley and Glenn Frey happened to walk in the room and dug it right away. That little warm-up exercise became the main hook of the song “Life in the Fast Lane.”

And, man, doesn’t it sound effortless? Yeah. It does. And that’s probably because for Joe, it IS effortless. He played the thing a million times. If you do any one thing that many times, you can’t help but get good at it. Some people call it the “10,000-Hour Rule.” Athletes call it muscle memory. William S. Burroughs called it “Doing Easy.” (Weird rabbit hole to go down, but if you like beat poets and such, it’s interesting to read up on.) It’s a time-tested concept I wish I’d invented. But I didn’t. I’m just borrowing it from basically all the greats there ever have been in any discipline—including the best option traders.

Options Trading Practice

If you think about it, there really aren’t a lot of actions to take as an option trader. You can buy or sell calls or puts. Get in, and get out. That’s it. Over and over again. Granted, there are steps, logical progressions and nuances. Reasons for buying or selling the calls or the puts. And we need them to be tight. Thus, the more systematic you make your option trading, the better for LOTS of reasons.

Traders want (or should want) consistency. If you’re always taking different steps on your trade entries or exits, always doing it differently, you definitely won’t have consistent results. (I figure I don’t need to overexplain that part. It’s what our Founding Fathers would call “self-evident.”)

Moreover, as option traders, we always seek the best way of doing things. While this constant seemingly Sisyphean quest is the plight of all option traders, as we strive to improve, our methodology continues to get better. Naturally. We get to a level, that’s good. Keep working it out. Then learn more. And get it even better. Rinse. Wash. Repeat. As they say.

Further, you know what can really mess you up as a trader? Stress. You know what stress is caused by? One thing and one thing only: uncertainty. If we’re always reinventing the wheel and trying to refigure it out every time, well, that’s the definition of uncertainty. You will trade worse if you do that. But if you know what you’re going to do every time, because it’s the same thing you did the last time, you will trade better. I’m breaking it down to first principles here.

It’s about practice. I always used to think it was weird that doctors and lawyers refer to their business as a “practice.” But one day I realized why: because they are still PRACTICING! No mystery, really. The best of the best are always practicing—at whatever they want to get good at. Maybe we as traders should call our “trading business” our “trading practice.” It might be nice to have that little reminder that to become great, we must keep doing this one thing over and over and all the little nuances eventually become simple. Practice. And that, my friends, is the most rockin’ lesson I can share.

Dan Passarelli

 

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Options Liquidity and Volatility

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Market Timing Is Important for Options Trading

Market timing is often defined as moving money in and out of the market or switching into other asset classes. But is can also mean timing your entry correctly. That is what I want to talk about here. But let’s be honest, as option swing traders (generally in the trade for 2 to 5 days), there is always the unknown of what the market may be the next session if holding the position overnight. That said, patience and the correct timing can still vastly improve your odds for success.

Is This the Best Time to Enter?

Although not all stocks are market stocks – meaning whatever happens to the market that day, the stock will tend to move closely with it – there are quite a few. I always like to have traders ask themselves this before entering any trade: Is this the best time to enter? What I mean is, is the market and/or the stock at a potential support and resistance level that might impede its progress in the intended direction? The reason is that support and resistance have a better chance to keep the underlying from moving through that level. Let’s take a quick look at a recent example we talked about in MTM’s Group Coaching class.

Market Heading South

In late May the market had been very volatile over several months, and it was predominantly moving lower. We were looking at a bearish potential opportunity in PayPal Holdings, Inc. (PYPL). What we noticed at the time on the hourly chart was a potential support level as seen below. The stock had either traded sideways or moved higher but was unable to break that level.

In turn, we took a look at what the overall market was doing at the time. Lo and behold, when we looked at the Invesco QQQ Trust (QQQ), it was sitting at potential support as well as seen below. Obviously, not every underlying will have its support and resistance levels line up accordingly, but when they do, it can be pretty powerful.

Moral of the Story

So, was it a good time to enter a bullish trade when you have the stock (PYPL) and the market (QQQ) at a support level that had better odds of keeping the stock from moving lower? The answer is clearly no, but as mentioned above, the next day could have brough a bearish open to the market and the stock. So, something you can consider as a technical trader is that if the level of support or resistance is not broken, thus giving you a directional opportunity, consider getting into the trade toward the close. Getting into a bearish trade with the market and underlying at support would most likely result in a losing position at the close that day.

Final Words

As a swing trader or any trader who holds a position overnight, you are at the mercy of the market next session. But if there is a way to improve the odds and put them a little more on your side by timing your entry, it should be considered. Watching the stock chart and market chart are an easy way to do so.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.
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Why Not to Work on Vacation

I’m taking some time off on what I’ll call “a well-deserved vacation.” But I wanted to share this blog with you, well, while I’m on vacation.

When I was a kid, my family never really went anywhere. There was one time my grandfather took all the grandkids to Disney World. Other than that, we pretty much stayed home. Once I started trading and earned a little money, I decided the family I planned to have would be well traveled. And, indeed, travel has become our family passion.

The Traveling Trader

One of the first trips Kathleen and I ever took was when she was pregnant with Sam. We went to Phoenix to visit some friends in late fall 1998. (And, yes. There’s a trading point here. Stay with me.)

I was about a year into my career as a market maker at the time. I’d left the trading floor for our trip carrying all my positions with me, instead of whittling them down to flat. (I didn’t want to miss any trades, so I kept trading right up till the day I left.) So that meant I had to wake up nice and early each day of my vacation and call my broker to put in my hedge trades before the open. I’d write them out on a lined, cardboard card and keep the card with me all day. I’d have to take calls or call in myself several times a day to see what was filled and what new hedges needed to be entered as a result and then update my card. Sort of a working vacation, I guess.

Why Not to Work on Vacation

A few days into the trip, Kathleen and I decided to drive up to see the Grand Canyon. Being my first time in Arizona when my friend asked me if we wanted to borrow some jackets, I thought he was crazy. It’s the desert, for goodness sakes! Fast forward two hours and we were driving in the scariest white-out snowstorm of my life. We had to pull over and hope to not get rear ended because we couldn’t see two feet in front of us.

After getting north of the storm, we returned to a bit warmer climate. It’s pretty up in Northern Arizona. Very different from Southern AZ. We found ourselves driving through some beautiful but barren landscape. I mean, there was nothin’ there. Mind you, this is 1998 we’re talking about too. That’s the year they rolled out the hot new G3 cellular network. While we were driving through this open country, guess what happened?

Knee Driving and Unhedged Deltas

My broker called me (on my flip phone) to tell me about a fill. Good. I was long gamma and every time one of my hedges got filled, I was locking in a win. Time to put a checkmark next to it on my card and tell the broker to add another hedge at a new price.

So, I had my trade card in my left hand, pen in my right, phone pinched between my ear, and my clavicle bone and my knee on the steering wheel. Good thing there weren’t any other cars for miles! Not a good scene. To boot, it was at that moment, when… You guessed it… The call dropped. Yeah. So that happened.

That ended up being pretty stressful for the remainder of the drive. I had to wait about an hour to get back into a cellphone coverage area, not knowing my positions or what the market was doing. And we were approaching the close. So, if I didn’t get all my deltas flat by the end of the day, I’d start the next day unwillingly long or short deltas. Kind of a big no-no for purist market makers.

I will tell you, that was not fun. Not smart either.

Take a Trading Vacation Too

It was then I realized it doesn’t make sense to have positions on when you’re traveling. Vacations are for recharging. Relaxing. Destressing. The market with all its opportunities will always be there. But it’s good to get away from the market now and then. Clear your mind and create space for new ideas. You end up trading better when you return to it refreshed and ready to take it all on again.

Enjoy your summer. I’ll share some more stories once I’m back in town.

Dan Passarelli

Founder and President
Market Taker Mentoring, Inc.

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Practical Uses for Average True Range

Practical Uses for Average True Range

Average True Range (ATR) is one of the most practical indicators and can be used in many ways. Some of the ways I employ ATR is to compare recent ranges with longer-term or benchmark averages. In this way I can judge whether current volatility is high or low. Spreads tend to pay off when current ATRs are lower than the long-term ones.

Setting Targets

Another use for ATR is to set profit targets. Prior to breakouts or acute vertical moves markets will often go through a series of days and even weeks with below average ranges and volume. These congestion patterns often take the shape of a rectangle (flag) or a pennant (triangle).

I believe the time it takes to develop these patterns may be directly related to the length of the breakout. For example, if a flag or channel pattern is 5-to-7-day longs and the upper barrier is breached the rally should extend about the length of an average week range. Theoretically, the longer it takes for a pattern to take shape the farther the trend will extend.

Determine Risk

The moment a position is taken the next move should be to set a physical or at least mental stop loss. Trading is tough enough, so setting a stop loss may relieve anxiety, which allows the trader to concentrate on profit potential and trade management. Risk varies for all traders and may differ due to time frame of trade, account size, lack of conviction or fundamental factors such as earnings or economic reports. There are seemingly countless factors that can affect a trade.

The art of defining risk should include current volatility.

I refer to recent ATRs and percentages of them to project profit potential and risk. They allow me to be consistent with risk/reward ratios. For benchmark averages I use 14-day, 9-week, 7-month and 5-quarter. A speculator or swing trader should focus on day and week ATRs. If you prefer longer-term trades use month and quarter ATRs to set risk and profit targets. One method I implement upon entering a speculative long position is to set a stop loss at 25% of an average day range below entry and set the first target at 50% of an average day range above entry.

risk-reward-balance ATR average true range Hand with chalk is drawing Risk and reward balance scale on the chalkboard.[/caption]

The Workhorse and Racehorse System

I call this 2-unit system the workhorse and racehorse. Let’s walk through the steps for managing risk for a bullish swing trade. When a bullish breakout is identified go long 2 units. A unit may be any number, but units must have equal amounts.

For this example:

  • Buy 1 contract for the workhorse (WH) and 1 for the racehorse (RH) at $1000
  • Average day range (ADR) = $40, average week range (AWR) = $100
  • Long 2 @ $1000
  • Entry price plus 0.5 average day range (ADR) equals Target 1 (T1) or $1020
  • Risk/stop loss is set at entry minus 50% ADR or $980
  • If T1 is reached, sell 1 unit (workhorse) for $20 profit, then move stop to entry
  • Now only the racehorse is active; if prices reverse to entry this unit will be a scratch trade
  • If T2 (100% ADR) is reached, move stop to T1 ($1020) to lock in another $20 profit if price reverses
  • If target 3 (T3 = 75% of AWR or $1075) is reached, risk moves to T2 ($1040); at this point total unrealized profit is $60
  • If T4 = 100% AWR or $1100 is realized, stop moves to 25% of an ADR or $1090
  • Assume this trade gets stopped after T4 was hit: WH +$20, RH +$90 for total of $110
The Goal for Swing Trades

T4 is the goal for my swing trades and that equates to an average week range. I recommend squeezing my stop at this point because the goal has been reached and I prefer to retain more profit from the high-water mark.

John Seguin
Senior Technical Analyst
Market Taker Mentoring, Inc.

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