Options Trading Blog

Thursday, July 9, 2020

Keep It Simple When Viewing Candles

Arguably daily candlesticks are the most widely used technical tool to analyze price action. The reason for this is because they are designed to track opens and closes, which are the most volatile and liquid times of the trading day. When a market closes above the opening price, it is thought to have positive momentum. And when a market close below the opening price, there is negative momentum and sellers have the advantage.

There are seemingly endless candle patterns that have been recognized over the years. I was reviewing an article I saved from back in the 1990s, and it included and named 32 bullish candlestick patterns and 35 bearish patterns. The patterns take two to five days to form and the names are interesting to say the least. A few of my favorites: abandoned baby, homing pigeon, gravestone doji, stick sandwich, 3 white soldiers, dragonfly doji and identical 3 crows.

Rather than trying to remember the names and patterns, I choose to study what the patterns have in common. Names are not important; interpreting whether bulls or bears have the edge is.

When you view candles keep it simple:

  • When you see few consecutive candles with small shadows or bodies (difference between open and close) it indicates neutrality. Thus, odds increase for a vertical move or breakout.

  • When a bullish candle completely engulfs the previous one, a rally often ensues.

  • Conversely, if a bearish candle engulfs the prior candle, a decline in price is common.

  • Long candle bodies with tiny wicks (prices outside the candle body) typically lead to continuation in the direction of the close.

  • Long wicks on the bottom with a small body on top (hammer shape) are a sign that bulls are taking control.

  • Long wicks on top with a small bearish body often lead to negative price action.

Markets trend and consolidate. Astute technicians need to identify only a few phases: neutral, uptrend, downtrend and reversal. Rather than focus on names, learn to read subtle changes in price action. Charts reveal history as well as psychology and sociology of the participants. 

John Seguin
Senior Technical Analyst
Market Taker Mentoring, Inc.

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Wednesday, July 1, 2020

Horizontal Support and Resistance Should Catch Your Eye

Scanning for opportunities based on charts is never really easy. In fact, sometimes it can be quite difficult. But if you keep in mind that support like resistance has a better chance to hold than break, you will be a better technical analyst. To me, one of the easiest things to do is to scan for horizontal support and resistance on all time frames.

With Experience…

The more you look for support and resistance the better you will get…I promise. When my mentor worked with me way back when, I remember I thought I would never be able to scan and pick out those areas the way he did. But over time, I got really good at it. As is the case with a lot of things about option trading, experience cannot be taught.

Support

Take a look at the chart just below.

Notice that every time it came down to the white line that acted as horizontal support, the stock moved higher again. Use the tools that come with your trading platform and draw a straight line. Move the line up and down until you find an area on the chart where the stock reversed off the most. That’s it. It is that simple!

Resistance

It is just as easy to find potential horizontal resistance areas too. Take a look at the chart below.

Several times the stock rallied up to the white horizontal line that acted as resistance and kept the stock from moving higher again. Remember, nothing is perfect and it is an art not a science. There is no way to draw the line perfectly. Just do the best you can. The wicks and opens and highs do not all have to line up perfectly.

Finally

Finding support and resistance on charts can give you an edge in your trading. Start by looking for the horizontal areas and then over time, look for trend or slanted support and resistance levels, which are harder to see. If you plan your option strategies based on these levels, you should stand a better chance of being right.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Thursday, June 25, 2020

How to Use Pivot Points in Your Trading

Moving averages are the most popular directional gauges. They are typically the first technical indicator in the novice trader’s toolbox. Many professional traders rely on them as well. Typically, the directional signals come when a short-term MA crosses a long-term MA. The problem with this method is that by the time the averages converge and cross the directional move is already well on its way. Thus, entering a trade using this method usually leads to late entry and poor trade location. Bad trade location increases risk and reduces profits.    

To improve entry, many traders use exponential moving averages (EMA). These are calculated with more weight on the most recent prices. Thus, they tend to converge and cross faster than simple MAs, which should lead to better trade location.

Most MAs are calculated using the close of the day. But for intraday or short-term traders, these MAs are often useless when volatility is high. Day and swing traders frequently use daily pivot levels for short-term directional signals. These indicators can be calculated in many ways. Maybe the most popular is to take the average of the daily open, high, low, close. If the market closes below this average price, it means sellers have the edge; a settle above this price, bulls gain the advantage.

I consider myself a swing trader most of the time. To me, that means my projected profit on a trade is roughly the length of an average week measured higher or lower from the price at which I take a position.

I designed a pivot that suits my time frame and style. To calculate this pivot, I take an average of the high, low, close over a three-day period, so the pivot is an average of nine prices. If the close is below this pivotal price on the third day, odds favor a move lower over the 24-hour period. On the other hand, a close above this MA means long positions should pay the next day or longer.

There are no right or wrong technical indicators. They all have merit at some point depending on market conditions. Each trader must find the technicals and time frames that fit their personality. Through experimentation I found my niche. Along with some other gauges, the three-day pivot suits my style. The average amount of time you intend to spend in a trade may dictate the pivotal price you should calculate.

John Seguin
Senior Technical Analyst
Market Mentor Mentoring, Inc.

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Wednesday, June 17, 2020

A Volatile Market Is an Excuse to Review Your Trades

With volatility picking up in the market once again, option traders can have an instant edge. But sometimes, because of market uncertainty or wider than normal bid-ask spreads, it may be hard to profit. As you hear me say plenty of times, no position is sometimes the best position. Traders need to consider sitting on their hands and doing nothing. Just because you are not trading or trading less, however, does not mean you should do nothing. Right now (but true at any time) is a great time to review some past option trades.

All traders should have time schedules for reviewing their trades when the market is closed. But when you don’t think you are putting the odds on your side enough to warrant a position, this could be a perfect time to go a bit deeper with your review. Here is the excuse you need to get you started. I know you might have put off writing that trading plan for a long time and hopefully you have finally completed it. This is a mandatory part of your trading plan, and putting it off is not doing you any favors.

The procedure is essentially painless. The reviewing part maybe not so much. Take some screenshots of the charts and option chain when the trade is initiated. Then take a few throughout the trade and, of course, when the trade is exited. Did the trade work out as planned or did you do something that was not planned? Was it a bad trade that still profited? These are just a few of the questions you might ask yourself as you review your trades postmortem.

When you have additional time, compare different strategies and their results. You might be surprised at the findings. I certainly was in the past, and that is what formed me into the option trader I am today. You might not think you like or do well at vertical debit spreads, for example. Then after reviewing some you have done, you might find you fared better than expected and did worse on another strategy you thought you favored.

Most importantly, do this when the market is closed so your full attention can be on the review and not the active market. Even without a position on, if the market is open you may feel the need to watch a potential position. If you do this on a regular basis and not just during times that you may prefer to avoid, such as volatile conditions or earnings season, you will put yourself in a better position going forward. I can guarantee that.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Thursday, June 11, 2020

Volatility Apt to Remain High Amid Fed Uncertainty

On Wednesday afternoon the FOMC meeting culminated with no changes in monetary policy. The equity indexes rallied on the news that the Fed will continue to be accommodative and use all their tools to ensure Americans receive financial aid where needed. However, 30 minutes after this news was reported, Chairman Powell held a press conference. He reiterated the stance of the voting members and mentioned that it may take another two years to recover from the devastating effects of the COVID-19 pandemic.

That means interest rates are likely to remain at historic low levels into 2022. The committee was surprised as much everyone else at the strength in the labor department’s latest employment report. He cited that even the Fed has no idea how deep and long the impact will last. Furthermore, he hinted that the usual economic indicators will be unreliable for the foreseeable future.

In other words, the Fed is uncertain and flying without instruments. This notion spooked the stock market, meanwhile treasuries and gold rallied in response. Many stock market analysts have little guidance, which impairs quality earnings estimates, and earnings estimates move markets. When clarity is lacking, many stocks perform poorly and the havens (fixed income and precious metal) tend to do well.

What does it mean? First, volatility is apt to remain at lofty levels. Second, it will likely take a few months of consistent economic data for the Fed to determine interest rate policy. Thus, confidence and clarity may be lacking deep into Q3. The issues with China and the threat of another bout with the virus make it difficult to make mid- to long-term trades or investments. In this environment, it’s highly recommended to be well-hedged. Utilizing option spreads is probably the best approach under these conditions.

We knew the economic data would be awful in May and June, so the July reports may have more impact than usual. Thus, it appears volatility will be rather high while the summer temperatures peak as well.

John Seguin
Senior Technical Analyst
Market Mentor Mentoring, Inc.

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Thursday, June 4, 2020

Hold Your Horses, Option Traders

Patience. It is a key attribute to a successful trader in my humble opinion. As I like to say, when the market is open and those candlesticks (if you use candlesticks) are moving, the blood is pumping and emotions are running high. But a trader needs to be calm and not let these moves takes away from his or her objective. Let’s take a look at what I mean in regard to selling premium generally as an investor.

Short Options

Selling a call option against a stock position is commonly done by investors (covered call). The call option’s strike is generally sold where the investor thinks the stock will be at the short call’s expiration. The call option expires worthless and maximum is earned for the stock position without being called away (assigned). When a time spread is bought (calendar or diagonal), the maximum profit is earned if the stock closes right at the short strike at the short expiration (just like a covered call) for either a call or put. Choosing which strike to sell is sometimes a challenge, but potential support and resistance can help.

Support and Resistance

Selling the short option close to a support or resistance area makes sense. The reason is that support and resistance have a better chance to hold than be broken. But using a covered call as an example, when the stock price moves through a resistance area and is trading above the short call’s strike, the first thing many option traders want to do is buy back the short option and roll to a higher strike. This works when the stock does indeed continue to move higher. But knowing support and resistance have a better chance to hold, it may make sense to show a little patience. Let’s take a look at a recent example below.

This 60-minute chart of Apple Inc. (AAPL) shows the end of May to the beginning of June 2020. The stock had some potential resistance around the $322 to $323 area as designated by the horizontal line. The area was tested numerous times. Going back to what you know as a trader, resistance has a better chance to keep the stock from moving higher. In fact, it was turned away several times.

In my Group Coaching class and one-on-one coaching sessions, I had several option traders asking what they should roll either their covered calls or time spreads up to. I replied with let’s see if the stock can break that resistance before buying back the short position and selling a higher strike. I ask them, what has a better chance of happening? If they are a student of mine, they know resistance like support will hold more times than not. Of course, that will not always be the case, but it will be the majority of the time. The odds are on your side!

Lastly…

Obviously, there are times to close out the short position and sell another strike higher or lower depending on the expected move. The key is to let the stock or whatever you are trading prove to you that it does want to break resistance or support. Closing above it or below it just once does not mean it is going to break that level. You want to see generally two consecutive closes through the potential support or resistance. The 2-bar close principle (2 consecutive closes above resistance or below support) has served me well as a technical trader. Remember to ask yourself on any trade, what has a better chance of happening?

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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