Options Trading Blog

Friday, July 13, 2018

Using Bell Curves to Spot Market Trends

Trend and consolidate, run and rest, trend and chop are expressions often used to describe the two things markets do. They move from balance to imbalance and back. Different strategies are employed during a trend cycle vs. a consolidation phase. When a market is trending, there tends to be very little overlap in prices from day to day. Conversely, prices often overlap severely during a consolidation phase.

Before markets begin to trend, they frequently establish balance areas. Such areas form when there is a series of consecutive days with below average ranges that are similar and thus overlap; plus volume is often below average.

The crude oil chart below illustrates this point. The colored boxes reveal value areas. Value areas contain approximately 70% of the volume during regular trading hours, which is the highest volume or most liquid time of day. When value areas severely overlap for a week or more, a trend or breakout often ensues.

Identifying the onset of a trend may be enhanced if one can establish when a market has found balance or completed a consolidation phase. There is a charting method that organizes price action into structures that measure the maturity of a consolidation period. Gaussian or normal distributions are also known as bell curves. Market profile or macrograph are industry terms for this charting method.

When a bell curve or normal distribution takes shape over a week or more, it is often an indication that a trend is about to begin. The macrograph below shows the same crude oil chart as the one above but in structures that display a fair value or balance area. These bell curves form by plotting time at price. The more time spent at price, the more volume accumulates. The point that sticks out the furthest is the fairest or high-volume price.

Note that just before the rally (week of 6/17) and the decline (7/8) began, a normal distribution or balance profile took shape. When timing breakouts, search for markets that have found balance and have a well-defined high-volume price. Normal distributions frequently form before and after trends. 


John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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Thursday, July 5, 2018

Quarterly Earnings Are Around the Corner

Here is a quick reminder of some things to think about pertaining to implied volatility and the pending rush of quarterly earnings. The definition of implied volatility I like is the estimated volatility of the security in the future that is reflected in the price of the option. In essence, it tells an option trader if options are cheap or expensive at the moment. Historical volatility is the volatility of the security based on the past. It is basically how quiet or volatile the stock has performed previously.

IV Rises as Earnings Approach

One major thought to keep in mind is that IV will continue to rise for expirations that take place after the earnings announcement as the date get closer. This is particularly true for volatile stocks that have gapped in the past after the announcement. In other words, option prices will increase due to IV levels rising, all other factors remaining constant, knowing there is a good chance there will be a reaction to the announcement. For an option trader, it is good to be positive vega (measure of the option’s sensitivity to changes in IV) with an expiration that takes place after the earnings date.

IV Does Not Rise for All Expirations

Many option traders will use the 30-day IV and HV. When the earnings date falls within 30 days, the 30-day IV will rise. The IV level will then be above the HV level, which many option traders look for when assessing if IV is high or low. But don’t be fooled. Just because the 30-day IV is above HV, does not mean the expirations that take place before the announcement are elevated too. Take a look at the two charts below. The company is expected to announce on July 17th (within 30 days). The first chart shows the 30-day IV above the 30-day HV. The second shows the IV level much lower for the expiration that takes place prior to the announcement and the expiration right after the announcement. You can see it is quite the skew.

30-day IV (red) 30-day HV (blue)

Earnings July 17th

After the Announcement

IV levels will decrease after the volatility event, like an earnings announcement, is over. It may be tempting to hold long positions over the announcement, but just know that option prices will decrease because of the IV dropping afterward. Many option traders find that out the hard way in that they are not well educated about the IV crush.

These are just a few things to think about as an option trader based on pending earnings. When in doubt, avoid the announcement altogether, which is sometimes the best way to go anyway. Good luck!

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Saturday, June 30, 2018

Dow Jones 30 Quarterly Review

Each day in our futures group coaching class, we examine the major commodity sectors for patterns that frequently precede breakouts or trends. Our goal is to recognize trend potential, which prepares us to enter trends in the early stages. There are several conditions that must be met before a market can be tagged as high probability trend trade.

First, we look for markets that have below average ranges for 3 to 5 days. Then, we look for severe overlapping or similar prices during that time span. Odds for a breakout increase when a series of opens and closes are near each other. An excellent indicator for that are candlesticks with little or no body.

To get a read on momentum, which often reveals the direction of the coming trend, we refer to the fair or high-volume price. Momentum begins at high volume prices. If the conditions above are met, odds favor a vertical move and the direction of that move is often revealed depending on where the market closes in relation to that fair price.

At the end of every quarter I like to check where stocks are in relation to the high-volume price of the quarter. If the range has been below average and the previous 3 months have seen severe overlapping prices, odds favor an above average rise or decline. Rallies tend to extend higher if a market closes out a quarter above the fair price. Conversely, a settle below the fair price often leads to lower prices over the next few months.

The chart shows quarterly bell curves or profiles (macrograph). Note JPM trended higher until March of this year. Q1 closed below the high-volume price for the first time in over a year and a decline ensued. And it appears that stocks will finish Q2 below the fair price as well.

Of the Dow Jones 30 companies there are some that meet the conditions that favor an above average move in Q3. Those with below average, overlapping ranges and are below the quarterly high-volume price are BA, CAT, JPM, MCD, PFE and WBA.

The one with below average, overlapping ranges in Q2 that is above the quarterly high-volume price is VZ.

When searching for trend type trades in Q3, the best candidates are the stocks above.

There are a few that are hovering around the fairest prices of the quarter, which means momentum is not obvious yet. They are PFE, UTX and WMT.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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Friday, June 22, 2018

How to Spot an Exhausted Trading Trend

Timing the onset of a trend is a difficult task; identifying the end of one is even harder. There are a few short-term patterns that frequently precede the end of a trend or the reversal of one.

Possibly the most widely recognized indicator that a trend is near an end involves volume. Markets were created to facilitate trade. As a market moves in a direction, it will tend to continue on that course if daily volume is near or slightly above average. If volume is diminishing, the market is not facilitating trade. The amount of transactions or volume often decreases before the reversal of a trend. Range sizes tend to be below average as well.

Another common occurrence in a trending market is the time of day extremes (high or low) are made. The first hour of the regular trading day tends to be the highest volume or most liquid time of day. During a rally the lows for the day are often seen very early in the day session. And when in a downtrend, highs tend to print in the first hour of the day. This phenomenon often reverses near the end of a trend. When we begin to see highs made early in the day during an uptrend, it is a signal that the market has probed high or gotten rich enough to entice sellers. On the other hand, when the lows over a few sessions are seen in the first hour of trade, it indicates a market has cheapened or dipped low enough to attract buyers.   

As a trend nears exhaustion, there is often one more thrust in the direction of the trend. This last push has a day range that is often twice the norm with volume that is well above average. It is as if the last sellers in an uptrend or the last buyers of a downtrend must be cleared out before the trend reverses. This occurred back in late January and early February just before the stock market topped out. More recently this activity occurred in soybeans.

The chart below shows soybeans in a methodical downtrend for a little over a couple of weeks. On Tuesday (6/19) there was a thrust lower and immediate recovery. The range that day was twice the norm, and volume was far above average. For now, the trend lower has ceased, and a period of consolidation or neutral price action ensued.

If you are aware of what to look for, you may be able to ride trends longer and exit them when exhausted, thus squeezing out more profit.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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Thursday, June 14, 2018

A Look at Bullish Bases

I talk about bullish bases in my Group Coaching class practically every day. The market has been predominantly bullish, but what does a bullish base look like and how can we use it for a potential bullish entry?

A bullish base forms when a stock moves considerably higher, usually over a short period of time, and then begins to trade sideways. If the stock does not pull back more than two-thirds of the move higher, it is a bullish base. For example, if a stock moved higher from $50 to $56, then traded sideways and never closed below $54 (6 X 2/3), it has formed a bullish base. But at the same time, the stock is stuck under some resistance that it has had trouble trading above.

Take a look at the recent example of Lululemon Athletica Inc. (LUL) below.

The stock broke out around the $107 area and traded all the way just over the $126 level. It then had trouble moving past the $126 level but never really traded much below the $121 level, which can be seen even better using an hourly chart (below).

I put this stock on my bullish watch list but would do nothing (bullish directionally) until the stock breaks above the $126 level. For me that constitutes a 2-bar bullish close (2 consecutive bullish closes above resistance) on the daily chart. But at the same time, selling put credit spreads below the support level may be considered as well.

Determining what a bullish base is can be fairly easy if you know what to look for and consider. Just because it is a bullish base does not mean it will eventually move higher. As traders we always want to put the odds on our side, and for me that would be a break above the resistance level of the base.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Thursday, June 7, 2018

Event Risk on the Rise

For decades, employment data were the catalyst for major moves in interest rate, equity index, precious metal and currency futures. The monthly job report frequently set the tone for days, even weeks.

Interest rates fall when the treasury futures rise. Essentially, treasury futures have been in a bull market since my first days at the CBOT back in the mid-’80s. But recently interest rates have been rising and treasury futures falling. In part this is due to a healthy economy and job growth. But it appears there has been a shift to focusing less on employment statistics and more on inflation data.  

The FOMC have been steadily raising rates to keep the economy from overheating. When an economy grows too fast, inflation often creeps in and we pay higher prices for goods and services. The Fed can stem the rise in inflation by being more aggressive with interest rate hikes. It has scheduled a few rate hikes this year and is widely expected to raise the federal funds rate again after next week’s FOMC meeting.

Assuming the rate hike is a given, the focus shifts to the press conference from Fed Chair Powell at 2:30 p.m. ET on Wednesday. If he hints that inflation has accelerated at a faster than anticipated pace, it may lead to additional unplanned rate hikes.

Back in early February, there was an unexpected uptick in wage inflation within the job report. The result was a hasty historic drop in stock prices. Inflation is not a bad thing so long as it is not rising too rapidly.

Next week is packed with event risk. Besides retail sales numbers, we get a look at producer and consumer inflation indexes. If these numbers are higher than consensus estimates, it may force the Fed to add another rate hike. In this case, stocks would likely fall quickly. On the other hand, if the inflation data are near expectations, the equities indexes should see steady to higher prices in the coming weeks.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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