Options Trading Blog posts page 2

Thursday, March 7, 2019

Think Like a Pro Trader

Spend time with a broker or pit trader from the era when all trades were executed at an exchange and you will learn about the auction process and the information it provides. Pits were created to facilitate trade. To an untrained eye a trading pit looks like a mess of mad, aggressive people wearing crazy-colored uniforms. But for a seasoned observer a trading pit reveals incredible amounts of information that is not available on screens or trading platforms. Professional traders monitor order flow. After assessing many variables from market-generated information (technicals and fundamentals), they decide to buy, sell or not get involved.

One of my duties as a broker was to relay and interpret price action to institutional traders and fund managers. I frequently felt like a commentator at a sporting event. For example, a trader from New York would call and ask who or what firm was buying or selling and how much. Meanwhile, another trader from overseas might ask how big the bid or offer was to find out if buyers or sellers were dominant. Another client might inquire if volume was light or heavy. Some traders sought support levels to buy or resistance prices to sell against. Some just wanted to know where to set risk or stop loss orders. They were searching for an advantage. The questions varied but there was some consistency to the information these professional traders sought.

To create a discipline or strategy, it is wise to follow the similar path professional traders take. The goal is to find the answers to the questions pros ask, day in and day out. I condensed these questions into an easy to remember acronym: VERTEX.

To become a successful trader, it is imperative that you learn to address and analyze the components that make up VERTEX.

The “V” stands for Value. Value is that price where buyers and sellers trade most often over a given time frame. It is considered the high volume or fair price. Momentum is defined as the movement away from a fair price, which brings us to the next letter.

“E” is for Energy or momentum. To catch a trend higher, it is important to recognize when bulls have taken control of momentum. And sellers will show dominance in a declining trend by hitting bids. There are many technical indicators that are used to determine momentum, most notably moving averages. I prefer to track fair prices to determine when momentum becomes apparent.

The “R” represents Risk. Risk can be defined as a change in momentum. Many traders asked about where they should enter a stop loss order. If a trader has entered a bullish position, it is important to enter a stop loss at a level where momentum turns negative and a short position should have a buy stop to determine risk.

“T” stands for Timing. Markets do two things: They trend and consolidate or run and rest. When a market is considered overbought or oversold it has moved too far too fast, thus favoring a rest period or consolidation phase. Therefore, the timing is not right to enter a trend type trade. On the other hand, when ranges and volume are below average during a period of consolidation, odds increase for a breakout or trend to begin. A trader should track ranges in various time frames (day, week, month). This statistic is commonly known as ATR (average true range). When these measurements are far below average, the timing is often right for a trend to commence.

The second “E” stands for Entry. Support levels are prices where long positions are taken, and a bounce or uptrend is anticipated. Resistance levels are areas where sellers are apt to take a stand and prices are expected to reverse lower. These support/resistance areas are often defined using old high-volume areas or very low volume prices.

The “X” in VERTEX refers to eXit. This can be defined as a risk level or a projected profit. When projecting profit potential traders seek to ride a trade or trend until exhaustion. In other words, they seek maximum profit while minimizing risk along the way. This is known as a trailing stop or chasing and locking in profit. Once in a profitable trade the goal is to erase risk as quickly as possible and pocket profits while the trade works in your favor.

If you want to trade like a pro, you will have to learn to think like one.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Friday, March 1, 2019

A Reminder to Review Your Trades

I have mentioned this before and will continue to mention it as much as I can: Please record your trades and review them often. Simply put, there is no better way to see what you are doing wrong and doing right. To me, it has always been an eye-opening experience to go back and review my trades. The reason to do this is to get better. But there is also another reason and that is to learn.

In Group Coaching, I tell traders to take screenshots all the time. I also tell them to take screenshots if they are paper trading. A trader will not learn much if he or she is just focused on the P&L statement, particularly if paper trading. But taking a screenshot like the one below and seeing how the option prices and greeks change over time can really benefit the option trader.

In the example above, a Mar-01/ Apr-2019 call calendar was purchased for 4.75 (5.75 – 1). After the stock moved higher and time had passed, you can see that the option prices and the greeks have changed as seen below.

You can see that same trade now would have to be purchased for 5.89 (6.85 – 0.96). The value has gone up 1.14 (5.89 – 4.75). But why has the value increased? That is what screenshots and reviewing them can do for you. There are so many moving parts with options. This will help you get a better feel about what is really going on…promise!

Taking screenshots, reviewing your trades and learning from how your trades function can help a trader tremendously. All it takes is a little effort, which will pay off handsomely.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Thursday, February 21, 2019

How to Read Open and Close Clues

Monitoring the time of day when extremes (high and low) are made can be helpful when timing entry and exit of a position. Liquidity is king. Large orders from professional traders are likely to be executed when volume is at a peak. The first hour of trade is frequently the highest volume or most liquid time of the trading day. Thus, moves either up or down early in the day give us clues about who is controlling momentum. In uptrends there is a tendency for markets to make the low of the day within 60 minutes of the opening bell. And in downtrends highs are often made within an hour of the open. So, if you carry a long position or own calls, early lows would increase the odds that the market will continue to move in your favor. If you are short or own puts, early highs might be the answer you need to hold the trade and increase profit potential.

The last 30 minutes of the day can be revealing as well. One of the most powerful and common signals traders use as a directional indicator is to refer to the close of the day. If a market closes near the low of the day, chances are it will extend lower in the next session. Conversely, a settle near the daily high tends to lead to higher levels over the next 24 hours.

A subtler signal that reveals momentum is the position of the close in relation to the first hour high and low. If a market closes above the first hour high, it will frequently probe higher the next day. And a close below the first hour low typically means lower prices are likely the following session.

These open and close clues can also signify when a trend is near an end. For example, as an uptrend nears an end you will begin to see early highs and late lows.  Conversely, downtrends frequently turn upward when the recent daily lows are made early and the highs late.

Good traders often use short-term price action to gain an advantage. Small clues occasionally tell us when to fold or hold a trade.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Wednesday, February 13, 2019

Traders Often Need to Be Reminded

Well over a year ago, I wrote about several of my favorite sayings that of course apply to trading. Well this is a short blog to remind everyone how important this one particular saying is to me and most likely to you. With the volatile market we have encountered over the past several months, there is no better time to remind you of this saying I like to use.

Many of you probably have heard the saying that the first rule in trading is to protect your capital. If you were anything like me when you started trading, you likely thought that the first rule is to increase your capital. Who could blame you as a new trader? But once you realize how trading works, it starts to make sense. Essentially when you think about removing risk first, profits are sure to follow if you are managing things properly. I try to ingrain this notion in my students’ heads, and it needs to come instinctively. You need to properly manage your trades and know when to remove risk, and then trading can become a whole lot easier.

It is always smart no matter what the market conditions currently are but particularly in a market like we have seen. A position is up one day and then down the next. Trust me, you do not want to always take small profits and full-size losses. You will never get ahead. That is why I like to use multiple exits for profits and losses. Remember, you are not just taking a profit or closing out for a loss, you are removing any additional risk too. That is what you really need to understand as a trader. If you do, I promise you will stand a greater chance to consistently extract money from the market for a long time.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Thursday, February 7, 2019

How to Catch a Trend Early

Timing an entry price is a critical component for successful trading. To identify the optimal time to get long or short involves a setup or pattern that typically precedes an above average vertical move or trend. To quantify the odds for a breakout, refer to the combination of time at price and range length. Time at price is the horizontal measurement and range (high minus low) is the vertical dimension. The vertical measure is known as ATR (Average True Range). The horizontal calculation is volume at price. It is the price that buyers and sellers transact most often. It is the fair price.

Markets trend and consolidate; that is what they do. One of the most powerful pre-trend indicators requires two components. A consolidation phase precedes breakouts and after a large vertical move a consolidation phase often follows and the process repeats. The combination of above average time at price and below average range is one of the patterns professional traders use to make wagers.

The vertical dimension is simply high minus low. If the recent ranges are below average, it is an indication that a trend is near an end and often detects the reversal of one. When time at price exceeds the norm a trend or above average vertical move frequently occurs.

So, if your goal is to catch a trend early, search for markets that have below average day ranges over a five-day period and have spent above average time at price. The gold macrograph below illustrates this phenomenon.

Time at price is shown as the price that sticks out the furthest to right in each of these profiles. When consecutive days overlap and recent ranges are below average, a breakout or trend often ensues. Trends frequently begin after periods of below length and above average width or time at price.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Wednesday, January 30, 2019

Don't Forget About Positive Theta

Here is something to think about next time you are bullish and are considering a bull call spread as one of your options as an option trader. Many times, moving the spread in-the-money (ITM) makes sense from a positive theta perspective. Let’s take a look at a recent trade idea we covered in Group Coaching.

On a recent Friday, we were looking for a bullish opportunity on Apple Inc. (AAPL). The stock broke above some morning resistance and was trading around the $146.85 area. A 145/150 bull call certainly could have been considered for about a 2.60 cost. Moving the spread $1 lower overall (144/149) cost 2.85 after middling the market but also moved the spread a little deeper ITM, as seen below.

What does moving deeper ITM do? As always in option trading, there are risk/reward tradeoffs and this trade is no exception. The risk goes up, which means the reward goes down, but lower strikes allow the spread to produce a positive theta on the trade sooner if the stock responds and increases in price. Remember theta is highest at-the-money (ATM), so when the stock price reaches past the breakeven point of the trade, in this instance $146.85 (144 + 2.85), the spread is increasing due to positive theta.

Fast forward to three sessions later. AAPL has responded and has moved higher and now the spread can be sold for around 4.50 without middling the market. Of course most of the heavy lifting came from the stock moving higher and positive delta increasing the premium. But as soon as the stock crossed the breakeven level, which it did sooner by moving the spread a little deeper ITM, positive theta added to the premium.

As you can see above, the position still has around 0.15 (0.24 (short 149 call) – 0.09 (long 144 call)) theta helping it to an even greater profit. Positive theta can be a great addition to vertical debit spreads like the bull call discussed above. It is great to count on delta to profit, but don’t forget positive theta can help too.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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