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The Reality Of
AI TRADING SOFTWARE
REITs
Winner
14 years
in a row!
Are you interested in learning more about using exchange pointed in their
traded funds (ETFs) in your trading? Leslie N. Masonson, outstanding price
an active ETF trader, is president of Cash Management appreciation. Build powerful
Resources, a financial consulting firm that focuses on ETF NA R EIT re-
strategies. He is the author of BuyDont Hold: Investing With search has shown
trading systems in
ETFs Using Relative Strength To Increase Returns With Less that from 1972 to MINUTES
Risk; and All About Market Timing, as well as Day Trading 2015, equity REITs
On The Edge. His website is www.buydonthold.com, where have delivered a
without coding
he writes a weekly blog. To submit topics for future columns, 12.0% total return,
reach him at lesmasonson@yahoo.com. which compares
favorably to 10.3%
by Leslie N. Masonson for the S&P 500
Im
index. Further-
sure youre familiar with the term REIT, or real more, according
estate investment trust. They were created by to JPMorgan As-
an act of Congress known as the Real Estate set Management,
Investment Trust Act of 1960. A REIT is simply REITs were the
a common stock fund similar to a mutual fund that buys or top performer of
www.NeuroShell.com
finances real estate property or mortgages. They are often 10 standard asset 301.662.7950
publicly traded on stock exchanges but many are non-public. classes from 2000
Three well-known benchmarks are the Dow Jones Equity All through year-end
REIT Index (REI), the MSCI US REIT Index (RMZ), and 2015. Actually, they were the number one performer in eight
the Cohen & Steers Realty Majors Portfolio Index (RMP). of those 16 years, which is quite an accomplishment.
REIT properties typically consist of hospitals, large shopping In their analysis, they found that REITs had an average
malls, office buildings, hotels, nursing homes, storage facili- annual return of 12.0% during this period, compared to large
ties, apartments, warehouses, and mortgages. However, most caps, which averaged 4.1%, and small caps, which averaged
REITs usually focus on only a single property type. 6.6%. Most investors would not have guessed this outcome if
asked which asset category would be the best asset class for
The devil is in the details such a long time period.
REIT investors receive periodic annual dividends that are With the phenomenal growth of the real estate sector over
subject to taxes as ordinary income, but the past few decades, there were dis-
can also receive a return on capital and cussions among industry participants
some long-term capital gains. REITs Largest REITs by Market Cap about potentially separating real estate
provide higher income than Treasur- Company Ticker Symbol from the financial market sector, which
ies, impressive total returns compared Simon Property SPG consists mostly of money center and
to the S&P 500 index, and other major Public Storage PSA regional banks, diversified financial,
averages. Real estate is a separate asset Prologis PLD insurance, consumer finance, and
class in addition to stocks and bonds, so General Growth Properties GGP capital markets. It was no surprise
adding it to a portfolio reduces risk by Welltower Inc. HCN
that on September 1, 2016, real estate
providing more diversification. stocks were removed from the financial
Ventas VTR
REITs can be bought or sold at any sector of the GICS (Global Industry
time during the day in a liquid market Avalon Bay Communities AVB Classification Standard) and placed in
source: NAREIT
without difficulty. Since REITs are Equity Residential EQR their own category. However, mortgage
required to distribute their taxable Boston Properties BXP REITs remained exclusively in the
income as dividends to shareholders, it Vornado Realty Trust VNO financial sector.
is not surprising that these vehicles are FIGURE 1: THE LARGEST ONES. They encompass The S&P 500 index contains 26
owned by investors looking for a solid regional shopping centers, outlet malls, storage units, REITs. The S&P 400 mid-cap index
high-quality apartment communities, senior housing,
high income stream of dividends and healthcare infrastructure, industrial development, and has 35 REITs, and the S&P small-cap
growth potential. And investors over office properties. Most REIT ETF portfolios contain all
the past decade have not been disap- or some of these companies. Continued on page 46
March 2017 Technical Analysis of Stocks & Commodities 7
8 March 2017 Technical Analysis of Stocks & Commodities
OPTIONS
The Equalizer
F
irst, lets agree that always trading 100 and then violent eruptions. To use volatility success-
shares, or one futures contract, isnt as good fully, traders need to know which onehistorical
as varying your position size based on price (HV) or implied (IV)is best. Historical volatility is
volatility. If you dont agree, my first example measured from actual prices, while implied volatility
will show why its a problem. Until then, Im going (also tracked as the VIX index) comes from options
to assume that well use volatility. When markets are pricing. I would like to think that IV would be more
quiet, positions will be larger; when they are volatile, accurate because it represents what traders are will-
positions will be smaller. The key here is: How big ing to pay today rather than the lagging calculation
and how small? represented by historical prices. You wont really
The principle behind correct position sizing is called know unless you try using it.
volatility parity, that is, you equalize the volatility of The chart in Figure 1 compares the long-term his-
each trade, which in effect equalizes the risk, more or torical and implied volatility (on the left) and 2008
less. There are more sophisticated ways to equalize on the right. The bigger picture makes it appear that
risk, but volatility parity is much simpler and gets you both methods produce close to the same values, but a
90% of the solution. closer look at 2008 shows the differences. Historical
By equalizing the risk of each trade, you give each volatility continues to increase after implied volatility
trade an equal opportunity to affect the results. From has flattened. But this pattern is not always the case.
that you can conclude youve maximized diversifi- IV can spike on surprising news, then disappear the
cation. If you concentrate your investment in a few next day when that news turns out to be only a rumor.
markets and trade larger positions in terms of risk, HV would show only a small change.
0 20
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
/20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 0
6 /23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 07/01/2008 08/01/2008 09/01/2008 10/01/2008 11/01/2008 12/01/2008
FIGURE 1: COMPARISON OF Historical AND implied volatility. The chart on the left looks at historical and implied volatility from 2000 to 2016. The
chart on the right looks only at 2008. The bigger picture makes it appear that both methods produce close to the same values, but a closer look at 2008 shows the
differences.
by Perry J. Kaufman
March 2017 Technical Analysis of Stocks & Commodities 9
Test Cap All PL Long PL Short PL All PF Long PF Short PF Comments
1 No 17,756 11,851 5,905 2.14 2.84 1.64 100 shares, unbounded
2 Yes 12,272 8,878 3,394 1.97 2.76 1.44 Most stocks are 10K
Both HV and IV have their good and bad characteristics, 2. 100 shares with a cap at $10,000 in exposure, so that any
which makes it difficult to decide intellectually which would be trade that costs more than $10,000 for 100 shares will be
a better choice for sizing. HV has a noticeable lag because it is reduced to a $10,000 investment.
based on a 20-day average. IV can be unreliable and erratic. 3. Size by price, that is, divide the investment of $10,000
by the current stock price. That assures that the exposure
Variations on position sizing is always $10,000.
If we use one share or one futures contract for each 4. Size by average true range (ATR) of price. The ATR is
trade, then those markets with higher prices and/or the maximum of the highlow range, but extended to
more volatility will overwhelm the performance of the previous close if there was a gap. This test allows
other markets with low volatility. If were trading any number of shares, not limited by the investment of
futures, crude oil will always have larger gains and losses per $10,000. For a stock with low volatility, the exposure can
trade than eurodollars, yet eurodollars and other interest rates be very large.
have been far more profitable over many years, with less risk. 5. Sizing using the reciprocal of the VIX, so that an implied
Using TradeStations EasyLanguage for testing, we apply a volatility of 70% would be interpreted as a 30% position
120-day moving average to the ETF SPY. I know that this mov- (1IV, but not less than zero); that is, as the volatility
ing average is profitable over time, so it will be a better basis for increases, the position size decreases. Any VIX value
seeing the changes caused by various methods of sizing. The over 100% results in a position size of zero.
table in Figure 2 shows the results of the tests, both the dollar
profits and the profit factor (PF is the gross profits divided by The chart in Figure 3 shows the position sizing based on
the gross losses). these five scenarios. Tests 1 through 3, which are displayed on
For some of these tests, the exposure (position size times the the left, show the number of shares. In test 3, the position size
entry price) is limited to $10,000; in others there is no limit. decreases as the price of SPY increases, which makes it look
The position sizing will be calculated five different ways: similar to the SPY prices, but upside-down.
In tests 4 and 5, you have very large position sizes because
1. 100 shares for all trades. This allows positions to be volatility can be low. Its not the position size that is important
greater than the investment of $10,000 when the price of here, but the pattern. Rather than declining as in test 3, the
SPY is above 100. position sizes fluctuate up and down in a more cyclic way. The
T1 100 Shares T2 100 Shares (capped) T3 Size by price Implied volatility Historical volatility
Figure 3: SIZING Comparison. Tests 13 on the left show the number of shares. On the right, tests 45 show relative changes in position sizes. The actual
number of shares wont matter, only the relative change in the position size.
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approval. Before trading options, carefully read Characteristics and Risks of Standardized Options. Contact TD Ameritrade at 800-669-3900 for a copy.
Probability of success analysis results are theoretical in nature, not guaranteed, and do not reect any degree of certainty of an event occurring. Trade
Finder does not predict or project performance of the underlying security. TD Ameritrade does not make recommendations or determine the suitability
of any security, strategy or course of action for you through your use of Trade Finder.
See tdameritrade.com/600offer for offer details/restrictions/conditions and information on account fees/expenses. This is not an offer or solicitation in
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The principle behind correct
position sizing is called would cost $15,000. In mid-2016 it was 220, an investment
of $22,000 per trade.
volatility parity, that is, you When you cap the exposure in test 1 to $10,000 per trade,
equalize the volatility of each which gives each trade equal impact, the results drop and are
trade, which in effect equalizes far less attractive. Trades when SPY was under 100 will still
your risk, more or less. have smaller representation, but any trading priced over 100
will have its size reduced. As an aside, we can infer from this
that trades in SPY have been better at higher prices.
pattern of tests 4 and 5 are similar, with a few added spikes in Test 3: Size by price
test 4 that do not appear in test 5. This is the most common way of sizing that achieves equal
risk in a simple way. The per-trade investment of $10,000
Which is better? is divided by the current price of SPY to get the number of
These tests were designed to show the ideal returns of each choice shares. When you use this method for trading, you should
rather than the practical application, where the size is limited avoid stocks priced under $5. They are more volatile and
by the investment. In the first two tests, using 100 shares means erratic, plus the position sizes expand rapidly as the price
that a few trades taken under high volatility might have large falls under $5.
gains or large losses, overwhelming many trades that occur at The results were nearly identical to test 2 because that
low volatility. In Figure 2 you see a summary of the results. test had all trades that were entered when SPY was over
Intuitively, you expect the returns from the long positions 100 reduced to a total exposure of $10,000. That was most
to be better than the shorts because of the upward bias of the of the trades.
stock market. Still, the shorts were all profitable, which is a
good outcome. Trades that can be profitable on both the long Test 4: Real volatility parity
and short side show that the timing is good. This is an interesting test because it is the ideal case, that is,
money-is-no-object case of volatility parity. Each trade size
Tests 1 and 2: 100 shares, without and with capping creates exactly the same risk as every other trade. This means
Tests 1 and 2 both trade 100 shares, but test 1 doesnt care that the position sizes are very large during low volatility,
if the 100 shares give an exposure of $500 or $100,000. The and very small during high volatility.
higher price of the SPY in the more recent years will have The long profit factor of 3.50 is far above the others, showing
greater value and will influence the results to a much greater that, in theory, true equal risk is the best way to trade. On the
degree. In 1998 the SPY traded at 80 and now trades at about downside, it takes more than $1 million to trade this way.
220. The five-year bull market that followed the financial
crisis will have a greater impact than the bear markets of Test 5: Using implied volatility
2001 and 2008. That creates a poor portfolio risk profile This is where I thought implied volatility could outperform
because lower-priced stocks may be performing well but are historical volatility by a large factor. Instead, it produced an
overwhelmed by losses in a high-priced stock. Even though average result. My experience with this is that implied volatil-
the profit factor of 2.14 is high, I see this case as highly risky ity jumps up quickly, avoiding the lag in historical volatility.
because it can be distorted by a few big trades. But then it also disappears quickly when nothing happens.
In addition, you need an increasingly larger investment to That results in a lot of false volatility spikes.
keep trading. In 2000 the SPY traded at 150, so 100 shares It may also be that my formula for turning the VIX price
Test 4
10000 600000
4000
400000
5000 2000 200000
0 0 0
-5000 -2000 -200000
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01 00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01
/ 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 / 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2
06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06
T1 PL T2 PL T3 PL T5 PL T4 PL
FIGURE 4: volatility parity is the best solution. On the left, test 1 outperforms tests 2 and 3 (which overlap each other), but this is unrealistic because
the investment size exceeds the limit of $10,000 per trade. In this case, test 3 is the most practical. Test 5, using implied volatility, has some unacceptable rallies
and drawdowns from 2008 to 2010. Test 4 gives the best results overall, but the investment size varies enormously, making it impossible to implement.
Visualizing
the results
Sometimes numbers
arent enough. In Figure
4 you see the cumula-
tive profits for each of
the five tests. On the left,
test 1 outperforms tests
2 and 3 (which overlap each other), but is
unrealistic because the investment size
exceeds the limit of $10,000 per trade.
From these tests you would conclude that
test 3 is the most practical.
Tests 4 and 5 (on the right) are more
difficult to interpret because position sizes have been allowed Perry Kaufman is a trader and financial engineer. He is the
to exceed the $10,000 investment. Here you are looking for the author of many books on trading and market analysis, including
smoothness of the returns. This shows that test 5, using implied Trading Systems And Methods, 5th ed. (with the first edition
volatility, has some unacceptable rallies and drawdowns from published in 1978 as a seminal book in the field of technical
2008 to 2010, while using the ideal volatility parity sizing based analysis), and A Guide To Creating A Successful Algorithmic
on historical volatility (test 4) gives the best results overall. Un- Trading System (2016). For questions or comments, please go
fortunately, with test 4 the investment size varies enormously, to www.kaufmansignals.com.
making it impossible to implement. However, it does prove that,
theoretically, volatility parity is the best solution. Further reading
Kaufman, Perry J. [2013]. Trading Systems And Methods, 5th
Making the choice ed., Wiley.
Except for test 5, which uses IV, the others are extremely close. [2015]. A Guide To Creating A Successful Algorithmic
As a final measurement, I calculated the ratio of the total profits Trading System, Wiley.
divided by the standard deviation of the daily profits and losses, [2003]. A Short Course In Technical Trading, Wiley.
a reward-to-risk ratio similar to the Sharpe ratio. Results are [1995]. Smarter Trading, Wiley.
shown in the table in Figure 5. [2014]. A Better Trend, Technical Analysis of StockS
To be practical, test 3 is the easiest choice because you simply & commoditieS, Volume 32: April.
divide the investment per stock by the current price. While test 2 [2014]. Timing The Market With Pairs Logic, Technical
may have a slight edge because it trades smaller exposure when Analysis of StockS & commoditieS, Volume 32: March.
the value of 100 shares is less than $10,000, it wouldnt apply
to SPY now. Given a choice, I always prefer simpler.
T
Your challenge is to measure the potential energy available to
S&P500:MATTZ90/GAUGE: RFVECTORS/
SHUTTERSTOCK/COLLAGE: NIKKI MORR
he performance of the S&P 500 can tell you a lot make the market rally. It has little to do with recent momen-
about global asset returns. If it goes up materially, tum or the consensus view you hear and read about. In fact,
then bonds usually fall, and if it goes down, bonds if you go with what you hear in the media, you may end up
usually rise. If it goes up, traders prefer currencies buying after a bout of weakness. If you buy into a trend, you
like the Australian dollar over, say, the Japanese can only do it if the conditions are right. Heres how I look
yen. If you start your trading day with an advantage for the right conditions.
or appropriate bias, then you would know how to To measure energy, I have to be confident that I know all
14 March 2017 Technical Analysis of Stocks & Commodities
TRADING STRATEGY
the forces that matter in the short term that lead to rallies. I 250
must then prove that there is forecasting value in the index. I 200
A Occurrences
use a daily timeframe and to the extent that a high index level 150
persists, I may be able to hold onto a long position for one to 100
10 days. It can augment a shorter-term trading method, but it
may not help if you have a monthly perspective.
50
0
00
80 0
85 5
90 0
95 95
55 5
60 0
65 5
70 0
75 5
45 5
50 0
30 0
35 5
40 0
10 0
15 5
20 0
25 5
7
8
8
9
6
7
5
5
6
3
3
4
4
1
1
2
2
1
0
There are three parts to the index:
Index Range
Figure 1: AN S&P FUEL GAUGE. The energy index ranges between zero and
100 with a mean of 52 and a median of 50. The distribution looks similar to what
1. fear you see here.
2. time since the last period of weakness
3. interest rates.
2,100.00 2,100.00
2,050.00 2,050.00
2,042.75
2,000.00 2,000.00
1,950.00 1,950.00
It is simply axiomatic that when investors are afraid, we want 1,900.00 1,900.00
50.00 50.00
wait to enter. If the market got hit and many investors were 40.00
30.00
Fear 40.00
30.00
can buy it ahead of those people before they get back in, which
40.00 40.00
40.28
30.00
Bonds 30.00
lower interest rates help equity valuations and force people FIGURE 2: BONDS VS. FEAR. The two are not correlated and neither are they
out of lower-yielding bonds and into stocks. connected. Bonds, as a factor, are more volatile than the fear factor.
How is it behaving?
2,100.00 2,100.00
2,050.00 2,050.00
2,040.50
The energy index ranges between zero and 100 with a mean
2,000.00 2,000.00
1,950.00 1,950.00
bonds and fear. I adjust both for volatility and where the index
1,850.00 1,850.00
>40 >45 >50 >55 >60 >65 >70 >40 >45 >50 >55 >60 >65 >70
2007 94 89 87 83 79 75 71 2007 18.50 14.50 32.00 51.25 33.25 11.75 15.25
2008 174 151 129 110 94 83 75 2008 -93.25 94.25 58.50 70.75 93.25 120.50 51.00
2009 160 127 95 84 70 54 40 2009 278.45 108.45 86.25 96.50 108.00 132.50 165.75
2010 207 161 129 107 88 72 59 2010 77.50 -38.25 -13.50 -44.50 -78.30 -17.50 14.75
2011 171 158 135 109 81 66 56 2011 120.00 45.25 -67.50 128.50 86.00 132.50 49.50
2012 181 155 138 123 106 94 82 2012 131.00 64.75 72.75 134.00 191.25 213.50 172.75
2013 220 193 167 145 126 105 84 2013 434.50 391.50 335.75 297.25 194.00 179.00 181.50
2014 144 122 98 77 69 56 44 2014 94.75 15.75 108.25 48.75 21.00 -9.25 -27.25
2015 95 74 60 43 27 17 14 2015 188.00 298.25 333.50 319.25 332.75 222.75 161.25
2016 39 29 23 19 17 17 13 2016 78.75 37.75 66.00 30.25 113.25 113.25 77.50
FIGURE 6: HOW OFTEN DO YOU GET HIGH READINGS? This is a good metric FIGURE 7: HOW MUCH DID YOU MAKE EACH YEAR? You can see there were
to know just so you can have an idea of how often you need to be long to get suf- sufficient declines during 2010 but you cant determine how much of a return you
ficient returns. made in a specific year.
400
to the upside, then you enter a long position. If the hourly chart -200
breaks down, you exit and wait for the next opportunity.
-400
Dont forget your daily
tune-ups
-600
-20 0 20 40 60 80 100 120
You know where the index stands every day, Interval Range Midpoint
and with that information, how can you figure
FIGURE 8: LOOKING AT A NARROWER RANGE. The size of each bubble is
out if the index is trending or not? The filters I proportionate to the number of occurrences. Each range band is 10 points. The
discussed will not work since they are group- most reliable levels where all the points are significantly above zero occur when
ing all outcomes above or below a threshold, the index range midpoints are >= 60.
and that dataset may include many better or
worse conditions than the current one. 2000
What you need to do is view the performance within a 1500
Cum ES Cum System
narrow band around the current level of the index. The most 1000
reliable levels where all the points are significantly above zero 500
occur when the index range midpoints are >= 60 (Figure 8). 0
Each range band is 10 points and the size of each bubble is -500
proportionate to the number of occurrences. -1000
I shall resist the temptation here to create a simple trading
/27 5
15
/13 4
/08 5
/01 3
/23 4
/16 3
/05 3
/27 2
/21 2
/14 1
/08 1
/02 0
/25 1
/17 9
/07 0
/30 9
/21 9
/13 8
/09 8
/28 7
/22 7
11 /201
02 /201
07 /201
05 /201
09 /201
07 /201
12 /201
09 /201
02 /201
12 /201
05 /201
10 /201
03 /201
07 /201
12 /200
05 /200
03 /200
07 /200
12 /200
05 /200
10 /200
/20
/07
system using the index. The index can be used just for risk
08
control but allow me this indulgence. Lets say you were forced FIGURE 9: S&P 500 VS. TRADING ONE ES CONTRACT WITH VARYING POSI-
to own the S&P contract. You can never be flat but you can TION SIZES. You can see there are some severe pullbacks. Thats because you
own the contract in proportion to the level of the index. The must be long through all markets. The nice thing is that the drawdown is 40% lower
and the total number of points earned is almost three times greater.
position quantity will be set at index/50 so the average position
over 10 years equals close to one1.03 to be precise. Lets
compare that with the S&P 500. You can see from Figure 9
that there are still some severe pullbacks. Thats because you the euro (Figure 11). I do this so I Filter Avg Ret
must be long through all markets but the drawdown is 40% can see the underlying behavior of >40 0.032
lower and the total number of points earned is almost three the Australian dollar without the >50 0.019
times greater. macro effect. For this, I would use >60 0.011
the following rules: >70 0.006
Boost the octane with bonds >80 0.012
An index that helps project equity returns might also indicate 1. Buy the A$/EC cross if the
>90 -0.004
when to buy or reduce bond exposure, since bonds, in the short index is > 65
FIGURE 10: WHAT ABOUT
run, are extremely negatively correlated to the S&P contract. 2. Short the A$/EC cross if the BONDS? The average bond
From Figure 10 you can see that the average bond return over index is < 35. return over this 10-year period
this 10-year period is 0.027 points per day. There has been is .027 points per day. Notice
a huge upward tilt in bond prices. Notice how as the index If the index is between 65 and how as the index reaches bull-
ish levels the returns on bonds
reaches bullish levels, the returns on bonds fall precipitously. 35, you wouldnt take a position. fall precipitously. Even if you
Even if you only trade bonds, you still can use this index to only trade bonds, you still can
manage your exposure or duration. Continued on page 45 use this index to manage your
exposure.
Top it up with forex 18
You may not have a strong feeling for how 16 A$/EC
06 014
11 015
12 013
06 013
01 011
07 012
01 012
06 013
01 010
07 011
02 009
08 010
/12 7
03 007
08 008
02 008
08 009
0
/20
/20
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/25
/10
/04
/28
/20
/18
/12
/03
/06
/31
/26
/19
/21
/07
/28
/24
/18
/11
09
This Butterfly
tions traders, collect time
premium (positive theta), I
used to think that my short
gamma and short vega were
Wears Kevlar
just things that I would have
Butterfly: butterfly hunter/yellow kevlar: horban iryna/
Butterflies are a well-known options trading strategy. But heres one thats a little different. to collect theta without, or at
least with drastically reduced,
by John A. Sarkett gamma and vega risk.
In
Thus, the Kevlar butterfly
the history of options trading, Jim Riggio goes way back. He started trading more was born. The name came not
than two decades ago. He was among thinkorswims first 100 clients; trained as from Riggio himself but from
an engineer, with degrees in computer science and information management, he a student, who, on grasping
admired their advanced platform so much he became a broker there, and wound its power and efficacy, said,
18 March 2017 Technical Analysis of Stocks & Commodities
options
Wow, this butterfly can survive huge market Profit/Loss by Change in SPX Index Price
$
moves ... its like the butterfly is wearing 90000 +610%
a Kevlar jacket or something. The name 81000
T+37
T+19
+550%
profound respect for the destructive capabili- FIGURE 1: Low IV and steep put skew. Here you can see that puts well below-the-money are expen-
ties of vega and gamma: The Kevlars risk sive compared to puts at-the-money (ATM). In this case, a symmetrical, below-the-money (BTM) butterfly
management methodology will exchange is paired with a deep in-the-money (ITM, with at least 60 delta) call.
theta (collecting time premium) for reduced
risk (gamma near zero and drastically lower short vega when He has two distinctly different approaches for the two main
IV is low). This had become an obsession of mine. If deltas market environments: low implied volatility (IV) (mode 1)
are under control, gamma is near zero, and vega is not too and high implied volatility (mode 2).
short when IV is low, the market is going to have a harder To determine low versus high IV, he looks at a VIX chart for
time defeating me. the past year. Which quartile are we in, he asks: 0-25, 26-50,
With a dash of self-deprecation that gives his online dis- 51-75, 76-100? The skews he gets from a proprietary source.
courses appeal, he says: Some people have called me paranoid Many platforms provide these as well: in thinkorswim, for
about the options market, to which I reply, I may be paranoid, example, go to Trade All Products Product Depth
but that doesnt mean the market is not still trying to take my Options. Change the filter from All to Puts, and change
money away. the view to show implied volatility (Impl Vol). Under Setup
Currently, he is sharing the ins and outs of the Kevlar but- Application Settings Calculations, you can change which
terfly at Capital Discussions, a new trade education and alert volatility calculation method is reflected (such as volatility
service featuring several top mentors he cofounded with op- smile or individual implied volatility).
tions veteran Tom Nunamaker. To his method, which volatility environment he is in at a
given time makes a significant difference. Once he determines
How he trades it where we are in the volatility universe, he feels confident to
Riggios vehicle of choice is the monthly SPX. He aims for move to create a position. In Figure 1 you see the risk curve
no more than one or two adjustments per cycle, and he targets of mode 1, where volatility is low and the put skew is steep.
5% to 10% gains per trade on a $50,000 account with less Note that puts well below-the-money are expensive compared
than 5% loss. He will scale into and out of trades. Target exit to puts at-the-money (ATM). In this case, Riggio creates a
time occurs at about 14 days to expiration (DTE), but this is symmetrical, below-the-money (BTM) butterfly paired with
flexible. He explains: The reason is that the risk, especially a deep in-the-money (ITM, with at least 60 delta) call. In the
the gamma risk, is much, much more as you get closer to SPX, he uses 100-point wings such as 1900/2000/2100.
expiration. I would prefer to take my measly 5% to 10% and In Figure 2 you see a risk curve of mode 2, or a high-
go home and start the next trade with 60 to 80 days to volatility environment and normal-to-flat put skew. In this
expiration. scenario, Riggio puts on a below-the-money (BTM) put broken
Indeed, in the Riggio schema, gamma is crucial. Riggio wing butterfly (BWB). The upper strike is usually 25 points
watches it like the proverbial hawk and he does whatever it above SPX price. This position has much more negative vega.
takes to keep it low. Here, the spacing is a right wing that is 75 points above the
All this seems sound and reasonable enough, but what short strike, and the left wing is 100 points lower. If the SPX
makes his approach unique is the entry scenario about which is 2050, then the BWB is put on at 1900/2000/2075. Theres
he is quite particular: operative entry elements are a) volatil- no long call this time.
ity and b) skew. It is best to enter both models on down days where implied
While other traders ignore these, he focuses on them like volatility is up. While its easier to trade all one type, for ex-
a laser. ample, all puts, he will employ iron butterflies (short put credit
March 2017 Technical Analysis of Stocks & Commodities 19
$ Profit/Loss by Change in SPX Index Price of rules ... for all the market conditions that
120K +240% I can think of, such as ... price, price trend,
110K T+56
T+28
+220%
speed of price move, greeks (today), greeks
(in one week from now), strikes, expiration
100K +200%
T+0
90K +180%
80K +160% cycle, days to expiration, implied volatility,
70K +140% skew, term structure, kurtosis, trade con-
60K +120%
figurations, tape reading, knowing when you
should be scared, and so on. These factors
50K +98%
40K +79%
30K +59% would all vary for every option structure.
20K +39% For example, if we had an existing broken
10K +20%
0%
wing butterfly with 100 points left wing vs.
75 right wing ... and when to adjust with a
0K
-10K -20%
-20K -39% symmetrical 25 wide wing put condor vs. a
-30K -59% 25/40 point asymmetrical condor ... and this
would be different if the center was 25 vs. 50
-40K -79%
-50K -98%
-60K -120% points below the current SPX point ... and this
1604.40 1639.40 1674.40 1709.40 1744.40 1779.40 1814.40 1849.40 1884.40 1919.40 1954.40 1989.40 2024.40 2059.40 2094.40 2129.40 2164.40
-16.2% -14.4% -12.6% -10.7% -8.9% -7.1% -5.3% -3.4% -1.6% +0.2% +2.0% +3.9% +5.7% +7.5% +9.4% +11.2% +13.0% would be different if the Brexit vote or US
FIGURE 2: High IV and normal-to-flat put skew. In this scenario, a below-the-money (BTM) put elections were tomorrow ... and this would
broken wing butterfly is put on. The upper strike is usually 25 points above SPX price. This position has be different if ... Do you get my point? There
much more negative vega. Here, the spacing is a right wing that is 75 points above the short strike, and are just too many potential ifs.
the left wing is 100 points lower.
Trade smart
spread under a short call credit spread) to generate credits and I could write 100,000 rules, and the next day, something will
conserve capital. The Kevlar butterfly mitigates risk by hav- happen in the market that I will need to write another 20 rules
ing a negative delta and a flat T+0 line. He says: In a market ... and following that, another 30 rules ... and the week after
decline, the S&P 500 market price must travel through my that ... well, you get the picture.
profit zone to get to my risk zone. This gives the Kevlar a strong For clients, he winnows down this mass of potentiality to a
defensive position for a market selloff, he says. Offense sells simple, specific recommendation, sent out by email and text
tickets, he says, but defense wins championships. as a real-time trade alert. And his platform keeps score with
a documented trade record and cumulative equity curve. We
Managing positions are transparent, he says simply.
While he is fairly rigid about entry, his adjustments are man- Most recently, while this piece was being written, in his
aged by the options greeks. To lift his T+0 (todays profit-loss current live trade, he elected to do that simplest and easiest
sum), he employs a variety of tools to flatten the profit peak adjustment: This old geezer is going to close the Oct Kevlar,
and generate credits. These might include condorizing his pick up my piggy bank, get a glass of lemonade, go to the
position with additional credit spreads, moving his position bathroom (if I am going to get out of my rocking chair, why
up or down, or just adding long puts or calls. waste the trip), and then go and sit back in my rocking chair
Veteran trader that he is, Riggio has a visceral reaction for with my measly 10% profit for the month.
how fast a profit can turn into a loss in an otherwise brilliant Self-deprecating, humorous, but with decades of options
options strategy, so his first adjustment can be as simple as wisdom stuffed into one pithy statement, he says: I know
taking a trade off when it reaches approximately 10% profit, Im not smarter than the market. Which is why he puts on
either entirely or by partials. For example, if a butterfly has 6 Kevlar garb when he ventures into it. And advises others
x 12 x 6 contracts, he might take off 2 x 4 x 2. exactly how to do the same.
If he feels motivated to stay in a positionwhich, by the
way, is a function of the math, not a feelinghe will look at Continued on page 25
a large variety of what ifs including but not limited to leaving
the position as is, selling calls, selling put condors (balanced
or unbalanced), adding put or credit verticals, and more.
What are his rules? He is not comfortable with the concept Anyone who learns sound
of rules, per se, and tells why: It is beyond naive to think options trading skills
that if you can get the perfect set of rules you will conquer and who masters risk
the options game. Anyone who learns sound options trading
skills and who masters risk management methodology should
management methodology
be able to become a profitable options trader. should be able to become a
It is all about understanding the tradeoffs when you are profitable options trader.
making decisions. I could put together a very, very long list
20 March 2017 Technical Analysis of Stocks & Commodities
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Too Much Braun
A
Then, when the extended cycle finally began to roll over,
rising stock marketit gives us a warm, fuzzy feel- the end result was the worst financial crisis seen since the
ing; it puts us in a state of complacency because Great Depression. Yet the response to the worst financial
it makes us think that everything is going to be crisis since the Great Depression was an even more extreme
just fine. In reality, that may not be the case. And version of the same policies that helped create the problem
heres why. in the first place.
Those resuscitation efforts have, for the most part, failed
Bear: DOUBLE BUBBLE/WORLD CURRENCIES: GRINGOS4/
Getting too inflated to stimulate the economy and have instead created an equity
I believe economic issues began in 2000 and have only been bubble. In 2015, the equity markets began what is still a ginor-
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
made worse. The world economy is in a systemic crisis and we mous topping process. After the initial decline into the August
are in a stock market bubble that has resulted from attempts to 2015 low, I expected there would be false bottoms and false
resuscitate the underlying economy. In spite of equities push rallies. Since the topping process first began in 2015, there
to a new high in 2007 and again in 20162017, I have held all have been four intermediate-term advances, with the most
along that the secular bull market peaked in 2000 along with recent carrying the market to yet another new high, and there
the underlying economy. have been three intermediate-term declines with the fourth
The first attempt at stimulating the economy and resurrect- pending as of January 2017. Admittedly, I did not anticipate
ing the secular bull market came in the wake of the decline the extent or duration of these rallies being what they have
22 March 2017 Technical Analysis of Stocks & Commodities
cycles
caused great confusion while 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0
creating an environment of FIGURE 1: SECULAR BULL AND BEAR MARKETS. On this chart of the S&P 500 you see that between 1982 and 2000,
enormous complacency. volume expanded as price rose and contracted on the declines, which is bullish behavior. The bullish price/volume relation-
In light of the new high that ship began to change after 2000 to one that was more typical of secular bear markets.
has followed in the wake of the
election, a recent Gallup poll reports US economic confidence which again is indicative of a secular bear market rally. Even
levels to be at the highest levels ever recorded. Many are call- with the additional post-election parabolic advance, volume
ing this move a breakout. I called it a fakeout that may has continued to shrink.
likely prove to be the biggest bull trap of all time and which I Since the inception of the DJIA in 1896, the four-year cycle
think is also likely to leave the market positioned for a nasty has historically averaged 48.11 months. The point of these
multiyear unwinding process in which the 2009 lows could charts is to show you that even though we have seen two of
potentially be revisited. the most extended four-year cycle advances in stock market
history, the price/volume behavior remains bearish. Thus, in
Will the bubble pop? spite of the most coordinated global intervention efforts in
Im going to take a moment and step back to look at the the history of the stock market, which are still ongoing, these
bigger picture so you can get an idea of what to expect for efforts have failed to change this underlying basic price/volume
the inevitable unwinding. Overall, this is still part of a very behavior, even with the most recent four intermediate-term
large, ugly top. advances.
Ill first look at a chart of the S&P 500 (Figure 1). In their
1948 book Technical Analysis Of Stock Trends, Edwards & The bigger picture emerges
Magee wrote that in a bull market, volume increases when Even though we have seen not one but two of the longest four-
prices rise and dwindles as prices decline; in a bear market, year cycles in history, I maintain that we have been operating
volume increases when prices drop and dwindles as prices in a secular bear market since 2000. But given that we have
recover, which is a very basic technical principle. seen new highs, what difference does it make whether we call
In Figure 1 you can see that between 1982 and 2000, vol- these two extended four-year cycle advances bull markets or
ume expanded as price rose and contracted on the declines, rallies within a bear market? The result will be the same,
which was clearly bullish behavior. This goes in line with
the underlying secular bull market that was prevalent during
that time period.
Now look how the bullish price/volume relationship began to The advance out of the
change. Volume began to expand as price declined into the 2002 2009 low has been the most
low, and it began to contract as price moved into the extended
2007 four-year cycle top. As prices moved down into the 2009 extended cyclical advance
extended four-year cycle low, you see that volume expanded. since the inception of the
Following that low, the bearish volume behavior was further Dow Jones Industrial Average
confirmed. The declines into the 2010, 2011, and 2015 lows in 1896.
also confirmed this. But then in 20152016, as price began
going parabolic into those tops, volume continued to shrink,
March 2017 Technical Analysis of Stocks & Commodities 23
right? Wrong! The difference is that, like M2 Velocity
the extended rally into the 2007 top, it
was not organic. It was manufactured
220 220
215 215
and it lacks the underlying foundation 210 210
175 175
even worse. 170 170
which I feel was also suggestive of the FIGURE 2: Velocity of Money. A divergent top occurred in conjunction with the 2000 top in equities,
secular bull market top. These two pieces which clearly telegraphed the peak in the underlying economy. This could suggest a secular bull market top.
of data are related. But what about the continued contraction in M2 velocity that has reached the lowest levels since the inception
I want to point out that the liquidity of this data in 1959?
campaign policies associated with the
2002 to 2007 extended four-year cycle Whats next?
were able to positively influence the velocity of M2 in that it I have several points to make in regard to these charts.
did turn up in early 2003. This upturn then peaked in early
2006, ahead of the extended four-year cycle top in October 1. The evidence clearly suggests that the secular bull market
2007. Then theres the upturn that was seen in association with and the economy peaked in 2000.
the 2009 four-year cycle low and the collapse that followed. 2. It has been the deflationary forces surrounding these
Theres a continued contraction and the lowest levels since secular tops back in 2000 that the Money Masters have
the inception of this data in 1959. In spite of what economists been fighting ever since.
say, my belief is there has been no economic recovery. In fact, 3. These charts show that the monetary policies in associa-
it has been just the opposite. tion with the most extended two four-year cycles in the
I also want to look at the job participation rate (JPR) data, history of the US stock market have not had a positive
which can be found in Figure 3. When you tie velocity of M2 impact on the most basic underlying technical conditions
and job participation to volume charac-
teristics of the market and other technical
data, the bigger picture begins to come 68.0 Labor Force Data 68.0
of the 2009 low. It collapsed, which is FIGURE 3: THE BIGGER PICTURE COMES INTO FOCUS. Job participation rate (JPR) peaked in 2000, along
with the stock market and the initial contraction of the velocity of M2. Note also that the peak in late 2006 fol-
consistent with the velocity of M2 chart lowed the April 2006 peak in the velocity of M2 and the collapse that followed. See how it is consistent with the
and the price/volume characteristics. velocity of M2 chart in Figure 2 and the price/volume characteristics seen in Figure 1.
options
M
unresponsive as the length
BUY GRAPHIC: HANOHIKI/CHART HAND CLOUD: RA2STUDIO/
any novice and even intermediate traders have told me over the years that they find the of the lookback period in-
ever-popular relative strength index (RSI) indicator confusing. The RSI is an oscillator creases. I have previously
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
plotted on a scale of zero to 100, and is typically used as an overbought/oversold indica- proposed a solution to this
tor, which means that it is used to signal impending reversals in direction. However, during problem via the stochastic
strong trends, the RSI can remain at extreme levels, either high or low, for the duration of RSI or stochRSI.
the trend, and thus, its not precise as an indicator of impending reversals. This is partly due A bigger problem is that
to range compression, which I will discuss later in this article. because the RSI is plotted on
a fixed 0100 scale, as op-
Digging deeper posed to an open scale with
Even expert technicians have expressed their concern about the smoothing built into the indi- no upper or lower limit, there
cator. In brief, calculations begin by separating daily changes into absolute values separated is massive range compres-
by days on which a market (or stock) closes up on the day or down on the day, so that there sion at the extremes, or the
26 March 2017 Technical Analysis of Stocks & Commodities
Indicators
area of the most interest. Visualize the two columns of daily RS decreases from Length Smoothing Effective Length
close-to-close changes described earlier as buying pressure 1 to 0.1, a 10-times of RSI Factor of EMA
or selling pressure. If there is strong selling pressure, the drop, the RSI itself
6 0.16667 11
absolute daily close-to-close changes on down days will be drops from 50 to 9
8 0.12500 15
much greater than the close-to-close changes on up days. So or so.
the ratio of selling pressure to buying pressure could be 10:1 The fixed range 10 0.10000 19
or greater (and vice versa). has two effects: 12 0.08333 23
Imagine a stock that surges on strong earnings, with strong nonlinear range 14 0.07143 27
buying over many days as investors follow through. In this compression, and 16 0.06250 31
case, the proportion of buying to selling pressure, that is, the asymmetric val- 18 0.05556 35
ratio of the average of up-day close-to-close changes to the ues. First, when the 20 0.05000 39
average of the down-day close-to-close changes, could move range compression
22 0.04545 43
from 3:1 to 12:1, a 300% increase, and yet the RSI would only is nonlinear, the
24 0.04167 47
shift from 75.0 to 92.31, a mere 23% increase. As a short-term greater the dif-
trader, you would rather be alerted to the 300% increase ference between 26 0.03846 51
in buying pressure than a 23% increase in RSI. The range the up-closes and 28 0.03571 55
compression gets even more extreme as the ratio of buying down-closes av- 30 0.03333 59
pressure to selling pressure increases. erages, which is 32 0.03125 63
In defense of the design of the RSI, it is a brilliant and precisely when the 34 0.02941 67
practical solution to the problems of its time, when computers indicator should 36 0.02778 71
were uncommon and data were plotted by hand. In order to be drawing your
38 0.02632 75
speed up hand calculations, the use of moving averages that attention to that
40 0.02500 79
required just one row to be calculated anew each day was most stock or market.
convenient, even essential. Similarly, the ability to plot RSI Second, though 42 0.02381 83
data on a fixed 0100 scale greatly simplified the problem of the displacement FIGURE 1: SMOOTHING BUILT INTO THE RELATIVE
STRENGTH INDEX (RSI). The smoothing factor seen
updating a large number of charts by hand. However, today from the center in column 2 is an inverse of the length of the RSI.
we can rework the problem to overcome these computational is symmetric, the
or charting challenges. numeric readout
50
48 calculations against a commercial package for
completeness. I can now use the RSI calculations
46
Jul 8 13 20 27 Aug 10 17 24 Sep 8 14 21 28 Oct 12 19 26 Nov 9 16 23 Dec 7 14 21 28
FIGURE 4: BUY/SELL PRESSURE IN DUPONT (DD). Dupont rallied in late 2015 and the RSI in Figure 5 and compare them directly to buy/sell
stayed above 70 for more than 45 days. pressure calculations (see Figure 6).
28 March 2017 Technical Analysis of Stocks & Commodities
Dupont: 14-day RSI with Wilders Smoothing Dupont Rally captured via Wilders RSI and Chande Buy/Sell Pressure
RSI Up Ref Dn Ref Wilders RSI Buy/Sell Pressure
100 120 12
60
60 6
50 50 5
40 40 4
30 3
30
20 2
RSI = 50.79 CBSP Surging
20 10 1
10 0 0
microsoft excel
15
15
15
15
15
15
15
15
15
15
15
15
15
15
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
0
/3 0
/0 7
/1 4
/2 1
/2 8
/0 4
/1 1
/1 8
/2 5
/0 2
/0 9
/1 6
/2 3
/3 0
09
10
10
10
10
11
11
11
11
12
12
12
12
12
15
15
15
15
15
15
15
15
15
15
15
15
15
15
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
/2 0
FIGURE 6: WILDERS RSI VS. BUY/SELL PRESSURE. The values are consistent
/16
/23
/30
/30
/07
/14
/21
/28
/04
/11
/18
/25
/02
/09
12
12
12
09
10
10
10
10
11
11
11
11
12
12
with those in Figure 3. The buying pressure was 10 times the selling pressure (values
FIGURE 5: 14-DAY RSI WITH WILDERS SMOOTHING. Here, the RSI calculations
above 10) with RSI greater than 90 just before DD flattened out in mid-November.
were reproduced in an Excel spreadsheet. The RSI value of 50.79 on December
The acceleration in CBSP values makes the buying pressure more obvious than
31, 2015 is the same as in Figure 4.
the flattening out seen in RSI values.
The rapid acceleration in buying pressure is more intuitively should be expected since I am using a larger fraction of the
obvious in Figure 6, even as the RSI values begin to flatten incoming data (0.13 vs. 0.07) to update the new value for the
out, topping out above 90 for BSP > 10, as can be expected moving averages used to calculate the relative strength.
from the calculations in Figure 3.
Ill now briefly revisit the internals of RSI smoothing. The spill in Kimberly Clark
Wilders formulation does not quite follow the usual EMA The shares of Kimberly Clark (KMB) had a bit of a spill in
formula. For example, for a 14-day RSI, it adds 1/14 of the late 2016. These defensive stocks have been following the
new value to 13/14 of old value, instead of adding 2/15 of the bond market lower, after bonds peaked in the immediate
new value to 13/15 of the old value to compute the updated aftermath of the Brexit scare. I show in Figure 8 how the
averages. This subtle change slows down the RSI computations. selling pressure reached -4, with the RSI in the range below
I compared the RSI values during the DD rally using the two 20, as is expected from Figure 3. The CBSP instantly com-
different smoothing schemes in Figure 7. The proper EMA municates selling pressure four times the buying pressure,
formulation, denoted by standard EMA smoothing in Figure whereas the RSI readout is merely an oversold condition
7, responds more quickly than the Wilder formulation, which below 30. Thus, when you compare the pressure of buying
Dupont: RSI with Wilders vs. Standard EMA Smoothing Kimberly Clark: RSI vs. CBSP (1:4 Selling Pressure)
RSI Standard EMA Smoothing Wilders RSI RSI Up Ref Dn Ref CBSP
80 3
120
80 50 0
40 -1
60
30 -2
40
20 -3
20 10 -4
0 -5
0
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
/26 16
16
/2 1
/2 1
/2 1
/2 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
/2 1
/20
10 0/20
15
15
15
15
15
15
15
15
15
15
15
15
15
15
/3
/20
/20
/20
/20
/20
/20
/20
/20
/20
/20
/20
/20
/20
/20
09
/30
/07
/14
/21
/28
/04
/11
/18
/25
/02
/09
/16
/23
/30
FIGURE 8: RSI CALCULATION AND CBSP. The selling pressure here is four times
09
10
10
10
10
11
11
11
11
12
12
12
12
12
FIGURE 7: WILDERS RSI VS. STANDARD EMA SMOOTHING. The RSI calculation the buying pressure, giving a CBSP reading of -4, intuitively clarifying that the stock
using the standard EMA formula reacts faster because it uses a larger proportion is under significant selling pressure. The RSI readout at about 20 merely shows an
of new data to update its internal moving averages. The more responsive RSI can oversold condition. Thus, the CBSP gives symmetrical readings (4:1 or 1:4, that is,
be quite attractive to short-term traders. +4 or -4) for the intensity of buying or selling pressure.
70 5
60
4
50
3
40
30 2
20
1
10
0 0
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
/25 16
16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/2 16
/2 16
/2 16
/2 16
/2 16
/25 16
16
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
/2 1
/2 1
/2 1
/2 1
10 0/20
/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
/20
/3
/3
09
09
FIGURE 9: PRICE JUMPS AND RESPONSE TIME. The 20% or so jump in NFLX in FIGURE 10: BUY/SELL PRESSURE WITH WILDER VS. STANDARD EMA
a single day was heavily damped in the RSI calculations using the Wilder smoothing SMOOTHING. The Chande buy/sell pressure (CBSP) calculations using the regular
formula. However, using the standard exponential moving average formula led to exponential average definitions responded more quickly to the one-day jump in
a faster response from the resulting RSI. NFLX than the CSBP calculations using the Wilder smoothing method. The CBSP
intuitively shows the sudden surge in buying pressure, and shows that it is many
times the selling pressure.
ES OPTIONS simple: Just because the stock exchanges report each individual trade to the IRS.
Why trade ES options, and not the SPX are closed doesnt mean financial mar- Instead, he receives a 1099 with a lump
or SPY options? kets around the worldand, therefore, sum of profit or loss. That single figure
Ive been asked on multiple occasions emini S&P 500 futures pricesarent is reported on the traders taxes.
why I recommend S&P 500 options moving.
trades using the emini S&P futures Lower barriers to entry and access to
options (ES) traded on the Chicago Preferable tax treatment option-selling strategies
Mercantile Exchange (CME) rather than Options on futures traders enjoy a Most equity brokers require their clients
equity products such as the SPX or SPY. 60/40% blend between long-term and to apply separately for access to trade
The truth is, I am a futures and options short-term capital gains rates on all trades options. Further, being granted the ability
broker who deals solely in futures con- regardless of how long they were held or to sell options is generally reserved for
tracts and options on futures contracts. which particular instruments are used. those with sizable speculative accounts.
But besides the fact that options on fu- This is a significant advantage for active For instance, most stockbrokers seem
tures are in my comfort zone and are the traders because most stock products to want at least $100,000 in a trading
bread and butter of my business, there require a trade be held for more than account before option-selling strategies
are some compelling reasons to trade a year to be eligible for the discounted are a possibility (although some brokers
emini stock index options and bypass long-term capital gains rate. will allow it in a $50,000 account). In
the equity market versions. any case, traders are expected to put up
at least five figures to trade short options
Around-the-clock market access Traders who trade and spreads in the stock market. Futures
The primary argument for trading emini options on futures stand options traders, on the other hand, are
S&P 500 options versus the stock market to potentially get more granted cheap and easy access to short
version, SPX, is that the futures options options and options spread trading. For
trade 23 hours per day. Accordingly, it is
bang for their buck when instance, my brokerage service allows
possible to exit them at any time of the day they are right in their options spread trading with as little as
or night, with the exception of the daily speculations. $2,500, but for naked option selling,
closure between 4 pm and 5 pm Central we prefer to see upwards of $10,000.
Time. This can be particularly helpful if In any case, it is a clear advantage for
there is some sort of event risk while the That said, the SPX is one of the few smaller traders to venture into options
stock market is closed. For instance, on stock products treated in this manner. on futures.
election night, traders holding long SPX Im not a tax expert, nor am I an equity
puts wouldnt have been able to exit their options expert, but I do believe the SPX Lower margin for less capital
position as the S&P futures plunged 100 options are afforded the same 60/40 Options on futures traders are provided
points, but those trading futures options blended tax rate under the IRS Section portfolio margining regardless of ac-
would have had the opportunity to lock 1256 provision. Youll need to consult count size. This means that traders who
in a profit on that Tuesday night before with your tax advisor for the details, but sell strangles are not charged full margin
the monster post-election rally started it is my understanding that SPY options for both the short call and the short put
on the following Wednesday morning. do not qualify for this. Nevertheless, the because they can only lose money on one
Similarly, they might have even had the tax benefit for futures options traders side of the trade. In other words, port-
foresight to go long calls in the overnight extends beyond tax rates to the hassle folio margining takes into account all
session while those waiting for the stock of reporting gains and losses. An emini positions held by the trader, determines
exchange open would have been chasing S&P options trader, unlike an SPX or
a rally that was already underway. Its SPY options trader, is not obligated to Continued on page 47
March 2017 Technical Analysis of Stocks & Commodities 31
Two Outcomes Or None
Y
markets (futures, commodities, and forex markets).
ou have probably heard the term binary options, but Binary options are short-term expiration contracts that
what are they really? Theyre different from tradi- provide a limited risk and limited payout environment for
rawpixel.com/shutterstock
tional options and if you arent all that familiar with traders. The maximum payout on any binary option is $100.
them, nows your chance to get to know them better. Risk is always limited to the price paid on entry. If the binary
Before jumping into all the different opportunities option indicative price expires in-the-money (ITM), the full
they provide, Ill start with a review of what binary payout is received ($100). The actual profit is $100 minus
options are. price paid on entry.
32 March 2017 Technical Analysis of Stocks & Commodities
OPTIONS
instrument B
price statement
> 1.2688
Sell Buy
- 6.00
expiration date and time. > 1.2678
Sell Buy
1.75 8.00
> 1.2668
D
the two-hour expiration
12:00 16:00 20:00 Dec 14 04:00 08:00 expiry
FIGURE 1: Binary Option Ladder, GBPUSD. On this binary option ladder chart of the GBPUSD, you see
Point CIndicative price, which the instrument, price statement, expiration date, and expiration time.
is used as the expiration
Point DDate and time axis.
the trader believes the statement will be false at expiration,
Choosing risk levels then he clicks on the red button to sell. The risk is limited to
A trader with a bias to the upside on the GBPUSD believes the maximum payout minus the price shown on the red button
the binary option statement will be true at expiration. If the (unless the trader modifies the price using a limit order).
trader believes the statement will be true at expiration, then Using the earlier example, the binary short opportunities are:
he clicks on the blue button to buy. The risk is limited to the
price identified on the blue button (unless the trader modifies The > 1.2658 strike is considered DITM because price
the price using a limit order). is trading at least two strikes under it. Risk is limited
Using Figure 1, the long opportunities with risk and profit to $82.00 ($100 minus $18.00). The profit potential
potential are: would be $18.00.
The > 1.2618 strike is the deep ITM (DITM) option, The > 1.2648 strike is considered ITM because price
as price is trading at least two strikes above this level. is trading at least one strike under it. Risk is limited to
The risk is $85 with a profit potential of $15 ($100 $67.75 ($100 minus $32.25). The profit potential would
minus $85). be $32.25.
The > 1.2628 strike is the ITM option, as price is trading The > 1.2638 strike is the ATM because price is currently
at least one strike above this strike. The risk is $71.75 and trading at this strike level. Risk is limited to $51.00 ($100
the profit potential is $28.25 ($100 minus $71.75). minus $49.00). The profit potential would be $49.00.
The > 1.2638 strike is the at-the-money (ATM) option, The > 1.2628 strike is the OTM because price is trading
as price is currently trading at this level. The risk is above this strike level. Risk is limited to $34.75 ($100
$55.50 strike and the profit potential is $44.50 ($100 minus $65.25). The profit potential would be $65.25.
minus $55.50).
The > 1.2618 strike (also OTM). Risk $21.25 ($100 minus
The > 1.2648 strike is the out-of-the-money (OTM) op- $78.75). The profit potential would be $78.75.
tion, as price is currently trading below this strike level.
The risk on this option is $38.75 and the profit potential
is $61.25 ($100 minus $38.75).
The > 1.2658 strike (also OTM). The risk is limited to When trading binary options,
$24.50 and the profit potential is $75.50 ($100 minus traders can never lose more
$24.50).
than what they paid on entry.
A trader with a bias to the downside on the GBPUSD believes
that the binary option statement will be false at expiration. If
March 2017 Technical Analysis of Stocks & Commodities 33
In addition, because there are several GBPUSD - 15 min they paid on entry.
expirations available at any given time, the In this case, if the trader entered the five
trader could also have chosen additional long positions described earlier using only
two-hour binaries, as well as daily expi- the two-hour binary options from 6 am8
ration, since Nadex offers multiple daily am and trading only one contract each, the
expirations on the forex pairs. For example, results would be what you see in the table
there is also a 7 am, 11 am, 3 pm, 7 pm, and in Figure 3.
11 pm daily expiration, providing traders Of course, the trader could have entered
with even more opportunities. a single binary option or any multiple of
the binary options you see in Figure 3 plus
teChniCal analysis and any of the daily or weekly options that
binary options were offered at the time.
Technical analysis in the simplest of terms Slow Stochastic Binary options are also great for trend-
is a mathematical approach to creating ing markets because the trader can simply
visual tools for forecasting the direction build positions throughout the day, using
of prices using historical data points. It different option strikes as well as weekly
is this forecasting ability of technical expirations that end on Friday. And if
analysis, combined with the power of 22:00 23:00 12/14 01:00 02:00 03:00 04:00 05:00 06:00 markets are moving sideways, traders can
limiting risk, that makes binary options limit their trades to either ITM or ATM
FIGURE 2: dIvERGEncES BEtWEEn IndIcatOR
ideal for technical analysts. Take the case and pRIcE. when you look at this chart of the
strikes.
of divergences between indicator and price GBpusD with the slow stochastic indicator, you
as an example. see that price was making lower lows while the lean toWard simple
The chart of the GBPUSD in Figure 2 slow stochastic was making higher highs. this When trading binary options, keep these
indicates that a position to the upside was divergence indicates that an upside move is likely
and you could take a position that supports an
two points in mind:
more likely because as price was making upside price movement.
lower lows, the slow stochastic was making For long positions, the indicative price
higher lowsalso known as divergence. needs to expire one tick greater than
Plus, the close of the price was greater the strike price.
than the open, providing further confirmation that the market For short positions, the indicative price needs to expire
would likely go up. equal to or less than the strike price.
When trading leverage accounts, traders hesitate to enter
these types of trades because the trade is going against the Gail Mercer, founder of TradersHelpDesk, is a trader, men-
trend (known as countertrend trading). If price were to spike tor, author, and speaker residing in North Carolina. She has
down, then the trader could lose more than he anticipated as over 15 years of experience in trading and in the develop-
price could jump over the stop price, which is why margins ment of custom indicators. She is experienced in trading
are required. However, that cannot happen with binary options futures, forex, and binary options using volume analysis as
and therefore, margins are not required. Remember, when well as divergence. She can be reached via email at gm@
trading binary options, traders can never lose more than what tradershelpdesk.com.
Further reading
Strike (GBPUSD) Risk ($) Gross Profit ($) Exchange Fee ($) Net Profit ($) ROI (%) Mercer, Gail [2016]. Choosing A Bi-
1.2618 85.00 15.00 1.80 13.20 16 nary Option Provider, Technical
1.2628 71.75 28.25 1.80 26.45 37 Analysis of StockS & commodi-
1.2638 55.50 44.50 1.80 42.70 77 tieS, Volume 34: November.
1.2648 38.75 61.25 1.80 59.45 153 NADEX
See Traders Glossary for definition
1.2658 24.50 75.50 1.80 73.70 300 See Editorial Resource Index
totals 275.50 224.50 9.00 215.50 78*
FIGURE 3: tRadInG tHE tWO-HOUR BInaRy OptIOnS FROM 6 aM8 aM. here you see the results of trading
five long positions, one contract each. *total roi% is based on total net profit/total risk.
A dollar saved becomes 1. Why would anyone want to stop out What we desire in mean-reverting
a dollar made a unit or layer of capital after put- trades is like the first line of the song
When I present on topics such as trade ting it on under such advantageous Spinning Wheel by Blood, Sweat &
some and hold some, as was the sub- conditions? Tears: What goes up, must come down.
ject of my column in this magazine last 2. Does a pair trade need or require But something that needs to be consid-
month, I have invariably been asked, that you plan for and utilize a ered is from the second line: Spinning
Well, what about stop-losses? stop-loss? wheel got to go round.
One of the benefits of spread trad- Applied to pairs or spread trading,
ing is the distribution of capital over a The answer is actually yes no that line would say to me: Is this a one-
range, by chosen methodology, allow- it depends. off, or single-opportunity trade, or is it
ing a dollar-cost-averaging approach to It depends on what the position size is compoundable? If it is a trade that can be
hedged trading. Not having to be right relative to your capital and the statistical repeated frequently, then it is treated dif-
on a single bet provides a reasonable edge. The position size might be so small ferently than a trade you have identified
level of comfort. that a stop-loss seems unwarranted. for this particular moment in time that
One of the problems with spread trad- might never present itself again.
ing is that which provides comfort also Traders would be less likely to require
creates anxiety when the layers have Anyone who has a stop-loss with pattern-based spreads
been applied and things are not going traded pairs or equity that have a significant statistical op-
swimmingly, in that you find yourself portunity to work it over a specified
swimming against the current.
spreads of any kind range, by keeping capital sliced into
Anyone who has traded pairs or equity has experienced the layers and distributing that up to their
spreads of any kind has experienced the symbols in that spread maximum planned-for capital. This is
symbols in that spread drifting apart drifting apart from each as we have shared in the past in this
from each other. This presents an op- columnharvesting the noise.
portunity that is even better than your
other. This presents an Back to the hook of this months
original starting point. Your plan may opportunity that is even column: A dollar saved becomes a dol-
have included this foresight through better than your original lar made. I touched on it in the February
running each potential scenario ahead starting point. 2017 issue when I wrote, Lets discuss
of time and planning your future trades. a technique for managing a pair going
In previous columns, I have spent quite a against you. I went on to explain the
bit of time on this and suggested this as Would you use fixed stops, trailing approach: Using the last in, first out
a process, method, and discipline. stops, time-based stops, or are you (LIFO) accounting method for your pair,
The philosophy of spread trading responding to any new informa- subtract a layer to reduce the losses of
would be to have capital available, that tion, or any change in the validity a pair trending against you by making
the bet size would be in keeping with of the trade? the effort to reestablish that pair at a
logical risk management formulas, and much better price. Use all your skills
that you would capture that window The general rule with leverage would and indicators to place that bet when
of opportunity as the spread moves be to utilize some form of stop-losses. conditions are suitable. In this case, a
to outlier regions. By definition, the So we have a quandary in spread dollar saved will become that dollar made
mean-reverting opportunity would only tradingthat stretched-out price, which when and if the spread travels once again
improve as the spread continues farther provides a great opportunity to get in in the direction of your bias. You may
from the main distribution areas. for the potential profit, is also flashing find it is warranted to remove all layers
This brings up two questions. red lights of warning of exponential
potential losses. Continued on page 45
March 2017 Technical Analysis of Stocks & Commodities 35
INTERVIEW
Patience Is A Virtue
Gavin, tell us a little bit about only job available having to do with
yourself and how you got financial markets.
Having a written trading
interested in the financial plan is not only important,
markets. And did you end up becoming a stock its impossible to succeed
My earliest memory about the finan- broker or did you turn to something without one.
cial markets is from primary schoolI else?
think you call it elementary school in Once I got a bit older, I realized I
the USand a fictional story my teacher didnt want to become a stock broker. to do and could be risky. So when I first
told. It was about an investor who bought They are just glorified salesmen. I didnt learned about options, I was hooked.
a stock that went from $1 to $999 and want to be pushing stocks on people in
he was greedy and refused to sell. Sure return for a commission, so I decided to What was it about options that you
enough, the stock fell back down to zero go at it on my own. liked so much?
and this fictional investor was back to I liked the flexibility. When I was first
where he started. From then on, I was Youre a self-directed trader but youre learning about options, I read a booklet
fascinated with the financial markets, also a self-taught options trader. Can that described 26 core strategies. There
so it is no surprise that I ended up in you tell us how you started learning to was so much flexibility in the way you
this industry. trade options? could trade. You could do bullish, bear-
My parents were also a big factor. I first learned about options in 2004 ish, neutral, synthetics, ratio spreads,
They bought me $2,000 worth of some from a small book I got from the Wall and volatility trades. I was like a kid in
telecommunications shares in the mid- Street Journal called Guide To Under- a candy store learning all these differ-
1990s. I was around 13 or 14 at the time. standing Money And Investing. It had ent ideas. Trading stocks is so boring
I remember checking the newspaper each the typical basic info on stocks, bonds, in comparison because you can only
day to see how the shares had performed mutual funds, and indexes. But it also be long, short, or in cash. Not a lot of
the previous day. From there I started had a section on options. flexibility there.
watching other stocks each day and I always knew people could make I read a countless number of books and
really developed a fascination for the money when the markets went down, but started trading in 2004. And then in 2007
stock market. up until then, I didnt really know how I started trading credit spreads and iron
I wanted to be a stock broker when I it was done. I knew you could short a condors. The ability to generate income
grew up because I thought that was the stock, but I also knew that was difficult without having to pick the direction of a
36 March 2017 Technical Analysis of Stocks & Commodities
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Debit spreads or credit spreads long leg and the one you sell is the short the most you could make is $5.00 per
which is best? leg. You would open both options at contract. The $5 potential profit is offset
Many people ask me this question the same time on the same order ticket by the cost of the spread trade, which is
about debit and credit spreads: I hear and your broker should charge you only the difference in the premiums already
one makes money and the other costs one commission, as this is one spread, calculated at $2.70. The max reward
money. Is that true? In a way, that is not two separate options trades. potential for this call debit spread is
correct, but its not as cut-and-dried as You would sell-to-open the short leg $2.30.
you may think. or the February 17, 2017 $1,530 call For that to happen, PCLN must be
Credit means you are generating a for $47.65 (all prices are based off the above the short leg strike price of $1,530
credit to the account. Technically, you mid-price shown). You dont want to end at expiration. With PCLN in-the-money
could say the credit or money brought up with a naked call position with sub- (ITM) at expiration, it is likely the ex-
in to the account is money made, but stantial risk and you also want to hedge/ ecution of the two strikes will take place
realize that this money must remain reduce risk so you would buy-to-open where the markets buy the stock from you
tied up until the trade is either closed or the long leg or the February 17, 2017 at $1,530. The account should execute
expiration happens. The credit received your buying PCLN at $1,525, making
to the account isnt money you can take that $5 per contract offset by the $2.70,
right now and go buy birthday gifts with, With both debit and leaving the profit of $2.30 all on a per-
because the trade is still open. Consider credit spread strategies, contract basis in the account. It should
money credited to the account like money happen without the actual purchase and
being held in escrow.
you are predefining your sale of the amount to buy and sell shares
Debit means you have incurred a debt. risk and predefining your taking place so that no requirements of
You spent money to open the position. max profit potential on all that capital and commissions will
The money you spent is your cost and the trade. take place.
is the most amount of money you will Recognize PCLN is already above
have at risk on the trade. the short leg strike. As long as it stays
With both option strategies, you are $1,525 call for $50.35. The difference above $1,530, this trade should be able
predefining your risk and predefining in premiums is $2.70 ($50.35 - $47.65 to realize max profit potential.
your max profit potential on the trade. = $2.70). This is your max risk/cost in I will now show you an example of a
This is different from the straight call or the trade. put credit spread on PCLN. The goal of
put buyer who has more profit potential The most a spread option trade of this this trade is the same in that you want to
but less of a probability of success than nature can make is the amount of the be profitable. You can anticipate PCLN
the spread trader. spread or difference between the strikes.
The question becomes, which one In this case, the strikes are $5 wide so Continued on page 44
should you trade? I will take a look at an
example of both spreads on the stock of
The Priceline Group, Inc. (PCLN). I will
look at a call debit spread and a put credit
www.tomsoptiontools.com
NinjaTrader 8
Part 2
L
ast month in part 1, I reviewed some and select new strategy, or you can open via support forums, the help desk, and
of the many features of NinjaTrader up a new strategy builder window and online tutorials.
8 and ended by saying that this
month I would cover the strategy
development features and some of the
advanced order-handling features. As
mentioned in the first part, there are so
many features available in NT8 that its
impossible to cover all its features in a
review. My objective here is to scratch
the surface enough to reveal to you the
powerfulness, efficiency, and flexibility
of NT8. The platform will meet the
needs of active traders, whether youre
a long-term or short-term trader, and
whether you trade equities, futures, op-
tions, or forex. Theres something in it
for everyone and the nice thing is you
can take advantage of the free trial to
find out more about the platform. FIGURE 1: NINJASCRIPT EDITOR. NinjaTrader offers a number of code sets to choose from. Here you see
the code for a simple moving average crossover strategy.
TRADING STRATEGY
EVANS / S&P FUEL GAUGE positions when the S&P 500 is at poor levels. Keep an eye on
Continued from page 17 that S&P gauge and when it has risen to an attractive level, put
on those risk-on positions and plan your next vacation.
Having this information gives you a tremendous advantage
even though there are many other variables that affect such Chris Evans is an independent research provider. He has
currency cross rates. worked as a global macro portfolio manager for various hedge
funds in London and New York. He currently offers fuel gauge
AND YOU HAVE A FULL TANK updates and a weekly research blog to subscribers. He may
This type of trade governs many, if not all, market relationships. be reached via his website at www.paratradesystems.com.
Face it: We are in a low-yield environment and we could see
a slow-growing equity market, which could tempt us to pick
stocks blindly without considering the existence of volatility
in the S&P 500 index. High volatility could slice through all
your gains and that could lead you to desperately hedge your
March 2017 Technical Analysis of Stocks & Commodities 45
Comparison of REIT ETFs (As of December 20, 2016)
With low expense ratios, tax Ticker Symbol VNQ IYR ICF RWR XLRE
efficiency, and instant liquidity, Inception Date 9/23/2004 6/12/2000 1/29/2001 4/23/2001 10/8/2015
REIT ETFs offer investors a high Total Assets $32.8B $3.91B $3.47B $3.30 B $2.37B
level of dividend income and Net Expense Ratio 0.12% 0.44% 0.35% 0.25% 0.14%
capital appreciation potential.
STOCKCHARTS.COM
FIGURE 3: HOW DID THEY PERFORM? Viewing four ETFs over a 12-year period from September 29, 2004 to December 29, 2016 shows that VNQ and ICF had nearly
identical results and were the leaders.
W
henever you are looking for swing trading breakout Step 3: As long as both SMA lines remain uncrossed in an
entries, it helps to use the same signals that institutional uptrend, you keep your position open. Close your position
traders follow. One of the most popular patterns is the once a trailing stop of two points or more is taken out, as
golden cross, in which a 50-period simple moving seen on December 13, 2016 at $59 per share.
average (SMA) line crosses above a 200-period SMA. In this Alternatively, you could use a trailing stop at the 50 SMA
months column, you will see how to trade this useful breakout level, especially for longer-term swing or position trades.
swing trading pattern. (In the chart in Figure 1, that would be $54.)
Swing Trading the Golden Cross Entry Insights: Why this technique works
When the 50-period SMA breaks above the 200-period The golden cross is particularly effective because it combines
SMA, it signifies a major short-term trend reversal. This can the shorter-term 50 SMA momentum signal with the longer-
help identify swing trading breakout entries when combined term major 200 SMA trendline. This combination provides a
with price action patterns such as bullish cups, ascending breakout confirmation signal because it uses both short- and
triangles, and increasing volume. It is important to note that long-term trendlines working together.
golden crosses, like most technical trading patterns, should
not be used in isolation. Instead, you should combine them Trade management tips
with other breakout entry signals. One of the keys to using moving average signals successfully,
as with most of the breakout patterns you learn about in this
Step-by-step action plan column, is to visually scan for charts with wide trading ranges.
Heres how you can start using this strategy with your swing You can see that this chart has nearly 20 points of range ($43
trades: to $61 on a 90-day chart). Price action also follows a classic
45-degree angle breakout trend pattern.
Further, note how cleanly defined the
trend isit is not a choppy, uncertain
chart. The more up-and-down oscilla-
tions a chart has, the tougher it is to trade
profitably. The cleaner, more in-focus the
chart is, the easier it is to trade, as you
can see in Figure 1.
As with all of our professional swing
and intraday charts, it is best to use this
strategy with stocks and ETFs priced in
the $20$70 per share range, because
these charts tend to have stronger, more
sustainable trends that you can trade. This
strategy should not be used with cheap,
risky penny stocks or stocks priced under
$10 per share, due to the high risk and
choppiness of these poor trading instru-
ments. You will often see strong upside
esignal
Figure 1: TRADING USING THE Golden Cross. Here you enter a swing trade when the 50-period simple
price action following golden crosses,
moving average (SMA) crosses above the 200-period SMA. Note that the exit takes place after the two-point because institutional traders use this same
trailing stop is hit. pattern to put on large block trades.
48 March 2017 Technical Analysis of Stocks & Commodities
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. Use the golden cross on stocks and
He is a UCLA alumnus and is the founder of TradeMastery. ETFs priced in the $20$70 per share
com, an educational resource site for active traders.
range, because these charts tend
Further reading to have stronger, more sustainable
Mustapha, Azeez [2016]. Golden Cross And Death Cross, trends that you can trade.
Technical Analysis of Stocks & Commodities, Volume
34: September. analysis programs. Accompanying program code can be found in
the Traders Tips area at Traders.com.
See our Traders Tips section beginning on page 50 for commentary
on implementation of Calhouns technique in various technical
At-the-MoneyAn option whose strike price option changes for every dollar move in Near-the-MoneyAn option with a strike
is nearest the current price of the underly- the underlying instrument. price close to the current price of the
ing deliverable. Delta-HedgedAn options strategy that pro- underlying tradable.
Black-Scholes Option Pricing ModelA tects an option against small price changes Out-of-the-Money (OTM)A call option
model developed to estimate the market in the option's underlying instrument. whose exercise (strike) price is above the
value of option contracts. These hedges are constructed by taking a current market price of the underlying
Bollinger BandsDeveloped by John Bol- position in the underlying instrument that security or futures contract. For example,
linger. Bollinger Bands widen during is equal in magnitude but opposite in sign if a commodity price is $500, then a call
increased volatility and contract in de- (+/-) to the option's delta. option purchased for a strike price of $550
creased volatility, and when broken, are Delta NeutralThis is an "options/options" is considered out-of-the-money.
an indication that the trend is powerful or "options/underlying instrument" posi- PremiumThe price a buyer pays to an option
and may continue in that direction. tion constructed so that it is relatively writer for granting an option contract.
Butterfly SpreadA sideways market strat- insensitive to the price movement of the PutA contract to sell a specified amount of
egy using all calls or puts, designed to underlying instruments. This is arranged a stock or commodity at an agreed time
profit from a stock trading in a specific by selecting a calculated ratio of offsetting at the stated exercise price.
range. short and long positions. StraddleThe purchase or sale of an
Calendar SpreadAlso known as a time Delta PositionA measure of option price equivalent number of puts and calls on an
spread or horizontal spread, calendar vs. the underlying futures contract or underlying stock with the same exercise
spreads exploit differences in time value stock price. price and expiration date.
between options. GammaThe degree by which the delta StrangleThe purchase or sale of an equiva-
CallA contract that gives the buyer of the changes with respect to changes in the lent number of puts and calls on an under-
option the right but not the obligation to underlying instruments price. lying stock with the same expiration date
take delivery of the underlying security at GreeksA loose term encapsulating a set of but a different exercise price. Usually, the
a specific price within a certain time. risk variables used by options traders. put has a low strike price and the call has
CondorEssentially, a butterfly spread with Historical VolatilityHow much contract a higher strike price.
two different strikes that make up the price has fluctuated over a period of time Strike PriceThe price per unit at which the
body of the option. in the past; usually calculated by taking a holder of an option may receive or deliver
Covered CallSelling a call option while standard deviation of price changes over the underlying unit; also known as the
holding an equivalent in the underlying a time period. exercise price.
tradable. Implied VolatilityThe volatility computed VegaThe amount by which the price of
Covered WriteWriting a call against a using the actual market prices of an option an option changes when the volatility
long position in the underlying stock. By contract and one of a number of pricing changes.
receiving a premium, the writer intends to models. For example, if the market price Vertical SpreadA stock option spread based
realize additional return on the underly- of an option rises without a change in the on simultaneous purchase and sale of op-
ing common stock or gain some element price of the underlying stock or future, tions on the same underlying stock with
of protection (limited to the amount of implied volatility will have risen. the same expiration months but different
the premium less transaction costs) from In-the-Money (ITM)A call option whose strike prices.
a decline in the value of that underlying strike price is lower than the stock or Volatility A measure of a stocks tendency
stock. future's price, or a put option whose strike to move up and down in price, based on
Credit SpreadThe difference in value of two price is higher than the underlying stock its daily price history over the last 12
options, where the value of the one sold or future's price. For example, when a months.
exceeds the value of the one purchased. commodity price is $500, a call option Volatility Index A widely used measure
Debit SpreadThe difference in value of with a strike price of $400 is considered of market risk. Sometimes referred to as
two options, where the value of the long in-the-money. the investor fear gauge.
position exceeds the value of the short Iron ButterflyThe iron butterfly spread ZetaThe percentage change in an op-
position. is a limited risk, limited profit trading tions price per 1% change in implied
DeltaThe amount by which the price of an strategy volatility.
W
henever you are looking for swing trading breakout Step 3: As long as both SMA lines remain uncrossed in an
entries, it helps to use the same signals that institutional uptrend, you keep your position open. Close your position
traders follow. One of the most popular patterns is the once a trailing stop of two points or more is taken out, as
golden cross, in which a 50-period simple moving seen on December 13, 2016 at $59 per share.
average (SMA) line crosses above a 200-period SMA. In this Alternatively, you could use a trailing stop at the 50 SMA
Swing Trading The golden CroSS enTry inSightS: Why thiS technique WorkS
When the 50-period SMA breaks above the 200-period The golden cross is particularly effective because it combines
SMA, it signifies a major short-term trend reversal. This can the shorter-term 50 SMA momentum signal with the longer-
help identify swing trading breakout entries when combined term major 200 SMA trendline. This combination provides a
with price action patterns such as bullish cups, ascending breakout confirmation signal because it uses both short- and
software.
45-degree angle breakout trend pattern.
Further, note how cleanly defined the
trend isit is not a choppy, uncertain
chart. The more up-and-down oscilla-
tions a chart has, the tougher it is to trade
profitably. The cleaner, more in-focus the
chart is, the easier it is to trade, as you
F TRADESTATION: MARCH 2017 TRADERS TIPS CODE Figure 1: TRADESTATION SCANNER. Here, the golden cross breakout strategy is
In Golden Cross Breakouts in this issue, author Ken Calhoun applied to a daily chart of Blackstone Group LP along with a TradeStation Scanner
results list of candidate symbols.
describes his methodology for trading using the popular chart
pattern commonly known as the golden cross. He defines the
golden cross as a 50-period simple moving average crossing if BarsSinceCross > 0
and BarsSinceCross <= MaxBarsSinceCross
above a 200-period simple moving average. The author sug- and PercentRange >= MinPercentRange then
gests using this indicator in conjunction with other price-action Alert ;
patterns.
Strategy: Golden Cross Breakouts
The TradeStation platform has many built-in indicators
that can be evaluated along with the golden cross. Here, we // TASC MAR 2017
// Golden Cross Breakouts
are providing TradeStation EasyLanguage code for a golden // Ken Calhoun
cross strategy based on the authors concepts. We have also
included an indicator that can be used in the TradeStation inputs:
FastLength( 50 ),
Scanner application to help identify trading opportunities. SlowLength( 200 ),
TrailAmountDollars( 2 ),
Indicator: Golden Cross Breakouts BreakoutLookBack( 20 ),
VolumeMultRequired( 1.5 ) ;
// TASC MAR 2017
// Golden Cross Breakouts variables:
// Ken Calhoun FastAvgValue( 0 ),
SlowAvgValue( 0 ),
inputs: BarVolume( 0 ),
FastLength( 50 ), AvgVolume( 0 ),
SlowLength( 200 ), BreakOutPrice( 0 ),
MaxBarsSinceCross( 10 ), EntryOK( false ),
MinPercentRange( 25 ) ; MP( 0 ),
TT( 0 ) ;
variables:
FastAvgValue( 0 ), MP = MarketPosition ;
SlowAvgValue( 0 ), TT = TotalTrades ;
BarsSinceCross( 0 ),
PercentRange( 0 ) ; FastAvgValue = Average( Close, FastLength ) ;
SlowAvgValue = Average( Close, SlowLength ) ;
FastAvgValue = Average( Close, FastLength ) ;
SlowAvgValue = Average( Close, SlowLength ) ; if BarType >= 2 and BarType < 5 then
BarVolume = Volume
PercentRange = 100 * ( Highest( High, FastLength ) - else
Lowest( Low, FastLength ) )/ Close ; BarVolume = Ticks ;
if EntryOK
and Close > BreakOutPrice
and BarVolume >= AvgVolume * VolumeMultRequired then
Buy next bar at Market ;
SetStopShare ;
SetDollarTrailing( TrailAmountDollars ) ;
Figure 4: THINKORSWIM. Here, the GoldenCrossBreakoutsLE strategy is shown Figure5: WEALTH-LAB. Here is a guideline for setting up the example system
on a six-month daily chart of Spirit Aerosystems (SPR). using drag-and-drop rules.
AmiBroker code: If you have NeuroShell Trader Professional, you can also
sm = MA( C, 50 );
lm = MA( C, 200 );
// charts
Plot( C, "Price", colorDefault, styleCandle );
Plot( sm, "MA50", colorRed );
Plot( lm, "MA200", colorBlue );
// buy/sell arrows
PlotShapes( IIf( Buy, shapeUpArrow, 0 ), colorGreen, 0, L );
PlotShapes( IIf( Sell, shapeDownArrow, 0 ), colorRed, 0, H );
Tomasz Janeczko, AmiBroker.com Figure 8: NEUROSHELL TRADER. Here is a sample NeuroShell Trader chart
www.amibroker.com showing the golden cross trading system for SPR.
!INPUTS: Figure 10: AIQ. Here are sample summary test results for the same entries as in
len1 is 50. Figure 9 for the golden cross strategy but using my alternative exit rules.
len2 is 200.
stopamt is 2.
minPrice is 5.
maxPrice is 70. Sell if Golden=0 or [close] < {Position High Price}-stopamt.
'GOLDEN CROSS BREAKOUTS Once the file is downloaded, you can import the strat-
'Author: Ken Calhoun, TASC March 2017
'Coded by: Richard Denning, 1/8/17 egy into NinjaTader 8 from within the Control Center by
'www.TradersEdgeSystems.com selecting Tools Import NinjaScript Add-On and then
selecting the downloaded file for NinjaTrader 8. To import
Sub GOLDEN_X(len1, len2, stopamt, minPrice, maxPrice)
'INPUTS: into NinjaTrader 7, from within the Control Center window,
'len1 = 50 select the menu File Utilities Import NinjaScript and
'len2 = 200 select the downloaded file.
'stopamt = 2
'minPrice = 20 You can review the strategys source code in NinjaTrader
'maxPrice = 70 8 by selecting the menu New NinjaScript Editor Strat-
Dim SMA1 As BarArray egies from within the Control Center window and selecting
Dim SMA2 As BarArray
Dim Golden,PriceOK the GoldenCrossBreakout file. You can review the strategys
SMA1 = Average(C,len1) source code in NinjaTrader 7 by selecting the menu Tools
SMA2 = Average(C,len2) Edit NinjaScript Strategy from within the Control Center
Golden = SMA1 > SMA2 window and selecting the GoldenCrossBreakout file.
PriceOK = Average(TSCLose,10)>=minPrice And NinjaScript uses compiled DLLs that run native, not in-
Average(TSCLose,10)<=maxPrice
terpreted, which provides you with the highest performance
If Golden And PriceOK Then Buy("LE",1,"",Market,Day) possible.
If Golden=0 Then ExitLong("LX","",1,"",Market,Day) A sample chart implementing the strategy is shown in
'If C < (Highest(C,BarsSinceEntry,0))-stopamt Then ExitLong("LX
stop","",1,"",Market,Day)
Figure 12.
Raymond Deux & Patrick Hodges
End Sub NinjaTrader, LLC
www.ninjatrader.com
Richard Denning
info@TradersEdgeSystems.com
for TradersStudio
March 2017 Technical Analysis of Stocks & Commodities 55
F UPDATA: MARCH 2017
TRADERS TIPS CODE
Our Traders Tip for this month is based on Ken Calhouns
column in this issue, Golden Cross Breakouts.
In the article, Calhoun proposes that this classical techni-
cal analysis setup be used in conjunction with other filters,
such as rising volume, to better identify trends with the po-
tential for persistence, with the suggestion that ETFs in the
$20$70 range are those products with better potential.
The Updata code for this article is in the Updata library
and may be downloaded by clicking the custom menu and
system library. Those who cannot access the library due to
a firewall may paste the code here into the Updata custom
editor and save it.
A sample chart is shown in Figure 13.
NAME Golden Crossover System FIGURE 13: UPDATA. Here is an example of the golden cross breakout system
applied to daily chart of Spirit Aerosystems Holdings Inc. (SPR).
Parameter "Period 1" #PERIOD1=50
Parameter "Period 2" #PERIOD2=200
INDICATORTYPE TOOL
In this trading simulation, we buy at the open of the next
DISPLAYSTYLE 2LINES bar.
PLOTSTYLE LINE RGB(255,0,0) The price hits our two-point trailing stop on 12/13/2016
PLOTSTYLE2 LINE RGB(0,255,0)
SHOWEQUITYCURVE and we sell at the open of the next bar.
The Excel spreadsheet I have created for this issue (and
FOR #CURDATE=#PERIOD2 to #LASTDATE which is posted for you at the Stocks & Commodities
IF HASX(MAVE(#PERIOD1),MAVE(#PERIOD2),UP)
COVER magazine website at www.Traders.com in the March 2017
BUY Traders Tips area) is set up to process 2,500 bars, or just
ELSEIF HASX(MAVE(#PERIOD1),MAVE(#PERIOD2),DOWN) short of 10 years of historical data.
SELL
SHORT The transaction summary tab shown in Figure 15 shows
ENDIF that in that period, there were six trades including a couple
@PLOT=MAVE(#PERIOD1) of nice wins, a couple of so-so wins, and a couple that lost a
@PLOT2=MAVE(#PERIOD2)
NEXT bit. Gotta love those trailing stops!
Figure 16 takes a closer look at the 6/11/2009 trade, which
Updata support team began with a signal on 06/10/2009. The signal bar was very
support@updata.co.uk nearly the highest bar on the chart, and things moved down-
www.updata.co.uk hill from there. The trailing stop pulled us out of this one.
That was pretty much at the same point that a stop based on
the 50-bar average would have hit.
F MICROSOFT EXCEL: MARCH 2017 TRADERS TIPS CODE
In Golden Cross Breakouts in this issue, author Ken Calhoun
explains the workings of a simple trend-following trading
Suggestions
There are several keys to using the golden cross indicator:
system based on the golden cross chart formation.
For any given security, you may not find more than one
Access to 200-plus bars of recent historical data for a lot
golden cross in any given year, and some years you may not
of symbols
find any. Thus, you should expect to scan quite a few securi-
A mechanism to scan across this symbol universe and
ties to find one.
flag symbols showing a golden cross signal in the last
But when you do find one, it can provide an interesting
several days. This may be a very small number of sym-
ride, as demonstrated by the Spirit Aerosystems Holdings ex-
bols much of the time
ample given in Figure 1 of Calhouns article in this issue.
Really good money management / position sizing for any
As I write this in the middle of January 2017, I have access
trades taken based on this indicator
to a few more bars of data than were available when Calhoun
Strict adherence to the stop-loss.
produced Figure 1 for his article. So we can see a bit more of
how this example played out (Figure 14).
For those who are not shy about taking short positions,
The golden cross signals a buy with the 50-bar average
crossing above the 200-bar average on 10/20/2016.
Continued on page 62
56 March 2017 Technical Analysis of Stocks & Commodities
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T
rading liquidity is often over- very high volumes. The greatest number three-year period. Thus, all numbers in
looked as a key technical of dots indicates the greatest activity; this column have an equal dollar value.
measurement in the analysis futures with one or no dots show little Columns indicating percent margin
and selection of commodity activity and are therefore less desirable and effective percent margin provide
futures. The following explains how to for speculators. a helpful comparison for traders who
read the futures liquidity chart pub- Courtesy of CBOT wish to place their margin money ef-
lished by Technical Analysis of Stocks ficiently. The effective percent margin
& Commodities every month. is determined by dividing the margin
value ($) by the three-year price range of
Commodity futures contract dollar value, and then multiply-
The futures liquidity chart shown be- ing by one hundred.
low is intended to rank publicly traded
futures contracts in order of liquidity. Stocks
Relative contract liquidity is indicated Trading liquidity has a significant ef-
by the number of dots on the right-hand fect on the change in price of a secu-
side of the chart. rity. Theoretically, trading activity can
This liquidity ranking is produced by serve as a proxy for trading liquidity
multiplying contract point value times All futures listed are weighted equally and equals the total volume for a given
the maximum conceivable price motion under contracts to trade for equal dol- period expressed as a percentage of the
(based on the past three years historical lar profit. This is done by multiplying total number of shares outstanding. This
data) times the contracts open interest contract value times the maximum pos- value can be thought of as the turnover
times a factor (usually 1 to 4) for low or sible change in price observed in the last rate of a firms shares outstanding.
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I
by Claudio Demb trading. But that doesnt mean emotions are all bad.
It is much easier to see things that are concrete or tangible.
am tempted to start with the end and give away the punch Numbers are an example of something that is concrete.
line. So here it goes: Psychology is destiny. I agree that Feelings are extremely important, but since you cannot see
it sounds very categorical, and whether or not this is true them, it can be difficult to understand and accept them. It is
doesnt really matter. You still have to go through the mo- not unusual for people to believe they have control over their
tions. As a good friend of mine often said, Not everything actions. They can speak clearly about their methods and trad-
ESD PROFESSIONAL/shutterstock
is psychological. I know that what he said is true, but to be ing plans. But when feelings kick up in high gear, it is very
fair, he had to learn to deal with his emotional issues in order possible to do something totally different, sometimes even
to become a good trader. take a 180-degree turn from the original plan. To sum it up,
we think we know, we believe we have a solid plan, but there
What does it really take? is some invisible force that takes over, uninvited, that helps
If not everything is psychological, then what are the other us to depart from our plan.
60 March 2017 Technical Analysis of Stocks & Commodities
at the close
Sneak preview...
Trading The Open Harmony and PATH Trading Elliott Waves Using
by Adam Ryan by Patrick Hughes A Top-Down Approach
The open of any trading day sets the When learning technical analysis, traders by Mircea Dologa
tone for the rest of the trading day. tend to look for perfection instead of look- When applying Elliott wave counts to your
Heres how you can take advantage ing at how perfection is created. Heres a charts, one of the challenges is knowing which
of the volatility of the open to generate
technique that could give you a deeper trend to use. Here is an approach that could
profits from it.
insight into the relationship between time help you identify which to use.
and price. Coming soon!
Figure 16: EXCEL, One of the small-loss trades. A strategy based on the golden cross makes for an interesting, simple trading system.
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