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The 21st-Century
Covered Call
How to kill two birds
with one option 8
Does History
Repeat Itself?
Looking for time-based
patterns for a trading edge 12
Trading
The FakeouT
Keep an eye on these
winning patterns 18
Interview
Claudio Demb and
the psychology of trading 34
Breakaway Gaps
Testing them for reliability
and profitability 38
MARCH 2019
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The editors of S&C invite readers to submit their opinions and information on subjects
relating to technical analysis and this magazine. This column is our means of communi- script LeavittProjection{
input y = close;
cation with our readers. Is there something you would like to know more (or less) about? input n = 20;
Tell us about it. Without a source of new ideas and subjects coming from our readers, this rec x = x[1] + 1;
magazine would not exist. def a = (n * sum(x * y, n) - sum(x, n) * sum(y,
Email your correspondence to Editor@Traders.com or address your correspondence n) ) / ( n *sum(Sqr(x), n) - Sqr(sum(x, n)));
def b = (sum(Sqr(x), n) * sum(y, n) - sum(x,
to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All n) * sum(x *y, n) ) / ( n * sum(Sqr(x), n) -
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name and address for verification. Letters may be edited for length or clarity. The opinions plot LeavittProjection= a*x+ b;
expressed in this column do not necessarily represent those of the magazine.—Editor }
script LeavittConvolution
{ input price = close;
LEAVITT CONVOLUTION indicator; I would be very interested in an input n = 20;
Editor, indicator that outperforms the HMA. def intLength = Floor(Sqrt(n));
I read with interest Jay Could you either share or direct me to plot LeavittConvolution = LeavittProjection
Leavitt’s article in the a place where I might be able to obtain (LeavittProjection (price, n), intLength);
January 2019 issue of the thinkscript for Leavitt’s convolution }
Technical Analysis of indicator? def price = Close;
input length = 9;
Stocks & Commodities, Thank you very much for your time.—
“Leavitt Convolution.” I then logged David def intLength = Floor(Sqrt(length));
in to the S&C archives at Traders.com plot LeavittConvolution = LeavittProjec-
and read all of his previously published Author Jay Leavitt replies: tion (LeavittProjection (price, length),
intLength);
articles in S&C. I just went into the thinkorswim plat- LeavittConvolution.AssignValueColor(if
I am a user of thinkorswim and I see form and perused the list of studies LeavittConvolution > LeavittConvolution [1]
that this is one of the trading platforms there, and I was able to find the Leavitt then Color.GREEN else Color.RED);
that Leavitt uses. The thinkorswim plat- convolution in the list. In any case, here
form has a very nice Hull moving average is the code:
http://store.traders.com
Trading Basics
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Does “intraday swing trading” sound up all day long you can gain as much as Build powerful
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FIGURE 1: Intraday Swing Trading (CGC). A large three-point intraday breakout moved up all day. Continued on page 32
March 2019 • Technical Analysis of Stocks & Commodities • 7
Weeklys To The Rescue
W
left with unlimited downside risk. Trying to get out of this
hen I began trading options in 1983, one of the situation usually resulted in selling lower strikes, which ended
hardest trades to execute was to buy a put to with the stock getting called away at a loss.
protect against the downside risk inherent in the As time moved on, the powers that be decided that if quar-
market. The problem with buying puts then and terly options were good then perhaps monthly options might
now is that the price you pay for the protection is even be better, so they added monthly options to the mix. You
HAND LOGO: ART4ALL/SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
high and it’s very hard to overcome the premium could write the same call 12 times a year. The advantage of
CAR: ALEXANDER KONDRATENKO/WEEKLY PLANNER: ISOLATED/
loss. An alternative trade was to sell a covered call for each writing the call 12 times a year was that it gave you more
quarterly expiration. Unfortunately, although this offers some downside protection. However, it also gave you four times as
protection, it can create a problem in markets that are in a much risk in that the premium in the call you sold may not be
long-term congestion phase. enough to cover an advance in the stock price and you could
Back then, executing a covered call trade was done by selling then lose the underlying stock.
a call every quarter against an underlying stock you owned. Around 2010, the SEC decided that if monthly options were
When the option contract expired, you kept the premium good, options that expired each week would be great! They
you received when you sold the call, no matter what. If the started a pilot program using weekly options, which is now
stock closed above the naked call’s strike price, you would the biggest option product in the world. So if selling covered
keep the credit, but the stock would be called away from you calls four times a year was a good deal, it must be a much
(exercised). Your upside was limited to the credit while you better proposition to write them 52 times a year, right? The
8 • March 2019 • Technical Analysis of Stocks & Commodities
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answer is a resounding yes. Over the years, this strategy has return and you still own the stock.
evolved and allows traders and investors a much better chance What about the downside? If Tesla’s stock were to close
to make money. No approach offers more opportunity than lower for the week, you would keep the $5.90 spread credit,
what I call the “21st-century covered call.” Let’s look at how which would limit your stock loss for the week. The good
this strategy works. news is that no matter what happens, if you write the 21st-
century covered call for around a $5.90 credit 52 times a
Initiating the 21st-century year, it would give you $306.80 ($5.90 × 52= $306.80) of
covered-call strategy downside protection, which is 95.6% of the purchase price
First, we must address the number-one problem of writing of the stock ($320.87).
covered calls: losing the upside potential if the stock takes
off. To counter this situation, I sell a weekly call-credit spread How does all this work in real time?
instead of simply selling a call. To see how this strategy sets Ideally, you want to do this covered-call strategy with stocks
up, let’s look at the option chain in Figure 1 for Tesla Motor that have a good chance of trading higher over the near term and
Co. (TSLA) when the stock closed at $320.87. that also have liquid, weekly options. To select stocks that meet
With TSLA at $320.87, the at-the-money (ATM) call is the this criteria, you can use a scanner similar to the one we offer
320.0 and it is trading at approximately $11.60. We want to at MarketEdge (www.marketedge.com, a website developed
use the ATM strike as the short call leg of the spread since it by Computrade Systems, Inc., which has been in existence as
gives you the most premium. Under the old method of selling either a software application or website since 1992).
covered calls, you would buy the stock at $320.87 and sell
the 320.0 call for $11.60. If the stock settled above $320, you Profit/loss scenarios
would lose the stock at $320 but would keep the $11.60 credit for the strategy
for a net gain of $10.73 ($11.60 credit - $0.87 stock loss). Not There are six scenarios you can expect each
a bad deal, but if the stock went on to $360, you would miss week when employing this strategy: flat, small
out on any profit past $10.73. gain, rally, big rally, small loss, and big loss.
Meanwhile, under the 21st-century covered-call strategy, Using TSLA as an example, let’s check out
you would buy the stock at $320.87, sell the 320.0 call at the possible outcomes. Say you purchase 100
$11.60 and buy another call at a higher strike price with the shares of TSLA at $320 and initiate the 320–335 call credit
same expiration date. You can buy any strike price you like spread for $5.90. For illustrative purposes, the following as-
but I recommend you buy one that is no more than $15.00 sumes the option positions are closed on the weekly expiration
higher than the ATM, which in this case would be the 335.0 date and the stock position remains open. Each week there
call (ATM +6). will be a realized gain or loss in your option account and an
So you would buy the stock at $320.87 and initiate a 320.0– unrealized gain or loss in your stock account.
335.0 call-credit spread by selling the 320.0 call for $11.60
and buying the 335.0 call for $5.70, resulting in a net credit Initial position: 100 shares (TSLA) @ $320 = $32,000
of $5.90 ($11.60 - $5.70). If the stock settles above $325.90 Options: 320–335 call credit spread @$5.90 = $590 credit
($320.00 + $5.90), let’s
say $335.00, the call
spread would be a $9.10
loser since you would be
called away at $320.00
but you would exercise
your 335.0 call for a
spread loss of $15.00
less the $5.90 credit.
However, the stock por-
tion of the trade would
make $14.13 ($335.00 -
$320.87), so you would
net $5.03 ($14.13 stock
gain - $9.10 spread loss)
for the trade. So while
your gain is $5.70 less
than what you would
have made the old-
fashioned way ($10.73
- $5.03), you get a nice FIGURE 1: OPTION CHAIN OF WEEKLYS. See what the at-the-money calls are trading for and then set up your trading strategy.
10 • March 2019 • Technical Analysis of Stocks & Commodities
1) Flat: The stock settles unchanged at $320
This is a no-brainer. You pocket the $590 from the call credit
spread. You have no change in your stock value. You want to do this covered-
Continue the next week by initiating another 320.0–335.0
call credit spread for a credit of around $5.90.
call strategy with stocks
that have a good chance of
Total account value: $32,000 + $590 = $32,590 trading higher over the near
($590 gain) term and also have liquid,
2) Small gain: The stock rises by about 1.5% to $325
weekly options.
You pocket the $590 from the call credit spread on Monday,
buy back the expiring in-the-money (ITM) short call at $500 on
Friday afternoon (before expiration) for a realized gain of $90
on the options, an unrealized gain of $500 on the stock. Continue the next week by initiating another 335.0–350.0
Continue the next week by initiating a 325.0–340.0 call call credit spread for a credit of around $5.90.
credit spread for a credit of around $5.90.
Total account value: $33,500 + $590 - $1,500 = $32,590
Total account value: $32,500 + $590 - $500 = $32,590 ($590 gain)
($590 gain)
4) Big rally: The stock rallies by about 9% to $350
3) Rally: The stock rallies by about 5% ($15) to $335 You pocket the $590 from the call credit spread on Monday,
You pocket the $590 from the call credit spread on Monday, and buy back the expiring in-the-money spread at $1,500 on
and buy back the expiring in-the-money spread at $1,500 on Friday afternoon (before expiration) for a realized loss of $910
Friday afternoon (before expiration) for a realized loss of $910 on the options, an unrealized gain of $3,000 on the stock and
on the options, an unrealized gain of $1,500 on the stock and
you keep the stock. Continued on page 33
SINCE
THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS
DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FAC-
TORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS
BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE
TESTIMONIAL IS NO GUARANTEE OF FUTURE PERFORMANCE OR SUCCESS. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS, INC.
Is
or oversold condition on a particular oscillator; the
it possible to forecast market moves by using completion of a particular pattern; or so on. Kronos,
a “time factor”? Here, we’ll attempt to answer on the other hand, represents the cyclical nature of
that question using monthly timeframes. For events that regularly happen in financial markets.
this study, we used the forex market and sta- Market timing (Kairos) is one of the pillars of
tistically analyzed historical monthly performances of technical analysis, while Kronos has not yet been
some of the major currency pairs. We hypothesized deeply detected. The question could be: Do we need
that the major currencies vs. the US dollar, which is to wait for a technical “event” (such as the break of
usually a mean-reverting relationship, could indicate resistance/support, the cross of a moving average, or
seasonality in the different months of the year. so on) to have a profitable trade, or do we, perhaps,
Then we looked at those monthly performances to need to wait for the “right” day (or month or hour) to
try to discover (ex post, or based objectively on past enter a trade? Let’s find out.
results) seasonal patterns that we later tested in an
in-sample/out-of-sample strategy. Would any seasonal Statistical research
effect discovered in exchange rates in past years or While classic technical analysis mostly focuses on de-
decades work as well in recent years despite market termining whether price is trending (ignoring whether
volatility and central bank quantitative easing policies? and when price trends could happen), technical analysis
Or is the market too unpredictable for the monthly based on time focuses on time-based alerts and trends
seasonal effect to prevail? observed in past data. In our study, we chose monthly
timeframes applied to three well-known and liquid
“Timed” technical analysis forex (FX) markets: EUR/USD, GBP/USD, and USD/
Ancient Greeks believed the concept of time was CAD. We followed these two steps:
so important that they had two gods dedicated to
it: Kronos and Kairos. The former referred to time 1. In-sample analysis. We looked for monthly
as “in being,” with the flow of hours, days, months, historical trends (bullish and bearish). From
and years, while the latter as “momentum.” Kronos 1998–2013 we calculated monthly returns for
connotes time quantitatively as “past,” “present,” and each major pair and the average return for each
INGA POSLITUR
“future,” while Kairos connotes time in qualitative month over a period of 15 years. When positive,
terms as “when something happens.” the trend of that month was defined as “bullish.”
the same trend (bullish or bearish), the trade wasn’t closed and 2
3
Feb
Mar
Short
-
1.349
1.379
1.380
1.377
2.30%
-0.11%
-310
0
-52
-52
immediately reopened, but rather kept in place until a month 4 Apr Long 1.377 1.387 0.72% 99 47
of the opposite sign occurred. 5 May Short 1.387 1.363 -1.71% 237 284
Our aim with this two-step analysis was to verify the earlier 6
7
Jun
Jul
Long
Long
1.363
1.369
1.369
1.339
0.43%
-2.21%
58
-303
342
39
long-term (15-year) results in a shorter (four-year) time period and 8 Aug Short 1.339 1.313 -1.93% 258 297
test whether the pattern holds up—indicating that history does 9 Sep Long 1.314 1.263 -3.85% -506 -209
EUR/USD 14
15
Feb
Mar
Short
-
1.128
1.119
1.119
1.073
-0.79%
-4.08%
89
0
505
505
The last row of the table in Figure 1 shows the 16 Apr Long 1.073 1.122 4.58% 491 996
average monthly returns of the EUR/USD from 17 May Short 1.122 1.099 -2.09% 234 1,230
trendless. 26
27
Feb
Mar
Short
-
1.083
1.087
1.087
1.138
0.37%
4.67%
-40
0
1,854
1,854
Once we defined the bullish and bearish months, we applied 28 Apr Long 1.138 1.145 0.67% 76 1,930
the second step of the analysis. The strategy was tested in the 29 May Short 1.144 1.113 -2.75% 315 2,245
and flat for four months). The chart in Figure 3 shows the equity 34
35
Oct
Nov
Short
Short
1.123
1.098
1.098
1.059
-2.26%
-3.59%
254
394
2,640
3,034
line for the strategy (3,263 pips earned in total). 36 Dec Long 1.059 1.051 -0.71% -75 2,959
37 Jan 2017 Short 1.053 1.080 2.53% -266 2,693
GBP/USD 38
39
Feb
Mar
Short
-
1.080
1.057
1.058
1.065
-2.05%
0.72%
221
0
2,914
2,914
“The cable” is a slang term used by FX traders to refer to the 40 Apr Long 1.066 1.090 2.22% 237 3,151
exchange rate between the British pound and the US dollar; this 41 May Short 1.091 1.124 3.08% -336 2,815
name was coined in the 19th century, when the rate began to be 42
43
Jun
Jul
Long
Long
1.124
1.142
1.142
1.184
1.63%
3.70%
183
422
2,998
3,420
transmitted across the ocean by a submarine communication 44 Aug Short 1.184 1.191 0.57% -68 3,352
cable (and since 1866 has been transmitted continuously). 45 Sep Long 1.191 1.181 -0.81% -97 3,255
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be considered bullish, while January, February, 1998 -0.85% 0.91% 1.46% -0.06% -2.45% 2.05% -1.94% 2.91% 1.13% -1.47% -1.74% 0.39%
considered trendless and wasn’t included in the 2002 -2.98% 0.35% 0.67% 2.20% -0.20% 5.32% 1.99% -0.86% 1.39% -0.40% -0.42% 3.43%
out-of-sample test.
2003 2.32% -4.29% 0.46% 1.11% 2.42% 1.65% -2.76% -2.14% 5.19% 2.11% 1.56% 3.54%
2004 2.60% 2.38% -1.49% -3.57% 3.23% -0.73% 0.03% -1.05% 0.51% 1.42% 3.81% 0.51%
With the benefit of historical data series 2005 -1.83% 1.92% -1.56% 1.05% -4.67% -1.49% -1.84% 2.73% -1.98% 0.35% -2.20% -0.36%
analysis, we adopted the same month-based long 2006 3.13% -1.38% -0.96% 5.12% 2.64% -1.19% 1.12% 1.93% -1.64% 1.77% 3.05% -0.36%
months and short in bearish ones. The table in 2010 -1.24% -4.51% 0.17% 0.59% -4.65% 2.80% 4.97% -2.35% 2.41% 2.04% -3.20% 0.30%
6 shows the equity line for the strategy (2,474 Avg -0.07% -0.84% -0.12% 1.11% -0.54% 0.71% 0.51% -0.66% 0.81% 0.01% -0.78% 0.46%
USD/CAD
The third major we exam-
ined was the exchange rate between the US N. Date Trade En.Price Ex.Price % Chg Profit Cum. Profit
dollar and the loonie, that is, the Canadian 1 Jan 2014 Short 1.656 1.643 -0.74% 123 123
in Figure 7 shows all monthly returns of the 5 May Short 1.687 1.675 -0.73% 123 241
exchange rate from 1998 to 2013. As usual, the last row of the
6 Jun Long 1.676 1.710 2.05% 344 585
7 Jul Long 1.711 1.688 -1.30% -222 363
table shows the average returns for each month. On a historical 8 Aug Short 1.689 1.660 -1.71% 288 651
basis, January, June, July, August, October, and November are 9 Sep Long 1.659 1.621 -2.30% -381 270
We applied the same out-of-sample strategy to this FX pair. 13 Jan 2015 Short 1.558 1.507 -3.28% 511 1,035
8 shows, in detail, all trades (24 total trades—12 long and 12 17 May Short 1.535 1.529 -0.40% 61 1,898
short), while the chart in Figure 9 shows the equity line for the
18 Jun Long 1.529 1.571 2.71% 414 2,312
19 Jul Long 1.571 1.562 -0.55% -86 2,226
strategy (2,124 pips earned in total). 20 Aug Short 1.562 1.534 -1.80% 281 2,507
21 Sep Long 1.534 1.513 -1.40% -215 2,292
operational strategy to test our hypothesis, we attempted to show 25 Jan 2016 Short 1.474 1.425 -3.33% 491 2,862
that for each financial instrument tested, in this case major forex
26 Feb Short 1.424 1.392 -2.28% 324 3,186
27 Mar Short 1.392 1.436 3.18% -442 2,744
pairs, each month of the year can have a particular bullish or 28 Apr Long 1.436 1.461 1.75% 252 2,996
bearish “personality” that lasts over time. Our findings show 29 May Short 1.461 1.448 -0.90% 132 3,128
Figure 3: equity line FOR THE strategy on EUR/USD, 2014–2017 Figure 5: Long & short trades on GBP/USD in the period 2014–2017
has a particular
2005 3.31% -0.41% -2.02% 4.00% -0.40% -2.35% -0.17% -2.89% -1.73% 1.33% -1.26% -0.33%
2006 -2.28% -0.25% 2.77% -4.38% -1.44% 1.40% 1.31% -2.48% 1.30% 0.45% 1.62% 2.22%
potentially actionable strategies. You could perform similar 1 Jan 2014 Long 1.062 1.113 4.74% 503 503
noise that is always present in shorter temporal horizons by 5 May Short 1.096 1.084 -1.10% 121 781
reliability and persistency, you could easily extend this analysis 9 Sep Short 1.087 1.120 2.96% -322 489
10 Oct Long 1.119 1.127 0.63% 71 560
11 Nov Long 1.126 1.141 1.33% 150 710
Continued on page 33 12 Dec Short 1.142 1.162 1.74% -199 511
13 Jan 2015 Long 1.162 1.273 9.55% 1110 1,621
14 Feb Short 1.273 1.251 -1.76% 224 1,845
15 Mar Short 1.248 1.269 1.67% -208 1,637
16 Apr Short 1.269 1.208 -4.82% 611 2,248
17 May Short 1.208 1.245 3.06% -369 1,879
18 Jun Long 1.244 1.249 0.42% 52 1,931
19 Jul Long 1.249 1.309 4.76% 594 2,525
20 Aug Long 1.309 1.314 0.31% 41 2,566
21 Sep Short 1.314 1.331 1.32% -174 2,392
22 Oct Long 1.331 1.308 -1.76% -234 2,158
23 Nov Long 1.307 1.336 2.20% 288 2,446
24 Dec Short 1.336 1.384 3.57% -477 1,969
25 Jan 2016 Long 1.384 1.397 0.95% 132 2,101
26 Feb Short 1.397 1.354 -3.10% 433 2,534
27 Mar Short 1.354 1.300 -3.96% 536 3,070
28 Apr Short 1.300 1.255 -3.47% 451 3,521
29 May Short 1.255 1.309 4.34% -544 2,977
30 Jun Long 1.309 1.292 -1.29% -169 2,808
31 Jul Long 1.292 1.303 0.81% 105 2,913
Figure 6: equity line FOR the strategy on GBP/USD, 2014–2017
32 Aug Long 1.303 1.310 0.60% 78 2,991
33 Sep Short 1.311 1.313 0.17% -22 2,969
34 Oct Long 1.313 1.341 2.10% 276 3,245
35 Nov Long 1.341 1.343 0.21% 28 3,273
36 Dec Short 1.344 1.343 -0.06% 8 3,281
37 Jan 2017 Long 1.344 1.303 -3.04% -408 2,873
38 Feb Short 1.303 1.330 2.06% -268 2,605
39 Mar Short 1.330 1.331 0.09% -12 2,593
40 Apr Short 1.330 1.365 2.62% -348 2,245
41 May Short 1.365 1.350 -1.13% 154 2,399
42 Jun Long 1.350 1.296 -3.98% -537 1,862
43 Jul Long 1.296 1.248 -3.76% -487 1,375
44 Aug Long 1.248 1.248 0.02% 3 1,378
45 Sep Short 1.248 1.247 -0.08% 10 1,388
46 Oct Long 1.247 1.288 3.30% 411 1,799
47 Nov Long 1.289 1.289 0.05% 7 1,806
48 Dec Short 1.290 1.258 -2.47% 318 2,124
Figure 9: strategy equity line on USD/CAD, 2014–2017 Figure 8: Long & short trades on USD/CAD, 2014–2017
A
you cut your losing trades quicker if you happen to be one of
false breakout—or fakeout—is by far one of my those breakout traders who got trapped.
favorite technical patterns. It is when price mo- In this article, I will discuss and share examples of: 1) how
mentarily moves above a previous high or below a to anticipate the emergence of such patterns, so you know
previous low, but then goes back within the existing exactly what to do when they occur; 2) how to spot these
range. This happens when there isn’t enough demand patterns after they are formed; and perhaps most important,
above the old high, or enough supply beneath the 3) how to trade them. I will also discuss various other factors
KTASIMAR/SHUTTERSTOCK/COLLAGE:NIKKI MORR
prior low, to help push price significantly in the you’ll want to take into account when spotting these patterns,
direction of the break. When a breakout fails, it suggests including how price gets to old highs/lows.
the move is exhausted, and the rejection alone could provide
significant reward if traded correctly. What’s more, price Identifying price action
typically then goes back to areas where the breakout traders, As your experience grows, you will hopefully become more
some of whom are now trapped, would be placing their stop- patient and better at reading price action. You will be able
loss orders. Those areas now become the ideal profit target to spot the difference between very high-probability setups
zones for fakeout traders. and normal trades. Professional poker players typically bet
18 • March 2019 • Technical Analysis of Stocks & Commodities
Trade options like you went to school for it.
Options trading doesn’t have to be intimidating. TD Ameritrade provides educational courses,
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TRADING TECHNIQUES
6632.0
6588.0
Figure 1: false break reversal pattern on a one-minute chart of the nasdaq 100. Notice how the had been a key short-term pivotal
index fell to below the 6592 level. This could have been because of a cluster of sell stop orders resting below the 6592 level.
Some may have been stop-loss orders from those who bought around 6592 earlier in the day (and then tightened their stops
zone on the higher timeframes,
to just beneath 6592 as price moved higher, in order to reduce their risk). The rest of these sell stops may have been from so the sharp 65-point jump off
breakout traders who, anticipating a breakdown of support, had placed their entry orders just below this low. the 6592 level just after the cash
market had opened made perfect
technical sense.
But when the market came
2120.0
2080.0
2060.0
celerated downward move just
2040.0
prior to the quick rejection. This
is where a lot of newer traders
2020.0
2000.0
1. Buy the break here 1860.0 ter of sell stop orders that were
1840.0
resting below the 6592 level.
Some of these may have been the
1820.0
1805.0
FIGURE 2: BUYING OPPORTUNITY? The follow-through that occurred on the day after the fakeout could have been a nice as price moved higher, in order
to reduce their risk), while the
breakout buying opportunity. And if you wanted to wait for extra confirmation, you could have waited for the break above
the old high at 1940. The index formed a false break reversal pattern and went on to make a higher low.
rest of these sell stops may have
been from breakout traders who,
large on premium hands. In trading, putting size on very anticipating a breakdown of the support, had placed their
high-probability setups could potentially make your month, entry orders just below this low (which is a typical rookie
quarter, or even your year. I am not implying that you should mistake, by the way).
be reckless and bet the farm on one trade. Rather, the risk In any case, the point I am making is that the liquidity
can remain the same, but the position size could be increased (cluster of sell stop orders) was used here to fill what must have
substantially as you become better with precision entry tech- been a large buy order, which explains why the market rallied
niques while simultaneously reducing the distance between sharply afterwards, as demand outweighed supply. Once the
entry and stop-loss placement, though not so tight that you index started to trade above the 6592 level, the idea here would
are shaken out of your position by market noise. have been to go long with a market order and place a tight
For me, these types of trades are typically made on the stop-loss beneath the most recent low. The potential reward
back of false break setups. Experience has taught me how to from this type of a trade would have been huge.
20 • March 2019 • Technical Analysis of Stocks & Commodities
What’s the ideal entry point?
False breaks can be traded many different ways and on dif-
ferent timeframes. In the daily chart of the S&P 500 futures The beauty of the false break
in Figure 2, I have highlighted at least three different areas setup is that sometimes price
to buy around, after the false break took place. Here, the
S&P spiked below the old low at 1805 but the sellers couldn’t goes significantly in the opposite
hold their ground for too long. To some degree, the fakeout direction, hence the saying
here could have been anticipated given the magnitude of the “from false moves come fast
prior drop and as the relative strength index (RSI), which moves in the opposite direction.”
is a popular momentum indicator, was in a state of positive
divergence already as the index retested that low. That is, the
RSI was making a higher low as the underlying S&P index
tried to break its old low, clearly indicating that the selling
momentum was waning. closes lower than the opening price. It clearly shows that the
As the false break could have been anticipated, intraday buying pressure has ended abruptly.
traders could have potentially bought near the low, based on These types of candlesticks are most effective when they
price action on a smaller timeframe chart such as the hourly occur at the top of trends, around old resistances or prior
or even the one-minute as per the Nasdaq example in Figure swing points, as is the case in this example. Based on this, a
1. But you don’t necessarily need to buy near the low. potential short trade would have been to simply enter once the
The important point is that once a false break takes place hourly candle closed. The stop-loss would have been a tight
and there is a good reaction away from that level confirm- one, placed just above this shooting star signal candle, and the
ing the mismatch between supply and demand, usually—not main target could have been, for example, the liquidity pool
always—the market goes in the other direction for several below the old low at $1,223 where sell stops would be rest-
days, providing plenty of subsequent tradable opportunities. ing, some of which are used to fill your closing buy order(s).
In this case, the follow-through that occurred on the day
after the fakeout could have been a nice breakout buying Downside directional bias
opportunity, as highlighted on the chart in Figure 2. But if To make it clear that false breaks can
you needed extra confirmation, well, the break above the old literally take place on any timeframe, the
high at 1940 was just that: Not only did the index form a false chart in Figure 4 shows a weekly chart of
break reversal pattern, it went on to make a higher low. As WTI crude oil. Although this fakeout has
the bullish trend is starting to emerge, traders can now utilize taken place on the weekly, you don’t nec-
various entry techniques to get onboard, such as the entry essarily need to trade on this timeframe.
examples I have highlighted on the chart. But it all started After a long-term reversal signal such as
with that false break!
signals
1237.00
1236.00
1235.95
the opening level of that time FIGURE 3: OLD HIGHS AND OLD LOWS CAN BE HELPFUL. Gold tried to break above its old high at $1236, but was met
period (in this case, hourly) but with rejection. The appearance of the inverted hammer suggests the abrupt end of the buying pressure.
1 “Euribor Products” means any and all interest rate swaps, forward rate agreements, futures, options, structured products, and any other instrument or
transaction related in any way to Euribor, including but not limited to, New York Stock Exchange (“NYSE”) London International Financial Futures
and Options Exchange (“LIFFE”) Euribor futures contracts and options, Chicago Mercantile Exchange (“CME”) Euro currency futures contracts and
options, Euro currency forward agreements, Euribor-based swaps, Euribor-based forward rate agreements, and/or any other financial instruments that
reference Euribor.
2 The “Settlement Agreement” means the agreement between Plaintiffs, Citi and JPMorgan, entered into on November 21, 2018, and filed with the
Court in this action.
(continued from previous page)
Notice of Class Action Settlement
Mar May Jul Sep Nov 2018 Mar May Jul Sep Nov 2019 price needs to travel a
FIGURE 4: LONG-TERM REVERSAL SIGNAL. After you see a long-term reversal signal on a weekly or higher timeframe, you much shorter distance,
can move down to a lower timeframe chart to look for entries. Keep in mind that price is now in a reversal profile and no longer in compared to setups with
a rising trend or sideways profile. lower reward-to-risk pro-
files. The shorter the
WTI Crude Oil Daily Chart 76.000
distance of your profit
Low from weekly fakeout candle 74.000
target, the more likely it
is it will be reached, since
73.128
Sell on break below this level. 72.000
Reason: No upside follow-through
despite bullish-looking candle
(highlighted) AND given weekly 70.000 the more time elapses,
the more likely it is for
bearish bias
68.000
something to go wrong,
Sell here
or here (similar setup to above)
62.601
more likely it will be hit by profit-taking and thereby increas- Fawad Razaqzada is an economist and market analyst who
ing the likelihood of a rejection. has been involved in the financial markets for almost 10 years.
Indeed, there are market participants out there—among He has worked for several leading brokerages as a market
them “mean reversioners”—who anticipate breakouts to fail analyst in London. Specializing in forex, commodities, and
and sometimes, when the conditions meet their requirements, stock indexes, Razaqzada has expertise in reading price action
enter heavily as price breaks an old high or low. on the charts. He uses his knowledge of economics together
The beauty of the false break setup is that sometimes price with fundamental analysis to forecast short-term price fluc-
goes significantly in the opposite direction, hence the saying tuations. He has also been trading his personal account for
“from false moves come fast moves in the opposite direction.” many years. Follow him on Twitter at @Trader_F_R.
In addition to the multiple entry potentials after the fakeout
is formed, it is also possible for traders to establish long-term ‡TradingView
position trades from price action on lower timeframe charts ‡See Editorial Resource Index
such as the hourly, as long as the formation occurs around
a higher timeframe technical level. These trades normally
have lopsided risk-to-reward profiles, allowing the trader to
put on size behind the trade as the stop-loss is typically very
tight, especially if the fakeout setup is identified on the lower
timeframes relative to, for example, an entry off a daily or
weekly chart.
These premium types of trades can significantly increase the
potential reward, simply because of having a tight stop-loss.
24 • March 2019 • Technical Analysis of Stocks & Commodities
Algo Q&A
ALGORITHMIC TRADING
Have a question about system or algo trading? Kevin J. Davey has over 25 years of
system trading experience. Davey is a full-time trader, and he also teaches and con-
sults via his Strategy Factory online workshop (http://kjtradingsystems.com). He is the
author of several bestselling trading books, including Building Winning Algorithmic
Trading Systems and Introduction To Algo Trading. Send your questions or topic sug-
gestions to Kevin Davey at kdavey@kjtradingsystems.com. Selected questions will
appear in a future issue of S&C.
Kevin J. Davey
A DAY IN THE LIFE OF AN algo traders. There is a phrase, “auto- diversification to a trading portfolio, or
ALGO TRADER mated trading doesn’t mean unattended just be an improvement over existing
As a new algorithmic trader, how should trading,” and that is wise advice. In ad- strategies. This is where many algo
I be scheduling my day? I am an expe- dition, there are always “maintenance”- traders spend most of their time. De-
rienced trader in futures and forex, but type trading activities to be performed, veloping strategies is time-consuming,
only as a discretionary trader. such as checking equity runs, conducting but it is critical to keeping your trading
It’s good you have trading experience, contract rollovers, adjusting portfolio al- at a high level.
since many people try to jump into algo locations, and more. In total, most algo Think of this task as research and
trading without knowing the basics. To traders spend part, but not all, of their development. Every successful company
know the markets and be able to use your day monitoring and correcting their dedicates some of its budget and man-
trading platform are two essentials any live trading. power to R&D. Without it, the company
trader should have before starting with Second, good algo traders constantly stagnates and will eventually be over-
algorithmic trading. Not understanding develop new strategies. These new taken by competitors. The same holds
how to manually enter an emergency strategies can replace broken ones, add true with trading—having a steady supply
order, or realizing you must roll of new strategies in development is
over futures contracts prior to a way to keep your trading going
expiration are just two examples You can’t just automate for years and years. No strategy
of the kind of thing you don’t want an algo and let it run with lasts forever—just ask the formerly
to have to learn in the heat of the well-known Turtle Traders!
moment! no supervision. Checking Finally, algo traders spend a
With the basics under your belt, positions throughout the day portion of their time improving
what kinds of tasks are involved in and night is typical for most their trading. This could include
day-to-day algo trading? Certainly algo traders. investigating new platforms or
not what you are used to in discre- programming languages, learning
tionary trading, especially if you different styles of algo trading (for
found yourself glued to a screen instance, pair trading or spread
throughout the trading day. Algo Algo Trader — Sample Time Distribution trading to complement directional
trading is not like that at all. trading), educating themselves on
First, since algo traders typically new trends in trading (for example,
Monitoring
run many automated strategies, Live Strategies machine learning), and researching
keeping an eye on these strate- novel and unique approaches to
gies is your highest-priority task. Enhancing Trading
Skills/Education
13% portfolio trading, position sizing,
After all, this is where your money and more. Just as with develop-
is made (or lost!). Luckily, most 28% ing new strategies, the top algo
trading platforms are pretty user- traders devote part of their time
friendly, and the chances of a tested to enhancing their craft. Reading
algorithm going rogue and placing this magazine, for instance, is an
thousands of orders are small. But Developing New important endeavor in this area.
odd things can happen, so “set it Strategies As an example, for a week I kept
and forget it” is definitely not ap- 59% track of my trading-related activi-
propriate here. ties. During this week, which was
You can’t just automate an algo fairly typical, my time was divided
and let it run with no supervision. as shown in Figure 1.
Checking positions throughout the
day and night is typical for most Figure 1: Typical Time Breakdown for Algo Trading Continued on page 62
March 2019 • Technical Analysis of Stocks & Commodities • 25
The On-Balance Volume
W
higher closes to give you a measure of buying pressure, and
hile the number of tools available to the trader subtracting volume on days with lower closes to measure selling
grows all the time, sometimes the tools and pressure. The formula assumes that on up days, all volume is
indicators that have been around a long time still positive and on down days, all volume is negative.
serve the trader well. In this article, I’ll examine The calculations are simple. Let’s say that today, stock XYZ
one of them, the on-balance volume (OBV), and closed higher, meaning that buying dominated. It would be
XYZ LOGO: FULLRIZQISHUTTERSTOCK/
Current OBV – Today’s volume = Today’s OBV trend—as opposed to diverging from it.
Here are two other important things to keep in mind as well:
Finally, we have to account for sideways moves. This is when You want to be on the lookout for volume spikes that can cause
today’s close equals yesterday’s closing price: the OBV indicator to be thrown off; and remember, OBV is
using closing prices so you should make it a point to note all
Today’s OBV = Previous OBV support & resistance levels using closing prices.
I’ll provide a couple of examples to clear up any confusion. Divergences can be key
Using one week’s worth of trading, here is a simple example I mentioned that you are looking for whether the OBV trend
to illustrate how to calculate OBV: matches the price trend or diverges from it. There are two
main types of divergences to keep a lookout for. A bearish
• On Monday, XYZ closed at 100.
divergence will be seen when price is advancing while the
• On Tuesday, XYZ closed at 101.10 with a trading volume OBV line is declining. Bullish divergence is when price is
of 40,000. declining but the OBV is moving higher, signaling that future
• On Wednesday, XYZ closed down at 100.10 with vol- prices will move higher.
ume of 10,000. For example, when looking at a chart, you want to look
for a break in price trend while the OBV remains higher; the
• On Thursday, XYZ closed up at 102 with volume of
higher OBV level signals there is still strength in the price
15,000.
trend, and this minor divergence can allow you to move into
• On Friday, XYZ closed up again at 102.75 with volume a security before it changes direction.
of 10,000. Now that you know how to calculate the OBV and under-
stand how it works, let’s look next at using it to trade. I traded
Now let’s put those numbers into the formula. a few stocks using the OBV line alone so I could present how
it fared. I simply entered a position once an OBV slope was
• Tuesday’s close was up, so we have a positive day. The
moving upward, and exited when that same OBV line was
OBV will be 0 + 40,000 = 40,000.
rapidly moving downward. Here are the stocks I traded, along
• On Wednesday, XYZ fell, and that’s a negative day. The with the results:
OBV will be 40,000 – 10,000 = 30,000.
• Thursday was an up day, so the new OBV will be 30,000 GOOG
+ 15,000 = 45,000. Google (GOOG) is my first case study. But first, just to illus-
trate what OBV looks like on a chart, Figure 1 shows a basic
• Friday saw another positive close, bringing our new
chart of GOOG in 2018 through December 28, 2018. OBV is
OBV to 45,000 + 10,000 = 55,000.
in the bottom panel, right beneath volume.
It’s a simple enough calculation that can also be plotted on a In Figure 2, the shaded rectangle that I’ve added labeled
chart, and I’ll provide some chart examples shortly. “1” tells us a few things. On January 2, the stock is moving
Calculating OBV and having all these numbers based on and closes at 1065, just shy of the high of the day. Volume
volume is nice, but what exactly do we do with them when it was not as impressive as the actual point move. That was
comes to trading? A rising OBV signals that the current buying followed by another new close on January 3 at 1082. This
pressure is strong and building and can
signal more buying. If the OBV is fall-
ing, that can tell us that selling pressure
is building and growing stronger and can
lead to more down days ahead. Accord-
ing to Granville, you can expect prices
to move higher if the OBV is going up
and the current price is either sideways or
falling slightly. The reverse is also true: If
OBV is falling, you should expect prices
to move down if current prices are either
sideways or rising slightly.
Granville explains that the actual OBV
number is irrelevant; instead, you want to
spot the trend of OBV before you worry
thinkorswim
Citigroup (C)
My next example takes us away from
the high-flying tech sector and to the
more mature banking sector. The chart
in Figure 6 is Citigroup (C).
I had an existing position in this stock
going into 2018. There are two price
levels drawn on the chart. The top one is FIGURE 7: ZOOMING IN. Here in higher resolution, you can see that the first sign of trouble is on October 23 and
then the real trouble starts around December 4 with a falling OBV, high volume, and falling price. By December
at 76.63 and the lower one was placed at 10 (point A), the OBV line is sloping downward fast and hard, an unmistakable exit signal.
64.26. Between these levels is clearly the
area where Citigroup stayed throughout the bulk of the year. the line signaled that the uptrend was intact. From that point
On January 29, it hit its high for the year at 80.70. Looking it’s a series of lower highs and just staying in the channel. But
at the OBV line, I was confident to stay in at that point, since this chart is far too wide for my taste so I’ll narrow it down
March 2019 • Technical Analysis of Stocks & Commodities • 29
instead, it remained fairly neutral. We had a minor rally toward
If the OBV is falling, that can the tail end of 2018 but no entry signal was generated.
tell us selling pressure is
TWTR
building and growing stronger Of course, it’s not all roses when it comes to trading. Here
and can lead to more down is one example where the OBV was in no way helpful. The
days ahead. stock is Twitter (TWTR), shown in Figure 9.
Where do we start? How about right at the beginning of
the chart at point A. There is a gap up. The move shows that
we should have gotten in since the slope was moving up
a bit to better see what’s going on (Figure 7). quickly even though the price was not moving up. This all
The first sign of trouble comes on October 23 when Citi- happened on February 1 when the OBV line moved upward.
group touches the lower price level and then closes below it. The gap occurred seven days later. We hit our first high on
After that, we have a mini rally but it closes below that level March 14. This was followed by a move in the other direc-
on November 14. At this point OBV is still high and not tion. We can see that OBV does not really head down to the
signaling any real worry. It trades below that level for a few lows and instead stays in the middle so I stayed in the trade.
sessions, does a brief rally, and on December 3, it hits a high I saw another buy signal to add to my current position with
of 66. December 4 is when OBV starts to slant downward, a strong upward slope at point B at May 31. This turned out
corresponding to a large drop in the price. Volume at this point to be an excellent decision, as the price nearly doubled from
is picking up steam and remaining high. The problem is the my original entrance price.
price is falling. Point A on the chart is on December 10 and OBV remains strong even though after the high is hit on
this is when there is no mistaking that the OBV line is sloping June 15 we are greeted with lower highs until we get to the
down fast and hard. This is an exit position straight away. In trouble zone on July 27, represented by point C. Is OBV head-
summary. we had a high of 80 and a low of 48. That’s nearly ing down? Yes, but its slope is not significant enough for me
half the value gone over the course of the year. Currently, there to exit the trade and that’s even followed by a higher OBV
is no buy signal from OBV even though the shares have seen line. Here is divergence in action. OBV remains high as the
a bit of a pop toward the end of 2018. price continues downward.
That brings us to point D on October 11 with a close of
ISRG 27. The OBV line is not even sloped downward but instead
Medical stocks are always worth trading and our next example remains strong. The price does bounce upward, eventually
is no different. Intuitive Surgical (ISRG) was a high flyer in 2017 hitting a high of 37.14 on December 12. The OBV remains
and made some pretty decent moves in 2018 (Figure 8). high on TWTR heading into 2019. Yes, with hindsight I can
I was not in this stock at the beginning of 2018 but I decided quickly point out my mistake of ignoring the lower highs
to enter a position on January 19. Price was moving higher and when I saw them occurring. However, you cannot successfully
OBV was sloping upward so I got in. The signal to get out came trade with a tool and second-guess it at the same time. Will
on February 2, which resulted in a loss. The stock continued Twitter move upward in 2019? I don’t know, but currently, I
to trade slightly upward but I waited until I got that gap up (B) am still in the trade.
and entered a position on April 18. Since
OBV stayed relatively benign I stayed in
the position and watched the stock move
up and it did so pretty consistently. The C D
first sign of trouble came on October 8
(point C) shortly after it hit its high. I
remained in the position for a little while A
longer and saw that indeed, the OBV line
B
was sloping downward, and I exited on
October 11. I continued to watch the stock
the remainder of the year and we got a
bump up on November 7 (point D), but
OBV remained right in the middle so
there was no signal to reenter.
Interestingly, even though the stock
traded up and down until December 14
and since then it has gone almost straight FIGURE 8: HIGH FLYER. The gray shaded rectangles highlight strong OBV slopes, which are the signals.
Here, the first trade from January 19 to February 2 ended in a loss while the second trade between April and
down, still, the slope of the OBV line was October was profitable. Throughout the ups and downs in ISRG late in the year, the OBV remained neutral,
not even close to confirming a downtrend; with no signals generated.
30 • March 2019 • Technical Analysis of Stocks & Commodities
TLRY
One of the hottest sectors of 2018 was
the marijuana stocks and there were
a couple that were worth playing. The
one I traded was the fast-moving Tilray A
(TLRY), shown in Figure 10.
B
As with most everyone else as well, I C
didn’t pick up on Tilray until September D
5, when OBV slopes upward. I did not
get in at that time; instead, I waited and
entered on September 13, represented by
point A at 119. It ended up being perfect
timing, since on September 19, TLRY
hit a high of 300 only six days later. The
price quickly came right back down and
remained in a trading range. On October FIGURE 9: OBV DOESN’T ALWAYS WORK. OBV was less helpful on TWTR in 2018. Two entries signaled by
upsloping OBV lines were promising but I didn’t exit my position in 2018 because OBV remained strong despite
2 at point B, an up day is followed by a a falling price. Will 2019 prove OBV correct for TWTR?
down day. OBV remained in the upper
range, and it stayed in the upper range
for the rest of the year. On November 7
at point C, the stock closed at 139.60.
That ended the good times, since from
that point, price meandered downward B
almost on a daily basis followed by a A C
declining, almost-dead volume level
and an OBV that remained flat but in
the upper range.
Real-world
OBV
These examples are
based on real trades
that were not fitted in
any way in order to FIGURE 10: FAST AND FURIOUS STOCKS. One of the hottest sectors of 2018 was marijuana stocks. The
fast-moving Tilray (TLRY) stock was one that was worth playing. OBV produced several signals.
make the OBV indica-
tor look good or bad. Understandably,
you will never want to trade using just
OBV, and the last couple of examples
demonstrate why. So what’s a better way
to use OBV? An easy way is to simply add B
another indicator to the same chart. C
A
Figure 11 is the same chart of TLRY as
in Figure 10 but with two simple moving
averages (SMAs) added. This is a better
real-world example of how OBV should
be used. The black line represents a 25-
day SMA and the red line is a 50-day
SMA. Looking at this chart, my exit
signal would have been at point C when
the 25-day moving average crosses below
the 50-day moving average. Why is this FIGURE 11: OBV WITH MOVING AVERAGES. Here’s the same chart as in Figure 10 but with two simple mov-
a more realistic example? Again, it’s not ing averages (SMA) added for signal confirmation. An exit is signaled at point C when the 25-day SMA crosses
below the 50-day SMA. It’s best to use OBV in conjunction with other trusted indicators.
because it’s hindsight, but rather it high-
lights why you shouldn’t rely on only one
indicator. No indicator, no matter what it measures, should be I’ve demonstrated a couple of examples where OBV worked
used in isolation. OBV is a good example of that. Granted, by itself pretty well and resulted in profits. The problem is,
March 2019 • Technical Analysis of Stocks & Commodities • 31
we never know which occasions those will be.
The other problem is when to get out. Sure, we can easily The second thing that OBV is
spot an entry point and say that an OBV sloping upward tells good at is indicating if a trend
you the trend is up and you can enter. But as we have seen, we is indeed real.
are not given a sell signal the same way, as OBV can diverge
from the current trend.
OBV signals, or tries to signal, money flowing into and out
of a security. An upward-sloping OBV line indicates money is For this article, I traded with only this one indicator simply
flowing in and it’s time to enter a position or add to a current to test its effectiveness. Clearly, OBV is a very useful tool
position. A downward-sloping OBV line tells us that money when used properly and in conjunction with another indicator
is flowing out and it’s time to get out. Pretty simple. that you can trust.
You could also use OBV to indicate when a prevailing trend
may be losing steam. If the OBV line is sloping downward John Devcic is a market historian and freelance writer. He
and price is moving higher, you should be looking for an exit may be reached at jdevcic@gmail.com.
as soon as you can.
In either case, when used in conjunction with other indica- Further reading
tors, OBV can signal spots where money is entering. Granville, Joseph [1963]. Granville’s New Key To Stock
In all the examples in this article, you can see when accu- Market Profits.
mulation happens. Use OBV along with other reliable indica- ‡thinkorswim (TD Ameritrade)
tors, as was shown in my final example where I simply added ‡See Editorial Resource Index
two simple moving averages that would have told me to exit.
Other indicators might have signaled an earlier exit.
TrAdinG On MOMenTUM
CALHOUN terns. I will often use this technique with it was my experience that many of my
Continued from page 7 three to fi ve trades per day. You should biggest winning trades used a “set it
always diversify, and trade several stocks and forget it” intraday swing trading
simultaneously, to minimize your over- approach. By this, I simply mean that
Step 3: Don’t watch the stock chart all risk. Successful trading is all about I initiated the trades between 9:30 and
all day long; instead, simply come minimizing upfront risk, and maximiz- 10:30 am, entered my stop-loss, then
back during the last 30 minutes or so ing overall profi t potential. This intraday came back during the last hour of the
and close the entire position around swing trading approach accomplishes market to close the trades. This helped
3:50 pm ET. both for you. My personal trading goal keep me from overtrading or getting
is to make the majority of my trades with out too soon during intraday minor
insights: Why this tech- this technique (it requires patience!). As reversals.
niQue WOrks a reminder, on down days in which there The two critical risk management
This strategy combines the best of both are few upside gaps, I use this technique variables are the initial share size and
worlds from intraday and longer-term with inverse ETFs and ETNs like TVIX, initial stop-loss price. You may want to
swing trading. You get the benefi t of a SQQQ, and LABD. On up/green days experiment with these to fi nd the best
multipoint move, without the risk of hold- I use this strategy with long ETFs like combination for your personal trading
ing overnight. I believe this is the single TQQQ, SPXL, and LABU. style. You can also consider adding to a
best approach for active traders, because winning trade sometime in the middle
you can use a smaller 100- to 300-share traDe ManageMent tips of the day to scale in; if you do this, then
size initial position and still have solid In doing over 2,280 real-money trades be sure to tighten up your trailing stop to
profi t potential. It also avoids the foolish during the last several months of 2018, breakeven on the entire position.
upfront risk that inexperienced, young,
small-cap daytraders advocate, trying Ken Calhoun is a producer of trading
to trade thousands of shares of cheap, This strategy combines courses, a live trading room, and video-
under-$10 stocks for quick scalps, which the best of both based training systems for active traders.
usually go against the trader and cause He is the founder of TradeMastery.com,
massive losses.
worlds—intraday and an educational resource site for active
By trading strong initial gap charts for longer-term swing traders and is a UCLA alumnus.
all-day-long trades, you can often get big trading.
moves out of these uptrending chart pat-
32 • March 2019 • Technical Analysis of Stocks & Commodities
Seifert/21st Century covered call a profit, and the stock can’t be called away. If the stock goes
Continued from page 11 slightly lower, you may win money. If the stock tanks week
after week, you lower your average price and hopefully when
it recovers you have lowered your average price so much that
you keep the stock instead of having it called away at $320. you are in a position to make money on the rebound. The trade
Continue the next week by initiating a 350.0–365.0 call requires just a few minutes a week to manage and removes
credit spread for a credit of around $5.90. almost all of the problems of the covered-call strategy!
Total account value: $35,000 + $590 - $1,500 = $34,090 Robert J. Seifert is president and CEO of The Optionomics
($2,090 gain) Group LLC, www.optionomicsgroup.com. He is a 35-year
veteran options trader and was an options market maker for
5) Small loss: Stock drops by about 1.5% to $315 almost 20 years at the CME, CBOT, and CBOE. In the early
You pocket the $590 from the call credit spread. You have an 1990s, he was appointed by the CME to the position of Vice-
unrealized loss of $500 in the stock. Chairman of International Monetary Markets (IMM), which
Continue the next week by initiating a 315.0–330.0 call was the highest-ranking options floor position at the CME.
credit spread for a credit of around $5.90. Until his retirement in 2018, he was an adjunct instructor at
UNLV where he taught Finance 485, an advanced options
Total account value: $31,500 + $590 = $32,090 strategy course. He is the author of Profiting From Weekly
($90 gain) Options and Trading Options My Way. He may be reached
at optionomics@marketedge.com.
6) Big loss: The stock drops by about 5% ($15) to $305
You pocket the $590 from the call credit spread. You have an Further reading
unrealized loss of $1,500 in the stock. Seifert, Robert J. [2015]. Profiting From Weekly Options:
Continue the next week by initiating a 305.0–320.0 call How To Earn Consistent Income Trading Weekly Option
credit spread for a credit of around $5.90. Serials, Wiley Trading.
[2018]. “One-Day Wonder Trades,” Technical Analysis
Total account value: $30,500 + $590 = $31,090 of Stocks & Commodities, Volume 36: October.
($910 loss) Trading Options My Way, digital booklet, www.op-
tionomicsgroup.com.
Manage the weeklys ‡Optionomics Group LLC
As you can see, the advantage of this strategy is that it can be ‡See Editorial Resource Index
used either long or short term. If the stock goes higher, you may †See Traders’ Glossary for definition
give up some of your potential gain, but you are guaranteed
Customizable Scanning
Pring Murphy Hill
Fully customized to your technical
parameters, our world-class scan engine
allows you to instantly find the stocks that
meet your specific criteria. Plus, our technical
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Swenlin Bowley Schnell
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and more!
G
I analyzed the backtesting results by focusing on the fol-
aps occur on a price chart because of some impetus lowing parameters:
that made the price move higher or lower than the
previous day’s closing price. Several types of gaps
are possible and in this article I’ll focus on upward Entry
breakaway gaps, which occur when price suddenly
jumps from a congestion zone and moves up. It is
considered to be a bullish action and something traders are
familiar with.
As tempting as it may be to simply jump on a breakaway
gap when you see one appear on a chart, I prefer backtesting
a trading strategy before applying it. For this reason, I created Gap
a computer program that recognizes breakaway gaps.
Candle type
Let’s look at the candle bars of the breakout day. The bars before the recent lowest price (shown as point A in Figure 1).
can be of different shapes and sizes, so I looked at two cases Then I calculate the distance: closing price of the breakout
that are considered bullish by most traders: day minus this lowest price. I add this distance to the closing
price of the breakout day. This means a potential reward/risk
1. The body of the candle was the longest of the past four
ratio of about 1.0. Nevertheless, I still limit the maximum
trading days (as it appears in Figure 1)
number of days in the trade to 20, that is, I exit the trade after
2. The upper shadow/wick of the candle is relatively short 20 days if neither the stop-loss nor the take-profit level has
(shorter than the candle body itself). been reached.
In the second case (case 2), the take-profit level will be
You can see the results I collected in the table in Figure 5. higher: the reward/risk ratio is equal to 1.5. The other condi-
The long body on the breakout day results in a significant tions are the same as for case 1.
improvement in results. Here again, all parameters in the The third case (case 3) is similar to case 1, but I don’t limit
table are better than for the standard case. The number of the number of days in trade to be less than 20. In other words,
trades is less, but the odds increase greatly if the breakout I wait until the stop-loss or take-profit levels are reached.
candle is bullish. The fourth case (case 4) is similar to case 2, but I remove
What about the second option, the short upper wick? The the requirement of the maximum 20 days in trade (like in
number of entries is reduced again and the strategy outper- case 3).
formed the standard one. Nevertheless, the performance isn’t All these four cases refer to the standard setup discussed
as remarkable as for the long bullish candle. Of course, these previously: Trading volume on the breakout day was at least
are two different scenarios and it’s like comparing apples twice the average of the past 14 days and the gap size was
and oranges. at least 1% of the closing price of the stock. I didn’t analyze
the candle type on the breakout day here. All the results are
A full trading strategy displayed in Figure 6.
Is it possible to develop a full trading strategy with the infor- The most important observation is that all the cases are
mation we have? For starters, I’ll need to specify a stop-loss profitable and the performance is acceptable. Most of the
and a take-profit level. Let us consider the four cases. parameters indicate that cases 3 and 4 outperform, that is, it is
In the first case (case 1), I place a stop-loss a few cents profitable to hold the stock longer and not exit too early. This
could increase your risk but the final result may be superior.
Short The most profitable is case 4, where the take-profit level
Long body upper wick is located higher but the percentage profitable is lower, as
Profit factor 1.51 1.41 expected, and the maximum drawdown is less attractive.
Maximum drawdown -3.24% -3.12%
OPTION SELLING: RISKS AND REMEDIES of protection. Accordingly, looking to illustrate, the trader would have needed
(Part 2 of 2) options with expiration dates prior to to purchase a March put with a strike
In late 2018, energy market option sell- that of the primary short option might price of $30 to keep the premium spent
ers paid a price for trading naked. How make sense. comparable, near $150. Of course, this
could this have been avoided? For example, a trader speculating on creates a spread with a much deeper risk
As I discussed in this column last an imminent rally in crude oil while the of roughly $8,000 before considering the
month, the practice of option selling market is valued at $44 per barrel might premium collected. This is obviously
is a relatively high-probability trading look to sell a March $38 put option with much more concerning than the $2,000
strategy in that it often comes with 60 days to expiration for $750, and then of exposure the previous version of the
unusually high win percentages. Yet we purchase a February $36 put with 30 days trade offers (prior to considering the
also know that it comes with unlimited to expiration for $150 to create a net credit credit collected).
risk, and the small percentage of losing of $600. Because the trader believes the While this column isn’t dedicated
trades can wreak havoc on trading ac- price reversal will occur within 30 days, to teaching the mechanics of option
counts. We witnessed several examples there is no need to purchase a March put spreads, I am compelled to clarify that,
of this in the energy complex in late 2018, as protection which is more expensive when trading options with differing ex-
where at least one large hedge fund (and (time is money when it comes to option pirations, it is impossible to quantify the
likely others we aren’t aware of) were maximum risk. This is because the profit
wiped out. and loss of such a position will depend
While I am a proponent of option- It is always in the best on time and volatility, whereas an option
selling strategies, years of trial & error interest of the trader spread utilizing securities with the same
and learning about the difficulties of op- to have some sort of expiration date can always be mathemati-
tion selling firsthand lead me to believe cally defined using an “at expiration”
it is always in the best interest of the
catastrophic insurance equation. In the case of a diagonal spread,
trader to have some sort of catastrophic in place to prevent such as selling the March $38 and buying
insurance in place to prevent the unthink- the unthinkable from the February $36, we have already noted
able from happening. This is in line with happening. the intrinsic risk between $38 and $36,
the thinking of a typical vertical credit which equates to $2,000 for a trader. But
spread in which a trader sells an option we must note the risk is reduced by the
and then purchases an option with the pricing). Further, the lack of time in the premium collected, in this case, $600.
same expiration date but with a more February options and cheaper pricing We can use $1,400 ($2,000 - $600) as a
distant strike price to limit risk exposure. structure because of the time difference starting point for a guess as to what the
In my view, traders shouldn’t confine enables traders to purchase protection worst-case scenario might be; to figure
themselves to buying protection in the with a more proximal strike price. In the upper end of the range we will use
same expiration month of the primary this case, the trader has “naked” risk the intrinsic risk of $2,000. Thus, when
short option. Instead, traders should look from $38 to $36, a gap worth $2,000 of deciding whether the risk and the reward
to various expiration dates in search for risk, but is covered beneath $36. Had the make sense, the trader should work on
the “option” (no pun intended) that offers trader constructed a similar spread using the premise that he is collecting $600,
the best protection, for the lowest cost, a March put option as protection, it would which represents the maximum profit
for the appropriate timeframe. In other have been necessary to either spend more potential, and risking $1,400 to $2,000
words, directional option sellers might money for the protection, which cuts into to do it (again, these are estimates not
be speculating on a move anticipated to profit potential, or purchase a deep out- hard numbers, depending on timing and
occur in the coming weeks, thus there of-the-money put option as protection,
isn’t necessarily a need to pay for months which weakens the risk management. To Continued on page 62
March 2019 • Technical Analysis of Stocks & Commodities • 41
Following The Money
Sector-Rotation ETFs
Underperform
Rotating into leading sectors while switching to a defensive the hype, especially in bull markets where moving between
position in downturns is an ideal tactic if it can be implemented sector funds too often resulted in missed opportunities and
successfully, but can it? Are there any ETFs that have suc- subpar performance.
ceeded with it? If there are, they could save you the work of Today, all of those newsletters have disappeared from the
implementing the approach yourself, so we’ll investigate. marketplace. There is probably a handful or so of active sector
fund ETF managers/timers who offer this type of investment
S
by Leslie N. Masonson service online. Some may be tracked by TimerTrac.com, a
market timing service tracking professional timers; however,
ector investing has been popular since Fidelity in some instances you have to pay for this service if you want
introduced its sector mutual funds in the mid- to check them out any further. A quarterly trial is $74.95 to
1980s, and even more so with the offering of view all the timing strategies compiled on 570 timing services.
nine popular SPDR sector ETFs in 1999. Since Alternatively, you can search the web for that type of manager
then many more have been made available from and request verified past results from those offering the service.
multiple ETF providers. Investors and traders And in some cases they will provide their TimerTrac results
looking to achieve a performance advantage are embracing for their performance, if they are tracked.
a sector-rotation approach to select the best-performing ETFs Because of the constant ebb and flow of the markets, and
based on fundamental and/or technical factors, and riding particularly the performance and volatility of individual market
them until their trend changes. In reality, that objective is sectors, successful investing with a sector rotation focus has
much more difficult to achieve than it appears, as shown by been fleeting compared to a simple buy & hold approach even
the disappearance of sector fund newsletters and the closure with its inherent bear market risk and losses along the way.
of two sector-rotation ETFs.
Sector rotation ETFs reviewed
Sector investing popular in past decades I have covered varying aspects of ETF sector investing in
For example, in the 1990s and early 2000s, I noticed a pro- three previous articles in this magazine, which are listed in
IMAGENTLE/SHUTTERSTOCK
liferation of ads from newsletters offering sector mutual the “Further reading” section at the end of this article. Those
fund investing/timing services for conservative to aggressive articles covered seven sector fund families, momentum sec-
investors. Their backtest results, when provided, were always tors, and a focus on three technology ETFs, respectively. This
excellent, and a few had outperformance with real-time article provides insights into investing in ETFs that offer actual
records, but overall, their expected results did not live up to sector-rotation strategies, where the sector mix is based on
42 • March 2019 • Technical Analysis of Stocks & Commodities
WHY TRADE ETFS?
predetermined criteria. The five existing ETFs, all open-end similar to FVC but below SCTO (1.6%) and SECT (1.02%)
investment companies, are shown in Figure 1. Their names The one-year performance through December 26, 2018 was
and ticker symbols are as follows: -7.77%, which was better than the others but lagging the SPY
(S&P 500) at -3.65%. However, over three years, FV advanced
• First Trust Dorsey Wright Focus 5 ETF (FV) only 13.30% compared to 34.53% for the SPY, not a favor-
able outcome for an actively managed rule-based portfolio.
• First Trust Dorsey Wright Dynamic Focus 5 ETF
This ETF had 48% of large-cap exposure, 37% of mid-cap
(FVC)
exposure, and 10% small- and micro-cap exposure with a 75%
• Global X JPMorgan US Sector Rotation Index ETF style exposure to growth.
(SCTO)
First Trust Dorsey Wright Dynamic Focus 5 ETF (FVC)
• Invesco DWA Tactical Sector Rotation ETF (DWTR)
FVC, the second five-sector rotation ETF from First Trust
• Main Sector Rotation ETF (SECT) Advisors, LP, follows the same investment logic and methodol-
ogy as FV with two differences. First, it was introduced two
First Trust Dorsey Wright Focus 5 ETF (FV) years later on March 17, 2016. Second, when market condi-
This ETF was the earliest entrant among the five reviewed, tions change, investment exposure to a one- to three-month
with an inception date of March 5, 2014. The fund was devel- US Treasury bill component can be put in place. This comes
oped to provide specific exposure to only five of First Trust’s into play when the relative strength of more than one-third
many sector and industry ETF offerings. Dorsey Wright & of the universe of First Trust ETFs declines relative to the
Associates (DWA), the fund’s manager, uses its proprietary cash index that is evaluated twice monthly. The cash index
relative strength approach to select the strongest-performing can vary from 0% to 95% of the Dorsey Wright benchmark
ETFs, which are ranked from highest to lowest. Also included index, but is limited to no more than 33% per evaluation. As
in the selection criteria are minimum daily trading volume of December 26, 2018, its current holdings were: FXL, FDN,
and sufficient liquidity. QTEC, FXH, and FBT—the same as that of FV! Since the
Initially, the ETFs with the five highest-ranking scores September 2018 highs and subsequent collapse into yearend,
were placed in the portfolio. Thereafter, twice a month, DWA it is surprising that this portfolio remained in the nondefen-
performs its review by replacing ETFs falling in ranking to a sive sectors—technology, Internet, biotech, and (somewhat
predetermined level. The remaining ETFs are then rebalanced, defensive) healthcare—rather than holding any cash position
so that there are five nearly equally weighted positions. The at all. If a 15% to 20% market drop doesn’t effect a portfolio
current portfolio holdings, as of the previous night, can easily change, then that is something investors should be concerned
be found on its website by keying in the ticker symbol in the about, as the portfolio is evaluated semimonthly.
site’s search box. In this way, you can look for any changes, Both FV and FVC have an annual expense ratio of 0.89%,
although they aren’t made often, sometimes for months. higher than that of the others reviewed here, which ranged
Its holdings as of December 26, 2018, each with about 20% between 0.75% and 0.83%. FVC’s one-year performance was
of the assets, we re: FXL, FDN, QTEC, FXH, and FBT. The -7.90% compared to -3.65% for SPY, and was slightly worse
market took a big hit during the last few months of 2018. More than FV’s by 23 basis points. There is no XTF rating for this
than 50% of S&P 500 stocks were down more than 20% for ETF, probably because of its short track record and perhaps
the year since the September 2018 highs and this portfolio its underwhelming performance.
remained in the nondefensive sectors of
technology, Internet, biotech, and health- ETF FV FVC SCTO DWTR SECT SPY
care (somewhat defensive). XTF Rating 4.3 1.7 9.7
XTF.com rates this ETF with an XTF Expense Ratio 0.89% 0.89% 0.83% 0.75% 0.88% 0.10%
rating of 4.3 out of 10. Its rating system Market Cap $2B $496M $3M $58M $375M $245B
methodology is provided on its website,
Avg. Daily Volume 286,493 98,964 933 17,405 63,632 87,752,464
and is based on a statistical analysis
Annual Yield 0.64% 0.65% 1.6% 1.02% 1.44%
of structural integrity and investment
metrics. Inception Date 03/05/2014 03/17/2016 10/22/2014 10/09/2015 09/05/2017 01/22/1993
As Figure 1 shows, FV is the heavy- Geography Global US US US US US
weight as far as asset accumulation with Index Composition Custom- Equal- Custom- Equal- Cap- Cap-
$2 billion—far outpacing FVC ($496 Weighted Weighted Weighted Weighted Weighted Weighted
million) and SECT ($375 million). It Avg. # of Components 5 5 5 4 11 505
DATA SOURCE: XTF.com
also has the highest daily trading volume Investment Metric rank 26% 33% 67%
of 286,493 shares, with FVC second at Perf. - 1 Year -7.77% -7.90% -9.59% -12.27% -8.01% -3.65%
98,964. It is the only one with options Perf. - 3 Years 13.30% 11.25% 1.32% 34.53%
available for the more venturesome trad- FIGURE 1: SECTOR ROTATION ETF COMPARISON. The SPY has outperformed these ETFs with a much
ers. It offers an annual yield of 0.64%, lower annual expense ratio.
March 2019 • Technical Analysis of Stocks & Commodities • 43
This ETF had 48% of large-cap exposure, 37% mid-cap
exposure, and 10% small- and micro-cap exposure with a
51% style exposure to growth, which is getting pummeled as These specialized, highly
this is written in late December 2018. concentrated ETFs have had
a rough time meeting their
Global X JPMorgan US Sector Rotation Index ETF
(SCTO) goals or keeping up with their
The current issuer of this ETF is Mirae Asset Global Invest- benchmarks or the S&P 500.
ments Co., Ltd. SCTO was introduced seven months after FV
in October 2014, but it has been unable to match FV’s massive
asset-gathering success, with only $3 million in assets—a
very low number by anyone’s measure—and a minuscule PRN (30.5%), PTF (28.0%), PEZ (23.2%), and PTH (18.3%).
daily trading volume of 933 shares. Its annual expense ratio These sector funds represent, in order: industrials, technol-
at 0.83% is lower than that of First Trust’s products, and its ogy, consumer cyclicals, and healthcare. Its September 30,
1.6% yield is 100 basis points better, as well as 16 basis points 2018 holdings were the same within less than a percentage
above the SPY. However, its one-year performance of -9.59% difference. So there was no portfolio change in that time span
is the second worst of the group. although the market took a 15% to 20% hit during that period.
This ETF’s goal is to invest in the best-performing three The healthcare ETF is somewhat defensive, but the fact that
to six sectors (out of the 10 available) while limiting expo- there was no cash at all is something that both potential and
sure during market setbacks or periods of high volatility. existing investors in this ETF should be concerned about,
The portfolio as of December 26, 2018 consisted of: RWR since the portfolio is evaluated semimonthly and a defensive
(28.3%), XLV (19.5%), XLI (17.6%), XLF (17.5%), and XLB posture could have been put into place to limit potential losses
(16.2%). This ETF had 75% large-cap exposure, 19% mid-cap as the market decayed.
exposure, and 6% small- and micro-cap exposure, with a 50% The ETF and benchmark index are analyzed monthly and
style exposure to growth. rebalanced and reconstituted as necessary. There is no XTF
Since the market’s large decline from the September 2018 rating. This ETF had 31% of large-cap exposure, 31% of mid-
highs to late December 2018, this portfolio had no cash com- cap exposure, and 24% small- and 14% micro-cap exposure
ponent but does have the SPDR Dow Jones REIT ETF (RWR), with a huge 83% style exposure to growth. Its sector exposure
which is somewhat defensive. On September 30, 2018, the is 30% technology, 21% industrials, 20% healthcare, and 18%
portfolio contained XLV (30.4%), XLY (18.4%), XLK (17.8%), consumer cyclicals.
XLY (17.0%), and RWR (16.4%). So you can see that since
the end of September through late December, the portfolio Main Sector Rotation ETF (SECT)
increased its exposure to XLV by just over 10 percentage points, This is an actively managed cap-weighted ETF introduced
eliminated XLY and XLI, reduced RWR by 12 percentage by Main Management LLC and is now known as Northern
points, and added new positions in XLF and XLB. Thus, the Lights Fund Trust IV Main Sector Rotation ETF. It seeks to
portfolio composition was shifted to include XLF and XLB, outperform the S&P 500 index in advancing markets, while
which don’t offer the expected defensive posture. limiting losses during market declines by using dynamic
sector rotation based on fundamental analysis (for example,
Invesco DWA Tactical Sector Rotation ETF (DWTR) economic forecasts, inflation data, macroeconomic and capital
This Invesco Capital Management LLC ETF came into ex- markets input). SECT was born on September 5, 2017 and has
istence on October 9, 2015. It is based on the Dorsey Wright amassed a respectable $375 million in assets in just over 14
Sector 4 Index. At least 90% of assets are invested in securities months. Daily trading volume is 63,632. Its one-year perfor-
in this index. A relative strength concept is used, as is the case mance is -8.01%, slightly worse than FV and FVC. Note the
with all the DWA-managed ETFs. The universe available for portfolio consists of 505 positions, a great variance from the
this ETF is the nine PowerShares ETFs. This ETF may hold other ETFs reviewed here.
up to 100% cash using one- and three- month T-bills when The portfolio holds 10 ETFs and a 3% component of cash.
stocks are out of favor, although as of late December 2018 The fund has a low XTF rating of 1.5. Its annual expense ratio
with the market in correction mode or worse, this ETF had is 0.88% and annual yield is 1.02%, the second-best in the
no cash holdings. group. Up to 20% of the portfolio can hold any market cap or
It has the second-lowest asset base at $58 million and the country-denominated security in any currency.
lowest annual expense ratio at 0.75%. Its one-year performance This ETF had 63% of large-cap exposure, 11% of mid-cap
is the worst at -12.27%. And its three-year performance of exposure, 10% small-cap, and 10% emerging market expo-
1.32% is poor compared to 34.53% for the SPY and 23.4% for sure with a 48% style exposure to growth. Its sector exposure
its Russell 3000 benchmark for that period. A daily trading when I checked it was 20% technology, 15% financials, 17%
volume of 17,405 is the second-lowest of the group. healthcare, and 9.7% banking, with another 34% spread among
The portfolio as of December 26, 2018 was as follows: six other sectors.
44 • March 2019 • Technical Analysis of Stocks & Commodities
Performance during year-end meltdown Indexes. The top three sectors with the best momentum (for
How did these five funds perform during the September 21 to example, relative strength) received 20% of the cash, with
December 26 market collapse? Here are the numbers: 10 stocks in each of those sectors each being allocated 2%
of the cash. The next four sectors with the highest relative
FV -20.78% strength received 10% of the cash, with five stocks in each
FVC -20.79% sector receiving 2% of the cash.
SCTO -15.71% This ETF used the Dorsey Wright proprietary Point & Fig-
DWTR -22.60% ure Relative Strength charts to select the 50-stock portfolio.
SECT -17.45% A quarterly ranking of sectors was used and ranking changes
SPY -15.20% were made as necessary. During its short lifespan, SWIN
returned a respectable 22%, which compared favorably to the
Clearly, none of the funds offered any benefit in performance SPY, which rose 22% as well.
compared to the S&P 500 index, even though they all profess A second ETF that folded was the Guggenheim Sector Rota-
to be able to assess the situation and move to more defensive tion ETF (XRO). It was launched on September 21, 2006 and
sectors or cash during a market downturn to minimize principal closed on March 23, 2012. During that nearly six-year period
losses. That goal was not met in any of these ETFs. it returned 10.7% compared to 18.3% for the SPY. The ETF
Let’s go to a longer time period to see if the results are used a proprietary quantitative methodology that focused on
any better. First, let’s review these ETFs with their earliest sectors with superior risk–return characteristics. The port-
common date of September 26, 2017. Figure 2 shows the bar folio held 100 stocks that were selected from a universe of
chart data. The S&P 500 outperformed these ETFs showing the 1,000 largest market-cap listed equities. It had an annual
a return (based on price, not total return) of 2.67% through expense ratio of 0.60%. Formerly, this ETF was known as the
December 26, 2018 compared to losses ranging from -1.2% Claymore/Zacks Sector Rotation ETF.
to -6.26%, again not a favorable outcome.
Finally, Figure 3 shows the return, excluding the more A rough road
recent SECT, to examine an earlier common date of March Clearly, these specialized, highly con-
18, 2016. Again, the S&P 500 beat all these funds over this centrated ETFs have had a rough time
30-month period by a minimum of 9.5 percentage points to meeting their goals or keeping up with
a maximum of 23.55 percentage points. their benchmarks or the S&P 500. Most
Thus, over the three time periods reviewed here, these
unique ETFs have consistently underperformed. Continued on page 55
Stockcharts.com
already closed their doors.
The most recent closure
was the ALPS/Dorsey
Wright Sector Momentum FIGURE 2: ETF PERFORMANCE SINCE SEPTEMBER 26, 2017. During this rapid decline, these ETFs failed to provide the
ETF (SWIN). It had a short defensive shift in the portfolio that was expected based on their objectives. The SPY did much better.
life, as it was introduced on
January 10, 2017 and was
liquidated on October 22,
2018 with about $11.6 mil-
lion in assets, and an annual
expense ratio of 0.40%.
SWIN used a rules-based
approach to select, from a
10-sector universe, a total of
50 stocks with the highest
relative strength (excluding
real estate) in the NASDAQ FIGURE 3: ETF PERFORMANCE SINCE MARCH 18, 2016. Once again, with a longer time horizon, these ETFs failed to deliver.
US Large Cap and Midcap The SPY outpaced them by at least 9.5 percentage points.
Got a question about options? Jay Kaeppel has over three decades of experi-
ence in the options markets. He was a head trader for a CTA firm, an options
trading software developer, and is a portfolio manager for an investment
management firm. He also spent several years writing a weekly column titled
“Kaeppel’s Corner” and now publishes a blog, “Jay On The Markets” (http://
jayonthemarkets.com). He is the author of several books, including The Four
Biggest Mistakes In Option Trading; The Option Trader’s Guide To Probability,
Volatility, And Timing; and Seasonal Stock Market Trends. Send your ques-
tions or topic suggestions to Jay Kaeppel at jaykaeppel@gmail.com. Selected Jay Kaeppel
questions will appear in a future issue of S&C.
ADJUSTING POSITIONS wanted to play this bias in a limited risk our trader may have considered several
USING OPTIONS fashion. One possibility would be to buy choices. The simplest thing to do is let
I hear traders refer to “adjusting” an a deep in-the-money (ITM) January 2019 the position ride and hope the decline
option position. What does that mean, put option on United States Oil ETF continues and that profits continue to
and is it worth knowing about? (USO) which ostensibly tracks the price grow. The problem here is that the trade
Learning to adjust an option position of crude oil. Say USO is trading at $15.52 now has essentially $2,990 of risk if USO
is absolutely worth learning about and a share and a trader bought 10 January reverses and rallies (the original $1,280
is one of the key advantages to trading 2019 17 puts at $1.82 apiece for a total cost plus the $1,170 open profit). If the
options versus other vehicles such as cost of $1,820. As shown in Figure 1, this trader decides to adjust at this point there
stocks, exchange traded funds (ETFs), represents the total risk on the trade and are many choices. What follows is a dis-
and commodity futures. To “adjust” an the breakeven price at January option cussion of just a handful of possibilities,
option position means buying or sell- expiration is $15.18 a share. not a definitive “best choice.”
ing options to change the nature of an By October 23, 2018 USO had fallen
existing position. The good news is that -8% and the put option was showing a 1. Sell enough to lock in a profit: In
option adjustments can often be used to gain of +$1,170 (+64%). At this point this example, to lock in a profit by sell-
improve the reward-to-risk profile of the
trade in question. The tradeoff—in most
cases you give up something in order to
get something else. This idea will become
clearer in the examples that follow.
Trade “adjustments” are frequently
used to try to “lock in” a profit and
then let the remaining adjusted position
“ride.” One old adage in option trading
is to “sell half after a double.” In other
words, if you buy a call or put option and
it doubles in price, you can essentially
lock in at least a breakeven situation if
you sell half of the options you bought.
While this isn’t bad advice, the reality is
that this approach first requires you to buy
a call or put and have it double in price.
Anyone who has traded for any length
of time will know this is no simple feat
(and doesn’t happen nearly as frequently
www.OptionsAnalysis.com
Crude oil
Crude oil has displayed a negative sea- Figure 1: Playing seasonal weakness in crude oil with USO put options. If you bought 10
sonal bias during the months of October January 2019 17 puts at $1.82 apiece for a total cost of $1,820 that would be the total risk on the trade. The
and November. Let’s assume a trader breakeven price at January option expiration is $15.18 a share.
To “adjust” an option
position means buying
or selling options to
change the nature of
an existing position.
Point( NULL ),
double NewSwingPrice( 0 ),
F TRADESTATION: MARCH 2019 TRADERS’ TIPS CODE double SwingPrice( Close ),
In “The V-Trade, Part 7: Technical Analysis-V-Wave Count,” int TLDir( 0 ),
bool SaveSwing( false ),
which appeared in the September 2018 issue of Technical
bool AddTL( false ),
Analysis of Stocks & Commodities, author Sylvain Vervoort bool UpdateTL( false );
introduces a tool to assist in counting waves based on Elliott
wave theory. His SVE zigzag ticks indicator automatically method TrendLine CreateNewTrendline()
draws trendlines highlighting the waves using a specified variables: TrendLine tempTL;
begin
number of points to detect the pullbacks. A sample chart is
if UseBNPoint then
shown in Figure 1. tempTL = TrendLine.Create(
Here is the TradeStation EasyLanguage code for a zigzag LastSwingBNPoint, SwingBNPoint )
indicator based on the author’s description. else { use DTPoint }
tempTL = TrendLine.Create(
Indicator: SVE ZigZag Ticks LastSwingDTPoint, SwingDTPoint );
// SVE ZigZag Ticks
// TASC Mar 2019
// Sylvain Vervoort
using elsystem;
using elsystem.drawing;
using elsystem.drawingob-
jects;
inputs:
double HighPivotPrice(
High ),
double LowPivotPrice(
Low ),
double RetracePnts( 5 ),
int LineColor( Yellow ),
int LineWidth( 1 ) ;
variables:
intrabarpersist bool
UseBNPoint( false ),
int DrawingObjectBar-
Number( 0 ),
TrendLine ZigZagTrend-
line( NULL ),
DTPoint SwingDTPoint(
NULL ),
DTPoint LastSwingDT-
Point( NULL ),
BNPoint SwingBNPoint(
NULL ), Figure 1: TRADESTATION. This sample TradeStation mean renko chart of the FDAX index shows the SVE zigzag ticks
BNPoint LastSwingBN- indicator.
Description:
The V-Trade. Part 7:
Technical Analysis—V-
Wave Count
by Sylvain Vervoort
Version: 1.00
01/15/2019
Formula Parameters:
Default:
NumberOfTicks
200
Notes:
The related article is copy-
righted material. If you are
not a subscriber
of Stocks & Commodities,
please visit www.traders.
com.
Figure 2: eSIGNAL. Here is an example of the study plotted on a 60-minute chart of SPY. *****************************
*****/
function preMain(){
F eSIGNAL: MARCH 2019 TRADERS’ TIPS CODE setPriceStudy(true);
For this month’s Traders’ Tip, we’ve provided the study Sve- setStudyTitle("SveHLZigZagTicks");
HLZigZagTicks.efs based on the article by Sylvain Vervoort,
“The V-Trade, Part 7: Technical Analysis-V-Wave Count,” from var x = 0;
fpArray[x] = new FunctionParameter("NumberOfTicks",
the September 2018 issue of Technical Analysis of Stocks & FunctionParameter.NUMBER);
Commodities. with(fpArray[x++]){
The study displays the waves (swings) on the price chart. setName("Reversal Number of Ticks");
A sample chart is shown in Figure 2. setLowerLimit(2);
The study contains formula parameters that may be con- setDefault(200);
}
figured through the edit chart window (right-click on the
chart and select “edit chart”). fpArray[x] = new FunctionParameter("LineColor", Func-
To discuss this study or download a complete copy of the tionParameter.COLOR);
formula code, please visit the EFS library discussion board with(fpArray[x++]){
forum under the forums link from the support menu at www. setName("Line Color");
setDefault(Color.RGB(0,148,255));
esignal.com or visit our EFS KnowledgeBase at http://www. }
esignal.com/support/kb/efs/. The eSignal formula script }
(EFS) is shown below and is also available for copying &
pasting from the Stocks & Commodities website at Trad- var bInit = false;
ers.com from the Traders’ Tips menu. var bVersion = null;
var vFlat = null;
/********************************* var vCurrentTrend = null;
Provided By:
eSignal (Copyright c eSignal), a division of Interactive var xOpen = null;
Data var xHigh = null;
Corporation. 2016. All rights reserved. This sample eSig- var xLow = null;
nal var xClose = null;
Formula Script (EFS) is for educational purposes only and
may be var vLastHigh = null;
modified and saved under a new file name. eSignal is not var vLastHigh_1 = null;
responsible var vLastLow = null;
for the functionality once modified. eSignal reserves the var vLastLow_1 = null;
right var vZZTemp = [];
to modify and overwrite this EFS file with each new var vZZfinal;
F NEUROSHELL TRADER: MARCH 2019 the current price is a new peak or valley.
TRADERS’ TIPS CODE Users of NeuroShell Trader can go to the Stocks & Com-
The SveHLZigZagTicks indicator that was in- modities section of the NeuroShell Trader free technical
troduced in Sylvain Vervoort’s September 2018 support website to download a copy of this or any previous
article in Stocks & Commodities, “The V-Trade, Part 7: Traders’ Tips.
Technical Analysis-V-Wave Count,” can be implemented in A sample chart is shown in Figure 4.
—Marge Sherald, Ward Systems Group, Inc.
NeuroShell Trader using NeuroShell Trader’s ability to call
301 662-7950, sales@wardsystems.com
external dynamic linked libraries. Dynamic linked libraries www.neuroshell.com
can be written in C, C++, Power Basic, or Delphi.
After coding the indicator in your preferred compiler
and creating a DLL, you can insert the resulting SveHLZig-
ZagTicks indicator as follows:
Figure 6: AIQ. This demonstrates the built-in zigzag indicator on an AIQ chart of SPY.
KoSInSKI/breaKawaY GaPS
Continued from page 40 trading breakaway gaps can
lead to profitable results.
Pawel Kosinski, PhD, MEng, is a professor in process tech-
nology at University of Bergen in Norway. His research Further reading
interests involve mathematical modeling of various physical Kosinski, Pawel [2018]. “Double Bottoms Revisited,” Tech-
phenomena, and he uses this experience for researching the nical Analysis of StockS & commoditieS, Volume 36:
financial markets. He was the principal founder of the site September.
lookintotrade.com, which offers backtesting of various strate- ‡TradingView
gies. He may be reached at pawel.kosinski@uib.no. ‡See Editorial Resource Index
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 contract’s 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 firm’s shares outstanding.
exchanges LINKS
The information in Traders’ Resource is the most accurate at the time of posting and is subject to change. Because the vendors posting to Traders’ Resource are responsible for their own listing, Technical Analysis, Inc. declines any and all liability
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accuracy and reliability of claims herein. You agree to release Technical Analysis, Inc., together with its respective employees, agents, officers, directors and shareholders, from any and all liability and obligations whatsoever in connection with or
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PAIR TRADES: TO BUILD OR In total, Trader A (TA) adds three lay- therefore didn’t reestablish.
NOT TO BUILD ers at spread prices -1, -2, -4, so the Regardless of TA’s decision to add or
Continuing with the theme of pair trading average is -2.33. Say the pair retraces not, production in the pair would have
that I set out to focus on in this column from -4 back to the average at -2.33. At occurred and closed profits would have
for 2019, I will discuss some of the areas this point, TA feels happy because the been made, offsetting the open losses
that offer opportunities to handle things pair is back to the breakeven price. TA from the first two layers. Note: Traders
in one of more ways, or not at all. takes no action, watching closely. What may differ from investors in tax consid-
is most likely going through TA’s mind erations, so be sure to know what is best
Tips on position building in pair is the thought that the pair will continue for your specific tax situation.
trading to move higher from this point. (Like Don’t mix styles on the fly or outside
In my opinion, it is more important to most people, TA would be inclined to your plan. In the heat of the battle or
be a student of your own trading than value the recent move from -4 to -2.33 the fog of war, traders can abandon dis-
a student of the markets. Through this heavily, when what should be consid- ciplines regarding rules, trading plans
sort of self-analysis, you may discover for the day, or plans for the specific pair.
that you are accurate on your initial Trying to hit homeruns, get your money
trades, resulting in “one-off” trades and
When pair trading, back, or get even will all work to hurt
without the need to build larger posi- it is better to trade you. I recommend readers to take a mo-
tions through averaging in additional each layer or unit ment to reflect on the value of managing
pair layers. Others may find themselves independently so that positions, trading around a core position,
usually wrong on the first pair trade, but and closing profits through the “produc-
able to perform better with the second
the trader focuses on tion” of multiple slices of capital into a
and third layer using that first layer for the production of some pair. Can this work with trading a stock
information-gathering. or all the units. naked? Certainly, but naked traders may
There is a difference between estab- have market exposure.
lishing a position through averaging When layering, logarithmic distribu-
layers (that is, having an average spread ered is overall context—what catalyst tion may provide an advantage over
price) and trading the position according caused the move up, the pair’s average fixed-distance scaling. Varying bets at
to that average price. For stocks, it may be daily range (ADR) or average true range key levels or inflection points may also
suitable to trade the average, but for pairs (ATR) and percentage move of that, and increase the benefits.
I never recommend trading the average readouts from other suitable indicators). Be mindful of my previous recom-
of a position. My personal experience, Later, the pair retraced back to -4 and mendations in this column to classify all
along with my numerous observations unfortunately, nothing was accomplished pairs into two distinct categories: those
in working with other traders during my as Trader A sat through the volatility. that are trendy by nature (signal) versus
career, is that the mathematics of success- Most likely, risk has increased with the those that are range-bound by nature
ful pair trading doesn’t support trading spread action, and TA is fully loaded (noise). Classifying pairs accordingly can
the average spread price. It is better to and exposed. assist you in allocating capital correctly.
trade each layer or unit independently so Here might be a better approach for Noise trading suggests scaling, while
that the trader focuses on the production Trader A: If TA in the same situation signal trading suggests “one-off” trades
of some or all the units. acted at the -2.33 by taking the -4 layer may be better for harvesting opportunity
Here are some examples: off, TA would have made 1.67 times the while managing risk.
position size of that last layer. This would
Trader A: have reduced the total capital needed. To stop-loss or not to: Tips on the
• Has a long bias for a pair In addition, when the spread sold back mechanics and psychology of stop-
• Wants to establish the first unit of down to -4, TA could have redeployed losses
capital or layer at a spread price that unit of capital. Or TA may have How should stop-loss considerations be
of -1. decided the risks were increasing and incorporated into our trading plans?
60 • March 2019 • Technical Analysis of Stocks & Commodities
Trading Perspectives
We all know that many traders bleed loss procedures could be introduced that abandoned self-management and any
accounts out through the repetitive are parameters based on any of the 10 attempt to produce any alpha. Some
actions of stopping out trades that are symbols or they could remain symbol- buy ETFs to somewhat self-manage, but
losing money. specific. The overall theme, though, is don’t want to be stock pickers. Others
So perhaps the answer is in the initial that going wide and reducing the size hand their money over to mutual funds,
construction of the trade. A benefit of into any one idea, you reduce risk and personal advisors, robo-advisors, or
trading pairs is the ability to reduce direct therefore reduce the stopping out of hedge funds.
market exposure and macro exposure in large losses. I understand the sentiment and reasons
some cases. Pair traders tend to be indif- for these decisions, but I will communi-
ferent to or insulated from the types of cate my views here. I believe that arming
problems naked traders can have. Let’s I view stop-losses not yourself with information and the educa-
say a strong setup or signal occurs and as stopping losses but tion on how to apply that information in
through point & click or through auto- as responding to the a focused manner can be a game changer.
mation, the signal is acted on opening a validity of a trade. There are still two distinct communities
long position. Through no fault of their in equities markets: the herd and the
own, the market has a significant selloff informed. The herd is rather large, and
and renders the trade as a loser. The pair I view stop-losses not as stopping the informed community is smaller,
trader may have seen no real change to losses but as responding to the validity of considering the information age.
his P/L during this market event, as both a trade. We need a valid reason to enter It is a challenge and it takes effort to
stocks went down together. a position, build a position, remain in create alpha, but through using analytical
Next, it’s about the position size. If the position, and finally, a valid reason data and tools, trading with a positive
you trade smaller per idea, there may to exit. If the pair you have chosen is expectation, and staying focused on
be less need to stop out with the minor no longer “business as usual,” then it relative performance, it is my view that
fluctuations that are hard to sit through may be best to exit the position, whether it can be achieved.
with size. This applies to both the naked profitable, breakeven, or a loss. Just as
trader and the pair trader. there is usually a fundamental reason
In my July 2018 column I wrote re- behind a chart pattern, there could be a
garding stop-losses: “One of the ways fundamental reason to enter, remain in, SUBMIT AN ARTICLE!
to position size is by how much you or exit a single pair trade or an averaged-
are willing to lose on any given bet.” I in position.
discussed that this is a noble ambition Stop-loss parameters are often in-
with no guarantees, especially if you troduced by drawing on the common
take positions overnight. Regardless, and familiar considerations. This is
position sizing is crucial and should be problematic for a naked trader more
specific to several factors. Position size so than for the pair trader. When a pair
should be based on risks such as news trader constructs a unique opportunity
catalysts, fundamentals, price, liquid- not widely known, or adopted, then that
ity, volatility, and your specific holding trader is insulated from the traps and
timeframes. predatory, informed order flow. If the Are you knowledgeable about technical
Perhaps it’s better to go wide rather pair is widely traded, the trader is more indicators, charting, trading systems, and
than deep into one idea or one strategy. vulnerable to many who are watching money management? Or do you have a solid
If you could touch 10 symbols with the same support, resistance, and key background with intraday trading, trading
qualified probabilities instead of just price points or ranges. psychology, options and cycles? If so, we’d
one, you would reduce your need to be like to hear from you!
perfectly right on the single selection, To trade or not to trade: timing the To write for any of our publications or
and your advantage could come from market obtain more information, please click on
being right as an average from all your From speaking to industry colleagues, Contact Us at www.Traders.com.
bets. Remember, there is only a one in 10 it appears the message that needs to be
chance of selecting the right (profitable) communicated to market participants
symbol out of 10 symbols, but if you have is “you can time the market.” This has
a positive expectation for each symbol, been a debated subject and of course,
then the outcome might be that four of the trading industry wants activity in the
the 10 give you significant profits, one form of volume and purchases of tools
a slight profit, three breakeven, and two and services related to the industry.
have a loss. As long as the magnitude of Many, through failure, disillusionment,
losses doesn’t outweigh the gains, stop- increased fees, and lifestyle choices, have
March 2019 • Technical Analysis of Stocks & Commodities • 61
Explore
Algo Q&AYour Options
Davey acceptable one is found. So this task is tion will be different, hopefully you now
Continued from page 25 frequently frustrating, which may be one have an idea of what to expect in the life
reason people do not spend enough time of an algo trader. I’m sure you’d agree
As you can see, I spend the bulk of my on it. Meanwhile, I still spend significant it is much different than for discretion-
time developing strategies. This is also time on the other tasks, which helps keep ary trading.
the hardest task, since many potential every trading day interesting.
KaePPeL
Continued from page 47
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