Two Simple Ways To Increase Your Options Win Rate
June 29, 2006
The Smart Profits Report: Issue #324
Thursday, June 29, 2006
Two Simple Ways To Increase Your Options Win Rate
By Karim Rahemtulla
Chairman, Mt. Vernon Research
You often hear complaints about how the rich receive investment breaks, how the laws are designed to let the rich pay less taxes, and how the rich don’t do enough good with their money. But earlier this week, you saw the world’s two richest men combine their fortunes in an extremely positive way.
Renowned investor Warren Buffett’s $30 billion donation of his $44 billion fortune to the Bill & Melinda Gates Foundation is thought to be the biggest non-governmental donation in modern finance. In the end, both men will have pumped more than $70 billion into the Gates Foundation. That means more than 80% of their wealth will now be used to benefit others…
These were not fortunes made in shady back rooms, from illicit smuggling or from warmonger profiteering. They were made publicly and honestly through innovation, hard work and smart investing. (And it’s important to note that they made the decision to part with their hard-earned cash - a personal choice, rather than one mandated by elected governments officials seeking to appease constituents or win elections.)
While you might not attain Buffett or Gates-like wealth, you’re certainly in a position to generate some wealth of your own by making heads-up investing decisions. Today, let’s look at two simple ways to increase your options win rate.
What Does Your Track Record Look Like?
In yesterday’s Smart Profits Report, D.R. Barton asked whether confidence is born from successful investing, or whether successful investing breeds confidence.
It’s a good question, and D.R. went on to give you three ways in which you can grow your investing confidence. (If you missed it, see the Crib Sheet below). But today, I want to follow up on that and focus on a couple of simple things you can do to evaluate your own system and become a better investor.
Take a look at your own trading track record. How often do you win?
With stocks, you should be aiming for a 60% to 70% win rate. But it’s trickier with options because:
- They move quicker than stocks
- Are often more volatile
- Lose value due to time decay
Your judgment also needs to be better, such as which way the option will go, how far, by what time, etc.
What To Do When Your Trades Go Against You
So, what do you do when your trades go against you? Sulking about it and getting frustrated won’t work. Neither will panicking. Here’s a better way…
- Know Why You’re Trading: Preparation and research is everything. Make sure you know the reasons why you’re investing in a security. It doesn’t matter what system or strategy you use - if you can’t answer the question and be able to support it, you need to do more research. Often, it helps if you’re familiar with the business the company is in and why it makes a good investment. Write these reasons down before you make the trade, so you’re clear.
- Review and Expand: Despite your best-laid plans, trades will sometimes go against you - it happens to everyone. When they do, review it. Look at the charts, the fundamentals, the technical analysis to see if there’s anything you missed or could have done differently. Diversify and expand your knowledge of trading systems, investment tools, company data and the way the industry/sector works to give yourself a better chance next time.
Harness this with the confidence-building techniques we gave you yesterday and there’s a strong chance that you’ll soon enjoy some great improvements in your trading success.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- The key to successful trading starts with the basics. In yesterday’s Smart Profits letter, D.R. Barton highlighted three ways you can build up your confidence when investing. Combine that with today’s message and you should soon improve your winning average. Check out Smart Profits #323, Trading With Confidence: How You Can Develop More Confidence In Your Trades.
- Want more on “fundamental” and “technical” analysis - and how to incorporate them into your trading strategy? Visit our Smart Profits Glossary to brush up on these terms.
Related Articles:
- Fundamental Analysis: Three Screens for Technical Traders
- Technical Analysis: Two Simple Tools for Spotting a Technical Trend
- Options Trading Strategy: A Five-Question Screen to Find the Perfect Option
Trading With Confidence
June 28, 2006
The Smart Profits Report: Issue #323
Wednesday, June 28, 2006
Trading With Confidence: How You Can Develop More Confidence In Your TradesBy D.R. Barton, Jr.
Advisory Panelist, Mt. Vernon Research
Confidence is contagious. So is lack of confidence.
~Vince Lombardi
Have you ever opened a magazine and seen a full-page ad of some luminary sporting a “milk mustache”? I like the question, too. “Got Milk?” Everyone from Michael Jordan to Britney Spears has appeared on a print or TV ad with the milk mustache and the famous tag line. The ads insinuate that the success of these stars is attributed to drinking the nutritious liquid.
So, if we lined up the finest traders and had to put a tag line under their picture, what would it be? There is one characteristic that distinguishes the “haves” from the “have-nots” - a quality that’s decidedly different for a top trader when he’s at the height of his game versus when he’s struggling (all traders have times of struggle)… What would the tag line be? Got Confidence?
Does trading success develop confidence, or is it the other way around? It’s a fair question, but probably not the “right” one. A better question would be, “Have you ever seen a consistently profitable trader who lacked confidence?” Or, “When you have had a string of trading excellence, did you feel more or less confident than usual?” Here’s why trading with confidence is crucial to your trading success, and how you can get it by focusing on three key elements…
Forming A Foundation For Confident Trading
As applied to the world of trading, let’s call confidence the ability to act without reservation. Confidence is developed when key underlying characteristics have been put into place. One needs to have his trading psychology in place, a strategy or system that is proven, and execution proficiency.
When these three elements come together, they form a foundation upon which a trader can act with great confidence. Let’s look at each of them, and see what steps you can take to help put them in place…
Confidence In Your Personal Trading Psychology
We’ll start with the most important item - your personal trading psychology. To have confidence when you trade, you will need to develop a keen sense of who you are and how you will react to both common and extraordinary trading situations.
For example, how will you feel after losing six trades in a row? How will this affect your performance on trade seven of this string? What will be your plan to develop the patience, discipline and other attributes needed to provide consistent performance while trading?
If you are not completely satisfied with your psychological state of readiness, your confidence as a trader will constantly be in doubt. If your plan for gaining psychological mastery needs to be upgraded, then look into the Peak Performance Home Study Course described in the “Tips and Tricks” section below.
Confidence That Your Trading Strategy Works
The second area that you need to develop is your trading system or strategy. While this is an area that traders spend most of their time on, I find that they spend very little time developing confidence that the strategy works. This takes time and patience.
Can you state succinctly why your system works? Do you know what types of market conditions are best for your system’s performance? In what types of markets does it perform poorly? What kind of losing streaks can you expect every month or quarter with your strategy? What size drawdowns will these loosing streaks produce? Too often, people buy a strategy or quickly develop one over a weekend and then start trading it without getting to know why, how and when the system works. So be prepared to spend the time required to really know the “nuts and bolts” of your trading strategy.
Confidence In Your Own Definitive Trading Plan
Once you have developed your trading psychology, and taken care to build a strategy that you know works, you need to be able to execute it consistently. There is a psychological element to this part of your trading (many traders have trouble “pulling the trigger”), but there are also some key logistics that you need to take care of in order to trade with confidence.
If you are worried that your trading software won’t work or that you don’t understand it, or if you’re concerned that power outages and Internet issues will keep you from executing your exits, or if you think that the market makers and specialists are “out to get you,” then you are definitely going to have trouble trading with confidence. The tool that can help you overcome these concerns is a well-defined trading plan that includes a “disaster plan” and a good understanding of how your trades are executed.
Confidence is not an end in itself, but it is a desired result of having a comprehensive trading process that works. If you struggle with achieving a state of confident trading, I suggest that you dissect the three areas that we talked about in this article. If you find one or more areas that need upgrades, then put together a plan to increase your mastery in that area - a psychology investment plan or a system upgrade plan, etc. Look toward improving your confidence to improve your trading.
Good Trading,
D.R. Barton
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Today’s Smart Profits Cribsheet
- My good friend Dr. Van Tharp has written the trading world’s definitive guide to trading and investing psychology and discipline. His Peak Performance Home Study Course is must reading for every serous trader and investor. Get your copy of this great study course now (be sure to scroll down to the first listing for Peak Performance Home Study Course)!
- Confidence in your trading couldn’t be more important right now, as the market continues to take big swings in both directions. For traders, the high volatility can actually be a good thing… To find out how, check out Smart Profits #321, Fast and Furious Volatility is Back in a Big Way: How To Profit Using Leg Spreads & The VIX.
Related Articles:
- Investor Sentiment & Market Behavior: Seven Tips For A Profitable Downside Bias
- Understanding Option Trading: Cut Your Losses… And Watch Your Gains Run
- What’s Happening in the Global Markets: The Global “Ripple’s” Headed Our Way
The Chart of the Week
Qualcomm (Nasdaq: QCOM) is a stock known for its gaps because of all of the news the company generates. But recent news has sent the stock into a tailspin since its May highs, slashing through two key levels. Another close below $38.50, and the share price could be headed to $32.
Sphere: Related ContentFast and Furious Volatility is Back in a Big Way
June 22, 2006
The Smart Profits Report: Issue #321
Thursday, June 22, 2006
Fast and Furious Volatility is Back in a Big Way: How To Profit Using Leg Spreads & The VIX
By Karim Rahemtulla
Chairman, Mt. Vernon Research
Fast and furious volatility is back in a big way.
Over the past few weeks, I’ve written about how volatility is barreling back into the market with a vengeance. But the level and rate at which it’s jumped in such a short amount of time is remarkable - the ultimate definition of “fast and furious.”
So why is this happening?
There are many reasons, including the obvious ones like rising inflation and higher interest rates, America’s bloated deficits, military conflict and geopolitical strife in the Middle East.
But there’s a bigger force at work here…
- Many investors became very complacent.
- They believed the markets wouldn’t go down…
- That commodities are king…
- And that the empire was fully-clothed.
You and I both know that, yes, the markets will eventually trend upwards again…that commodities might well be king…and that the empire will hopefully regain a full wardrobe. But beware: This is a longer-term picture. In the short-term, it’s that complacency that has led to higher volatility and made some investors pay.
How We Cashed in on Volatility for 50% Profits
However, no matter what the event is, or how serious it is, there’s usually a way to profit from it. And that’s exactly what the subscribers in one of my services (The LEAPS Trader) did recently.
In anticipation of higher volatility, I advised them to take a position that went LONG on volatility, using the VIX Volatility Index, which basically measures implied volatility over the coming months. The options are as easily tradeable as any other option in the market and the recommendation said to buy February 2007 options.
Having entered the trade when the VIX was hovering around 13, it hit 22 within a few weeks. That was a day many investors probably felt like turning off their computers and packing up for the day. But LEAPS Traders cashed out - and pocketed 50% gains, just as the markets were down a full 10% across the board from their highs. Much better than the ugly 30% slump in emerging markets, but down nonetheless.
That’s iron-clad proof that even when volatility is rampant and the markets are stumbling, it’s still possible to grab excellent profits.
The End of Volatility and Profits? No Way! “Legged Spread” Leads to More Gains
Many investors would be delighted with 50% gains - and rightly so. But whenever there’s an opportunity to make more, we’ll grab it with both hands.
Realizing that the spate of volatility was far from over, LEAPS Traders then made that 50% seem tame by engaging in a “legged spread.” This is my favorite type of trade, because it accomplishes what every investor dreams off: No downside and huge upside.
At the time of the trade, the initial options that my traders bought for $2.70 was bidding for $4.20. Those who wanted to sell did so - and enjoyed the 55.5% gains.
I advised those who wanted to stay in to hold on to their existing options and sell some others against the position they held. Why? Because when I checked the prices of the options that were one strike higher, I noticed that the bid was $3.
How The Legged Spread Leads To “Option Envy”
We bought the original options, a $15 strike price for $2.70. Against this position, we sold the $17.50 strike options, worth $3. When you sell an option for more than the one that you are holding is worth, you end up in a position known as “options envy.”
Net result? Those investors were being paid $0.30 cents per contract to hold this position (the difference between $2.70 and $3).
Here’s the kicker: Ultimately, this trade cannot lose. The least amount of profit available is $0.30 per contract. And the upside potential? The price of the spread - $2.50 (the difference between the original $15 strike price and $17.50 strike price that you’re selling against the first option).
Since it’s complicated to calculate a return on a trade where your basis is negative, let’s use a nickel as our bet. Assuming you buy ten contracts, the cost of your spread would be $50.
Here’s the upside: If the VIX, closes at $17.50 or higher at expiration, each ten-contract spread would be worth $2,500. So if you risked $500 initially, then your upside would be $25,000. Worst-case risk scenario? You “only” make $0.30 per contract.
Market Moving Against You? Use the VIX
Investors ask the question all the time: I can make money when the market is trending up - but how do I protect my investments when it moves against me?
That’s where the VIX can be your best friend. When the market is moving against you, it’s made for a trade like the VIX spread illustrated above.
Remember…the options market was created by professionals to hedge positions against risk. You’re just exploiting their secrets and using them to protect yourself from the inherent risks of investing in today’s unpredictable markets. It’s just about as ideal a solution you’ll find.
And what’s almost as good as making money on the VIX? Making money on the QQQQs…if you are short that is. More on that next time.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- You’ve seen how my LEAPS Trader subscribers pocketed 50% gains and more, simply by using what the market gave them - volatility - to profitable advantage. Find out how you can join them and make money like that for yourself. Call our VIP Trading Services team at: 1-888-570-9830
- Several key options terms for you to learn in today’s message. Use our Smart Profits Glossary to find out the meaning of phrases like: LEAPS, Volatility, VIX, and Spread.
Related Articles:
- The VIX Index: Instant Access to the World’s “Best Contrarian Indicator”
- Market Volatility: How to Pay $27 for a $50 Stock
- LEAPS vs. Stocks: How to “Own” Almost Any Stock for Pennies on the Dollar
What’s Happening in the Global Markets
June 20, 2006
The Smart Profits Report: Traders’ Tuesday: Issue #320
Tuesday, June 20, 2006
What’s Happening in the Global Markets: The Global “Ripple’s” Headed Our Way
By D.R. Barton, Jr.
Advisory Panelist, Mt. Vernon Research
My first and last roommates in college had one common characteristic - neither had ever wandered very far from their respective hometowns until they went off to university. They were great guys. Both were good, respectful roommates. But I must say that in a broad sense, they lacked perspective. All of their views had been formed by local events. They were sketchy on issues of national importance. And their knowledge of anything on the international scene was nonexistent.
This may sound like a naïve way to go through life. But I know many traders and investors who take the same approach. If something happens outside the U.S. markets, they don’t know a thing about it. And right now, BIG THINGS are happening outside the U.S. markets. Of course, you wouldn’t know it by watching business TV in the U.S. Even the traditionally reliable Wall Street Journal has provided only spotty coverage of the devastating moves that have struck foreign markets.
When such big swings are happening throughout the global markets, they will eventually have ramifications for us here at home. Let’s take a look at why this happens and what we can do in our trading and investing to protect ourselves and take advantage of global trends.
Don’t Believe the Perma-Bulls; All’s Not Rosy In The Global Markets
Last Thursday (June 15), we had one of the strongest days of the year. The TV analysts were giddy - some declaring that “the bottom of the market was in.” This may be true for the short run. But during the summer doldrums, we are almost sure to see lower stock market prices.
There’s a simple reason for this: the global markets have really been rocked in the recent decline. And while it’s easy to shrug this off and say that the U.S. economy is just stronger than the rest of the world’s economies, that would be a mistake.
The global economy is intertwined, and prudent traders everywhere are keeping a close eye on what’s happening elsewhere.
The bottom line is that huge drops in global markets will have a ripple effect in global consumption - especially on discretionary spending. And this will have an adverse effect on the U.S. markets that we haven’t felt yet.
Before we discuss what you can do in your trading and investing, let’s look at what has happened in the global markets. These numbers are current through June 8:
As you can see, the U.S. market suffered much less during the current pullback. (The S&P 500 Index did trade down further after I made this chart, but has not gone lower than 8% off its highs).
I don’t expect the U.S. markets to drop 50% like those in the Middle East. But I do expect further declines this summer, if for no other reason than lowered consumer spending worldwide (as well as in the U.S.)
What You Can Do To Prepare For Summer
There are several things that every trader and investor can do to prepare themselves for the summer months:
- Long-Term Investors: Keep your head out of the sand! Don’t be like the TV pundits who think higher market prices are a birthright. The markets will move up and then they will move down. Then this pattern will repeat. Make sure that you have an exit strategy for each of your positions. Then you can protect yourself should this sell-off become more severe. Be patient and watch for signs of a global market turnaround; after prices strengthen for a week or two (or three), some serious values will be available globally.
- Intermediate and Swing Traders: Beware the current volatility. Wider stops and smaller positions are prudent until the volatility pattern becomes more defined. Remember that the market has two sides - there will be long and short opportunities for us.
- Short-Term Traders: Enjoy the volatility! Enjoy the rapid direction changes and two-sided market. This is the market short-term traders wait for all year.
- All Traders and Investors: Seriously consider widening your scope of research and trading. Active traders can look at the German DAX futures contract (traded on the Eurex exchange), which is popular among intra-day traders. Investors can consider adding country-oriented Exchange Traded Funds (ETFs).
Good Trading,
D.R. Barton
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Today’s Smart Profits Cribsheet
- My good friend Horacio Márquez, Advisory Panelist for The Oxford Club, follows the global markets like few analysts. His trading service, the Money Map Advantage, has made some great calls in global markets and gotten investors involved in easy-to-implement and profitable ideas outside the U.S. Learn more.
- To learn more about our newest addition to The Smart Profits Report, check out D.R. Barton’s bio.
The Chart of the Week
While the market has firmed up a bit off of last Wednesday’s low, traditional momentum indicators are not yet giving us anything to sing about… Our analysis says that the bottom is not yet in for the summer.
Related Articles:
- The Best Emerging Market of the 21st Century
- Correlation Strategy: Identify the Tide And Ride It To Profitability
- Understanding Option Trading: Cut Your Losses… And Watch Your Gains Run
Looking for Sector and Company Trends
June 19, 2006
The Smart Profits Report: Issue #319
Monday, June 19, 2006
Looking for Sector and Company Trends: Profiting From the “Templeton Tactic”
By Dean Albrecht
Advisory Panelist, Mt. Vernon Research
The period immediately before you take a position in a stock or option can be one of the most apprehensive times you’ll face as an investor.
The question that runs through most minds is: “How do I know this investment is going to pay off?”
Well, as any seasoned investor will tell you, the short answer to that question is that it’s impossible to predict what’s going to happen. There are no guarantees - not in a volatile market, where the climate can change without warning and for no reason.
But there are steps you can take to make the process go smoother and avoid some sleepless nights. And the process all starts before a potential investment even pops up on my radar screen, when I first look for sector and company trends.
Conservative or Speculative? Appreciation or Income?
You first need to identify what you’re looking for from the underlying stocks in which you have options positions. Are you looking for growth or value? Solid capital appreciation over several years, or a conservative, income-based stock that pays a decent dividend? Perhaps you can afford more risk and want to go for a speculative small-cap?
Personally, I look for an investment that provides solid growth at a reasonable price. And unlike many investors who immediately shun a sinking stock, I also look to buy good companies on a growth pullback.
There are two ways to look at the overall market climate:
- When the market is trending up over the short term, you want to be invested, because the bullishness is likely to spill over (or as the adage goes, “a rising tide lifts all boats”), and if you make a short-term error in your actual investment, there’s a good chance the market will bail you out.
- When the market is trending downward, the usual reaction is to short it, or buy puts. This can often pay dividends, if only because of investor behavior. Sometimes all it takes is a little negativity and the “investment herd” panics and blindly follows everyone toward the exit.
But be careful. If the situation reverses and the market (and your investment) heads back up, you need a decent tolerance for risk, patience and courage in your convictions to wait it out.
Or you could take the Templeton approach…
Turning $10,000 Into $40,000… In Four Years
Sir John Templeton is one of the most renowned investors - a man who once famously placed his bets without really paying too much attention to overall market direction.
Back in 1939, he simply formulated an idea, did his homework and borrowed $10,000 from his boss to buy the 100 cheapest, most undervalued stocks that he thought represented incredible value. Many of the companies were trading under $1 and/or were close to bankruptcy.
But by employing an astute macroeconomic view (remember, this was the start of World War II, when American patriotic spirit was at its highest) and the “rising tides lifts all boats” theory, he cashed out on all the stocks within four years and pocketed $40,000 in profits.
At the onset of the dotcom crash in 2000, Templeton also spotted the top 100 overvalued stocks that were in the most trouble and shorted them. He took profits between 50% and 75%.
Keep It Simple: Looking for Sector and Company Trends
However, not everyone can have the same success as Templeton did.
With options, the key to maximizing profits is searching for the right trends in the underlying securities/companies and their sectors.
Take Apple Computer (Nasdaq: AAPL), for example. The company is benefitting from a surge in the lucrative online music sector and trending upward. With that, it makes sense to go long, even on a pullback. After a remarkable run, the stock then expectedly retreated, but continued to feed off strong sector momentum and moved back up.
The same occurred with Research In Motion (Nasdaq: RIMM). At the height of its problems in court over the Blackberry patent, I analyzed all the sector and company fundamentals and sent out a bullish alert. That, coupled with the trend on my stock analysis system, told me that this was a company primed for a move.
Despite RIMM temporarily edging down, true to form, the system proved right and the stock jolted up by $20 over the next couple of months.
Remember that the market primarily moves on two simple - but very powerful -emotions: Fear and greed. So, first identify what kind of investor you are and what you’re looking for from your investments. Then use that investor sentiment and any underlying market/stock trends to your advantage.
Good Trading,
Dean
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Today’s Smart Profits Cribsheet
- Timing your investments properly is one of the most critical elements to successful trading. So if you want to maximize your options profits, you’ll need Mt. Vernon Research Chairman Karim Rahemtulla’s essential four-step guide in Smart Profits #104.
- Fear and greed are the only two forces that move the stock market. Learn how to turn “maximum fear” into maximum profits in Smart Profits #211.
Related Articles:
- Market Volatility: How to Pay $27 for a $50 Stock
- Exit Strategies: Prenuptial Agreements for Options
-
Become a Better Trader: Small Changes You Can Make for Big Profits
The Best Commodities Website on the Internet
June 15, 2006
The Smart Profits Report; Issue #318
Thursday, June 15, 2006
The Best Commodities Website on the Internet
By Lee Lowell
Advisory Panelist, Mt. Vernon Research
Whether you’re an amateur investor or master trader, one thing is clear: In this day and age, you need to obtain your investment research and data from quality sources.
In Tuesday’s issue, my colleague Jim Stanton told you about the archaic way he used to go about getting stock and options prices back in the early 1980s, and how far investment technology has come since then. I’ve been trading commodity options professionally for about 14 years now and like Jim, I’ve seen some major advances in research and data over that time.
There are a vast number of websites you can go to get information, but picking the best ones can sometimes be tricky. How do you know they have the best information available? Today, I’m going to give you the benefit of my options experience, both as a professional commodities trader and former market maker on the floor of the NYMEX, and give you the best commodities website on the internet that I use every day for getting commodities quotes. And the greatest part? It’s free…
The Best Commodity Quotes And How To Use Them
My favorite site is FutureSource.
Quite simply, if you don’t want to pay for a fee-based service, just go here and you’ll be able to do just about everything that a high-end subscription service offers.
When you get to the homepage, you’ll see tabs along the top. You can choose to see charts, quotes, option chains and read the latest commodity news. The site also has a section, named “My FutureSource,” which allows you to set up these choices any way you like and create your own personal, free workspace.
If you’re serious about trading commodities, then this is the site for you.
To pull up quotes, simply click on the “Quotes” tab at the top. This will take you to a page where you can either pick the exact commodity you want, or you will see commodity groups. These include meats, grains, energies and metals. Type “S” into any one of the blank symbol boxes and the page will bring up soybean futures, along with all the trading months available.
FutureSource At A Glance
Take a look at the snapshot of that page:
Once you’ve decided which soybean month you want options prices for, click on the middle icon in the far left-hand column. This will bring up the relevant options chain.
In this case, I’ve chosen the November 2006 options:
As you can see, there are two drop-down menus at the top of this screen. This lets you choose which type of options chain you’d like to see. To the right, I usually like to opt for the “Adjacent” menu as it shows the call options on the left and the put options on the right. It’s easier to see the numbers that way.
The other drop-down menu lets you choose the refresh rate for the options. Since this is a free site, option quotes are delayed by the amount of time set by the specific commodity exchanges. Quotes on most New York markets are delayed by 30 minutes and by 10 minutes on the Chicago markets. You can either manually refresh your browser or use the auto refresh option from the menu.
In the far right-hand column of the chain, you’ll see the number of days left until the options expire. In previous Smart Profits issues, we’ve talked extensively about time decay and how longer-term options offer the best value, so this is a key piece of information.
One Major Difference Between Stock Options And Commodities Options
One extremely important thing you need to know about commodities options is that the price breakdown is not the same as with stock options.
With stock options, each contract is based on a multiplier of 100. For example, if you bought a stock option for $2.25, that would equate to $225.
However, each commodity has different multipliers. For instance, a soybean option has a multiplier of 50. So if you bought a soybean option for 20 “ticks” or “points,” that would equate to $1,000 in total dollars.
Before you decide to invest in any commodity option, it’s essential that you know what its point multiplier is, as it can affect your price in a way that you might not be prepared for. You can find each commodity’s point multiplier from their respective trading exchanges.
Put Your Investment Future In Good Hands
Despite being recently acquired by eSignal, Futuresource.com naturally also offers its own datafeed product that you can buy, in addition to the free service that it offers.
I get many requests from friends as well as attendees at our option conferences to where the best place is to get commodity option quotes. I always tell them that if they’re not subscribing to a data retrieval service or using their broker, Futuresource.com is still my favorite place.
And since I’ll be launching my own commodity options advisory service in the near future, I also want to give you the easiest way to get commodity option quotes. Use Futuresource - it’s well worth it.
Good Trading,
Lee Lowell
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Today’s Smart Profits Cribsheet
- Surf on over to FutureSource and check it out for yourself, the best commodities website on the internet.
- With the strong, ongoing bull market for commodities set to continue, it’s a sector that’s well worth your attention. Mt. Vernon Research Chairman Karim Rahemtulla shows you how you can profit by setting up your own commodities-based “Mini Hedge Fund“.
- I talked here about the importance of noting options expiration dates and time decay, so you always get the best value for your investment dollars. Read about this in more detail in one of my previous Smart Profits Report: #307: A Lesson on Time Decay and How to Go In-The-Money for Top Buys
Related Articles:
- Option Chains: How to Pick the Right Option if You’re Bullish on a Stock
- The Chicago Board of Options Exchange: The Website Every Options Trader Should Know
- Time Value: With Options, You Need to Be Right on Time
Continuation Patterns
June 13, 2006
The Smart Profits Report: Issue #317
Tuesday, June 13, 2006
Continuation Patterns: Cashing In On Technical Analysis
by Jim Stanton
Advisory Panelist, Mt. Vernon Research
When I was a stock and bond broker back in the early 1980s, I used an archaic “Quotron” machine to get prices. As for technical analysis, the only investors using that trading method did so using a large, printed edition of the weekly Daily Graphs publication. This was a laborious and time-consuming task, since it required the use of a ruler and pencil to determine support and resistance levels along with uptrend and downtrend lines - certainly none of the fancy computer graphics available today.
One of the first companies to offer computerized technical analysis was CQG (Commodity Quote Graphics). I came across it in 1985 while visiting a client and the range of built-in analytical tools fascinated me.
I’ve been hooked on technical analysis ever since and, after years of research and fine-tuning, have developed a proprietary technical trading model. And it can generate a lot of money, especially when you are using continuation patterns within your charts…
The Trend Is Your Friend
My system is based on chart pattern recognition - and is a vital tool in identifying trends such as consolidation patterns (what many traders refer to as trading ranges) that you can profit from.
Consolidation patterns represent investor indecision and usually occur after a sharp or extended up or down move. While they can take on different forms - pennants, flags or triangles - there is one type of consolidation pattern that is easy to recognize. And, if you’re patient, it can be traded with a high degree of success.
It’s called a continuation pattern, which basically means the stock will continue moving in the same direction once the consolidation is complete. It occurs after a significant high or low is made and is followed by a sharp reversal.
Bullish Continuation Pattern
Take a look at the daily AT&T/SBC (NYSE: T) chart below, which illustrates a bullish continuation pattern at work.
Charts Courtesy of Trade Navigator Software (www.genesisft.com)
Having plodded downward for over a year, AT&T then staged a sharp reversal in October of 2005. It went on to rally more than 17% before the consolidation phase began.
Here’s the key to recognizing that it’s a bullish pattern: Note that throughout December 2005 and January 2006, the stock traded in a fairly narrow range and did not retrace back down by more than 38% of the initial move up.
As I mentioned above, you do need to show a little patience before trading. But if you bought some call options at the breakout point, it was well worth the wait.
Bearish Continuation Pattern
Now let’s look at the system in reverse. Take a look at the weekly Dell (Nasdaq: DELL) chart below that shows a “bearish” continuation pattern.
As you can see, DELL made a significant high in December 2004, and then retested it in July 2005 before falling almost 30%. It hit an initial low in November 2005, and although it moved back up again, it bounced around in consolidation mode for the next five months without ever exceeding its 38% retracement level. Again, exercising patience and then buying puts on the eventual breakdown would have chalked up another winner.
Consolidate And Accumulate
Technical analysis doesn’t have to be difficult.
Recognizing consolidation and continuation patterns is relatively simple. They show up on both longer-term stock charts, as well as intraday charts. Just look for an extended move after a significant move either up or down. Within the consolidation pattern, there are usually at least three smaller up and down moves, depending on how bullish or bearish the markets are acting.
Once you become familiar with these patterns, your knowledge will tell you the best time to invest at a better price, before the stock breaks out or breaks down.
In these examples, I used the 38% Fibonacci retracement line. Usually, the steeper the decline, the less of a retracement you’ll see as the consolidation pattern forms.
Another characteristic you need to be aware of is that while the stock is consolidating, it’s not unusual for the stock to set a new low or high while it’s in the consolidation pattern. It’s not shown in the chart above, but this happened with DELL, as it ticked down from its initial November low of $28.62 to $28.60, only to pop back above $30 before the full breakdown occurred.
But if you learn how to read consolidation and continuation patterns and spot trends, you’ll be able to take profitable advantage.
Good investing,
Jim Stanton
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Today’s Smart Profits Cribsheet
- Want to know more about Fibonacci and 38% retracement lines? I explained it all in Smart Profits #313: “Fibonacci Retracement Levels: Let “Leo” Calculate Your Support and Resistance”
- For more than 20 years, I’ve used technical analysis as the foundation of my approach to investing profitably. Get the key definition on exactly what this is, as well as other terms such as “breakout” and “resistance” in the Smart Profits Glossary.
Related articles:
- Head and Shoulders Pattern: A Proven Sell Signal Called Breaking the “Neckline”
- Breakout and Resistance: How to Anticipate and Profit From These Twin Concepts
- Technical Indicators: How to Overcome the “Evil Twins of Trading”
The Best Emerging Market of the 21st Century
June 9, 2006
The Smart Profits Report: Issue #316
Friday, June 9, 2006
The Best Emerging Market of the 21st Century
By Karim Rahemtulla
Chairman, Mt. Vernon Research
When I first started in the investment business, I spent more time on the road than in an office, exploring the exceptional opportunities that the best emerging markets presented.
More than a decade later, what was true then remains true now. Those same great opportunities still exist. But emerging markets like China, India, Brazil, Mexico and Malaysia are also fraught with risks. Most notably, these include political tensions, poor economic management and currency issues, inadequate infrastructures that can’t keep pace with the strong growth and a lack of decent research.
With international equities in the midst of a sell-off, much like the markets at home, now’s a good time to take a closer look at what lies ahead for three emerging markets in particular… and the one I like most.
The Turkish Transformation
A couple of weeks ago, I visited Turkey. And the changes in that country over the past five years have been nothing short of amazing. For example, Istanbul, where I stayed for a week, has radically transformed itself from a “kind of European city” to one on par with many other European cities. Okay, it hasn’t quite reached the “A-List,” like London and Paris, but it’s definitely in a league with places like Prague and Athens.
Upon arriving in Istanbul, an impressive, brand-new airport greets visitors. The city is clean, its hotels are excellent, monuments are striking and higher prices have moved Turkey out of the “massive bargain” realm of a few years ago.
By emerging market standards, Istanbul is an expensive city. In fact, were it not for my visit to China last year, I would have thought that prices were still very good. But a good meal that cost me $5 a few years ago now costs about $10. The markets and bazaars are busier than ever.
But therein lies the problem for countries like Turkey, India and a host of other emerging economies: They can’t compete with the world’s factories. In fact, many of the items for sale in Istanbul’s bazaars came in boxes marked “PRC” - the Peoples Republic of China.
The Sinking Stock Market In India
Besides Turkey, I’ve also embarked on a research trip to India over the past year.
Yes, India has changed markedly, but it’s still not close to being the juggernaut that China is today. Opportunities still exist, just not at current prices.
When I was in India in February, with colleagues James Boric and Greg Grillot, we all felt that the stock market did not reflect reality. I often remind readers that the entire market capitalization of the Bombay Stock Exchange is less than the market cap of the top-five U.S. companies. A close examination of the market revealed it was overdue for a fall - one that is now happening hard and fast.
From a 52-week high of 12,671 on May 11, the index has since plunged 22.5% in just one month. Indian papers are now even talking about the high possibility of investor suicides, as many have lost everything.
What about China?
The Best Emerging Market of the 21st Century
Undoubtedly, China is the best emerging market story of this century. But even that does not make it a good investment if you can’t withstand a lot of risk.
China is a major depressionary force for other emerging markets since it is the lowest-cost producer. That puts a cap on the prices of goods worldwide. It also puts a cap on profits from companies that operate in many sectors.
The best sectors for profiting in the Chinese Millennium: Infrastructure, aviation, commodities and finance.
Sectors to avoid: Manufacturing and retailing. Why? Because they are going to continue to witness margin pressure as the never-ending flow of goods pours from the Great Dragon.
Don’t get me wrong. I’m bullish on China. Just not today. Remember that China is an emerging market - and that means risk and lack of transparency. The financial system, for example, is nothing more than a house of cards. The banking system is a mess and the government hides most of the bad accounting from Western eyes.
I believe there will be a major shakeout for Chinese stocks. There has to be. And it will happen when the Chinese government decides to take the painful measure of coming clean in an S&L type of crisis. This will wipe out a lot of equity, but it will be the first real step forward for the Chinese market. And that is when I will be buying China.
Good Trading,
Karim
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Today’s Smart Profits Cribsheet
- I first alerted Smart Profits readers to the impending Indian market correction back in early March. Get the details on this emerging - but still very raw - market in Smart Profits #287, Emerging Markets: Two Plays in India…with Caution.
- And around Christmas 2005, I told readers about one of the key economic issues today - and one contributing to the massive U.S. trade deficit: the abundance of cheap goods in China. Read all about it in Smart Profits #269: Emerging Markets: Forget the Great Wall of China - Let’s Go Shopping!
Related Articles:
- Maximum Fear: How to Turn “Maximum Fear into Maximum Profits
- Principal Protection: How to “Defend” Your Principal from a 50% Bomb
- Event-Driven Markets: The ONE Case for Using Short-Term Options
Hedging Long Positions
June 7, 2006
The Smart Profits Report: Issue #315
Wednesday, June 7, 2006
Hedging Your Long Positions: “Putting” More Money Into Your Portfolio
by Steve McDonald
Advisory Panelist, Mt. Vernon Research
The bears must love this market…
We have two unpopular wars and another highly combustible situation brewing with Iran; inflation is raising its head for the first time in years; the Federal Reserve is threatening to raise interest rates another 0.5% to combat it; and oil prices are doing their usual yo-yo routine.
For the past several weeks, I’ve been studying the market closely, wondering what it’s going to take for the market to drop even farther than it has recently. Just yesterday, the Dow dipped back down under the 11,000 level - and it seems to me that the herd is just waiting for the right time to send the market over the cliff.
The good news is that this is the perfect time for hedging your long positions…
Minimizing Portfolio Damage With Hedging
If you’re like most investors, the majority of your portfolio positions are long in stocks and calls. You’ve bought a good company, you’re riding out the inevitable ups and downs in the market, and ultimately benefiting from its long-term upward movement.
But hedging minimizes the damage those “downs” can cause along the way…
Hedging simply means buying put options on your current long positions. By doing so, you give yourself a profitable safety net to offset the downside blow when the market takes a tumble.
Let’s take a look at the Dow’s one-year chart, including its 50-day and 200-day moving averages. (Note that from October 2005 until the first week of May, the index rose almost straight upward.)
Once the Fed started talking about raising interest rates again, and oil prices jumped above $70 per barrel, the dip started. If you follow the 200-day moving average (in green) to the point where it intersects the price (in blue), you’ll see that the most likely stopping point is somewhere around 10,700.
Take a look at the one-year charts for your current holdings and see if any of them have the same dip.
The chart of Alcoa (NYSE: AA), for example, is almost identical to the Dow’s, and the stock will most likely follow the market down.
The logical thing to do here would be to buy a put option to benefit from what appears to be an inevitable drop. Here’s how you could do that. (Note: This is not a recommendation, just an example.)
Hedging Your Long Positions With Put Options
- Alcoa is currently trading around $30.60.
- The October $30 put (AAVF) is priced at $1.95 per contract.
- So, for every 100 shares of stock, we could buy a put option for $195.
As the underlying stock drops toward $30, the option price goes up and you make some money, while still holding the stock for the longer-term.
This is a simple - yet powerful and profitable - strategy. But keep in mind that if the market reverses course and heads higher, you could lose some - or all - of the $195 you paid for the put. But if you monitor it, you should be able to limit your loss. Remember, you cannot lose any more than what you paid for the option.
With all the current negative pressures surrounding the market, we’ll be lucky if the market does indeed stop at the upper 10,000s. Of course, if you’ve followed the markets for as long as I have, you know there’s a possibility that it won’t. So, it stands to reason that learning to develop a downside awareness will make your life a lot easier - and a lot more profitable - during the inevitable downturns.
Good investing,
Steve
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Today’s Smart Profits Cribsheet
- With the stock market hitting the skids of late, now is a great time to protect your investments. Find out how to develop a downside bias and profit when stocks go up or down by taking a look at Smart Profits # 311, Investor Sentiment & Market Behavior: Seven Tips For A Profitable Downside Bias.
- In today’s issue, Steve mentioned that buying put options could also make you money in a down market. Take a closer look at “put options” or “LEAPS” in the Smart Profits Glossary.
Related articles:
- Put Options: Why Short a Stock When You Can Buy a Put?
- LEAPS vs. Stocks: How to “Own” Almost Any Stock for Pennies on the Dollar
- Trading Short Term Options: A System for Reading the “Market Weather”
Breakout Trading
June 1, 2006
The Smart Profits Report: Issue #314
Thursday, June 1, 2006
Breakout Trading: The “Stanton Gap Rule” For Next-Day Profits
By Jim Stanton
Advisory Panelist, Mt. Vernon Research
“New highs are bullish and often lead to higher highs. New lows are bearish and often lead to lower lows.” This is just one of many old Wall Street adages. For the most part, it’s true. But as with many rules, this one has an exception…
I’ve spent the last 20 years working with brokers and traders, and when a stock they’re following makes a new short- or long-term high, also referred to as a breakout, they immediately buy shares, or some call options, and then monitor the trade constantly, trying to figure out how much profit they can squeeze from it.
But I’m going to give you a much easier way to confirm a true breakout. And, just as important, I’ll show you how to prevent taking a loss…
Steer Clear Of False New-Highs
There are a number of reasons why stocks gap up.
The most common is based on news, whether it’s general economic news or bullish news on the company itself.
Think about it. How many times have you seen the indexes open higher on encouraging economic news, only to run out of steam and reverse course later that day? Similarly, a company makes a positive announcement that sends the stock higher, but investors quickly grab profits and the stock ends up lower.
This is the famous “buy the rumor; sell the news” adage in action. And if you’re not quick enough, you’re often the one left holding the bag at the end of the day.
Many traders believe the technical definition of a gap opening is when a stock jumps significantly higher once the market opens. But the trouble is that if a stock opens higher and a breakout occurs that day (we’ll call this “Gap Day”), the gap sometimes creates a false new high. This is where many investors get tripped up, as they pile into the stock with gusto, only to see it correct back down later that day.
Making Sure The Breakout Is Valid
Save yourself the frustration and a financial loss, and be patient. Don’t blindly follow everyone else. I’m a conservative trader and I’m always looking for ways to reduce my risk, so wait for confirmation that the breakout is valid before buying. And the way to confirm that it’s a true breakout is to wait a day and place a buy order just above the high of the “Gap Day” - let’s call this strategy “Stanton’s Gap Rule.”
Even if the “Gap Day” does prove to be a valid high, and you end up paying a little more for the stock, it’s much better than pulling the trigger too soon and then watching your investment decline as the stock fails to maintain its momentum.
Take a look at the chart below. It shows the performance of Time Warner (NYSE: TWX) from June 2005 to April 2006. It’s a perfect example of the “Gap Rule” exception in action:
Chart Courtesy of Trade Navigator Software http://www.genesisft.com
As you can see, TWX was pretty volatile over this period:
- Having set a high of $18.70 on August 9, 2005, it then pulled back to the $17.50 level just three weeks later.
- It then shifted course again and rallied back up to $18.59 on August 15, before closing at $18.50.
- The following day, it opened at $18.63 ($0.13 higher) and quickly climbed to $19.
But look what happened after that. If you’d bought the stock on August 16, based on that breakout, you’d have lost money very quickly. And if you’d held your position, you’d have watched the stock sink for nine months.
The Key To Maximizing Profits While Minimizing Risk
Watch the market carefully and follow “Stanton’s Gap Rule.” In the example above, if you had waited a day and placed your buy stop at $19.01 (one penny above the “Gap Day” high), you’d have safely seen TWX fail to maintain its momentum, and avoided a loss.
If an economic report comes out after the market opens, or news comes out on an individual stock during the day, causing a breakout, I don’t take the bait. Investor sentiment is critical and it often makes sense to wait and see if the stock can maintain its momentum the following day.
At times, I use a breakout above a downtrend line to enter a trade, but using my own gap rule in these situations has kept me out of bad trades on many occasions. Sure, there will be times when applying this strategy might result in you paying slightly more for the stock/option, if it does continue its run higher. But doing so will lower your risk, and you’ll avoid the feeling of seeing your investment head south immediately after you’ve bought it.
Good Trading,
Jim Stanton
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Today’s Smart Profits Cribsheet
- May was a rocky month for the market. And some investors saw potential gains evaporate in a matter of 10 trading sessions, from May 9 to May 23… But Advisory Panelist Steve McDonald viewed the market’s recent slide as an opportunity. Find out why in Smart Profits #311, Don’t Let a Down Market Get You Down: Seven Tips For A Profitable Downside Bias.
- We’ve taken a close look at “gaps” and “breakouts” today… While you’re at it, browse the free Smart Profits Glossary to round out your options vocabulary.
Related Articles:
- Breakout & Resistance: How to Anticipate and Profit From These Twin Concepts
- How to Avoid Panic When the Train Leaves Without You
- Head and Shoulders Pattern: A Proven Sell Signal Called Breaking the “Neckline”
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