Hugh's Strategy: 'Bread and Butter' A methodology that earns 5-10% per day

Transcription

1 2014 Hugh's Strategy: 'Bread and Butter' A methodology that earns 5-10% per day This strategy is simple yet effective, buying and selling straight calls and puts. No complex spreads or intricate formulas required to create long term wealth. Use it wisely and enjoy the fruits of your labor! estockoptiontrading.com bestchoicedaytrader.com optionstrainingonline.com All rights reserved. July, 2014

2 Hugh s Bread and Butter Strategy The object of this exercise is to fast track you to making money quickly, consistently and efficiently in the stock market. Hence, this program does not teach everything there is to know about the markets, the 30,000+ stocks out there, the various exchange traded funds, penny stocks or the countless strategies, etc. You can learn all that on your own, if you so wish; or I can teach you that as well but you will likely find that learning one great strategy is all you need. Through years of trading and learning, winning and losing, I have determined that quick, reliable gains create long term wealth, as long as you keep your wits. My Bread and Butter strategy is primarily based on statistical analysis. It is designed to take the emotions out of the trade entirely and let the probabilities work in your favor. Executed properly, this strategy should double your money every month, even with the inevitable losses. I should also mention at this point that it is assumed the reader is familiar with basic options trading. A word, too, about the examples and charts: even though they may be dated, they are every bit as valid today as the day they were first introduced. The math behind the system will never change. I use SPY as my stock of choice. Very liquid, high open interest, weekly expirations, 50 cent strikes and penny spreads, SPY represents the top 500 stocks. It spans all the sectors and is not controlled by any one stock. As the economy goes, so does SPY. It also has predictable chart patterns and is very forgiving. Individual stocks, on the other hand, are affected by market conditions, the personal health of a CEO, the president s relationship with his staff, dividends, earnings, competition, pending government approvals the list goes on. SPY is immune to those factors. Furthermore, SPY options trade until 4:15 pm. As a trader, you need to understand that there is no fool proof strategy that could never lose. There will always be a risk to trading. In fact, there must be because the only thing a buyer and seller agree on is the price; they disagree on the value. A seller thinks the price will drop whereas the buyer believes it will rise. If there was a system that never lost, that would mean that it could be automated and market prices would soon be in equilibrium. The result would be the elimination of market volatility. Hence, losing is every bit as important as winning. We just have to ensure that it is we who win; let someone else take the loss. Of course our objective is to gain the edge and just take our little piece out of the market every day. If you believe that this system will never fail, you ll be disappointed. If anyone tells you they have a 100% failsafe system, as sure as I m sitting here, they are lying. With the market having been around for centuries and the many thousands working the numbers, certainly by now, somebody would have invented that fool-proof system already. Would you gamble your money on it? I sure wouldn t. That said, this system works incredibly well, based on statistics. The sample spreadsheet below identifies the date, opening stock price, the strike price of the calls and puts you would have purchased at opening that being the highest price paid between the opening bell and 9:31, the highest the calls and puts hit for the day and the differential between that opening high and highest daily prices shown as a percentage.

3 I ve also identified the direction of the macds and stochastics on the 1 hour, 30 minute and 5 minute charts prior to open. This is but a sample. My actual current worksheet includes a sample size of hundreds of trades, representing weekly and monthly expirations of at the money options. I ve selected a typical sample from November, 2011 to illustrate the movements SPY. The indicators work equally well any time of the year, even in the summer doldrums. Judging from the above analysis, you can profit handsomely if you: a) pick the right direction, b) enter at the preferred time, c) don t be greedy exit aiming for 5-10%, depending on the strength of the move, and d) use money management techniques to control your losses. a) Direction: There is an art and science to this, brought about with experience. Get to know the stock it s patterns, it s behavior. The longer you study and trade paper or real the more you will conceptualize the trade. Find out how it reacts to news. How much importance does the market put on overseas exchanges from overnight trading? How much does it care about the European economy? Does it respond to actual news items or the analysts response to news items? Does the market stay with the news of the day or does it bounce back quickly? Does the market overreact to news?

4 Then I look at longer term charts: monthly, weekly and dailies, along with their respective indicators, which incidentally, are all historic. The only indicator that shows what the price is doing now is the price itself, that being best illustrated using candlesticks. 10 Year Monthly Chart with the macd on the sub chart. Each candlestick represents 1 month.

5 Look for prices approaching a support or resistance area. See if prices are range bound or looking to break out to hit new territory. This gives the reader a feel for the pressure points. I actually spend only a few brief seconds in premarket on this aspect of the analysis; nothing in depth, just a cursory review. How does the weekly chart compare? Does it support the monthly charts? Determining longer term trends gives us a sense of market direction, albeit not necessarily where it s heading at the moment. It would be comforting to know that we are riding the same wave, should we enter the market in the same direction. 10 Year Weekly Chart. Each bar represents 1 week.

6 Longer term trends are caused by shorter term price movements. It s a short term price change that changes direction first, that is true. However, longer terms do indicate trends that are more integral than short term variances. The stock still has to breathe, vacillate in its chosen shorter range. Longer term trends provide a strong bias, even though we re aiming for short term trends to fulfill our daily goals. With longer term trends, in this case gravitating upward, it doesn t take much to knock it a notch higher. Money begets money so as more cash fuels the market, the more it attracts. Monthly and weekly charts all support a longer term upward movement but look at the macd on the daily chart below. As hard as it is to fight that longer term trend, there will be times to consider shorter term trends. The dropping macd suggests that the price is likely to drop in the coming days.

7 We were correct; the trade took a turn to the down side shortly after peaking at around $190, dropping about $8, which means a huge profit on put options. All charts and indicators are courtesy of TD Ameritrade Think or Swim

8 More on the direction: Futures Just before market open, I check the futures. Try to find the flow between 8 and 9 am and between 9 and 9:20 am. Are they down and dropping further? Did they bottom out and are now rising? Was there bad news that saw them drop at 8 am and now they re recovering? Where is the current movement going? I place more weight on the latest time frames but I correlate it with the news and overseas markets. Below is what I look at the DOW (/YM), S&P (/ES) and NASDAQ (/NQ) How much weight do we put onto the Net Change? If it s up to on the DOW, I consider it neutral. At a -66, I would consider shorting. I also look for consistency among the futures. Bottom line: I try to establish a 'flow'... long term to short term, from monthly drilled down to daily, hourly, 15 minute to minute charts to see general market direction, condition and how prices reflect news. News drives stock prices. Using I observe the scheduled news releases for the coming day. How the market reacts to high impact news matters. For example, if a high impact unemployment report is negative, yet the market takes it all in stride, prices will probably overall rise during the day or at least enough to get me out of a trade with a profit, provided I enter at a favorable time. Bloomberg.com and MarketWatch.com are also good sources of financial news. Gauging market direction will become second nature the more you do it. Despite all best intentions, there will be days where you will miss the mark. Consider that your trade will be saved by buying the right option, with enough time ahead for the stock to work through its meandering. I like to buy next week's 'at the money' options, giving me ample time for the trade to mature. It's a lower stress trade. Two week's out is even better, although your options may not move as much. For greatest movement and excitement, trade the nearest expiration; just be aware of the greater risks as they will expire quickly. Time value (theta) erodes options faster the closer to expiration.

9 b) Entry Point: I use the 5 minute chart as an entry guide. My direction is decidedly short looking at the latest candlestick. Notice that once the drop takes hold, it runs its course for most of the morning. I expect to be in and out of the trade quickly, by noon at the latest. Going short is fulfilling the prediction. Macd supports the move. The 5 minute chart is my grounding chart; I want to ensure to trade in that direction.

10 My actual trade, however, will be triggered by the 1 minute chart with the stochastics and macd in concert with each other. Both indicators need to be going down, preferably with the stochastics dropping off the 80 overbought line or if in mid stream, taking a sharp turn to the down side. I want to ensure that the 1 minute macd is also in compliance with the stochastics. Therefore, 1 minute stochastics, 1 minute macd and 5 minute macds must all be in agreement to launch a trade. 2 Day 1 Minute Chart. Each bar represents 1 minute.

11 The 1 minute charts provide the triggers to the moves but realize there s a lot of noise in these charts. Prices will fluctuate, at times wildly, while maintaining a longer term trend. Vacillation on the 1 minute charts is normal and in some ways, should be welcomed. After all, that is where the profits are. The 1 minute charts form the basis of the 5 minute charts. Individual trend divergences are not uncommon nor should they be viewed as a threat but as the price breaks through ranges, keep an eye on the longer term charts for clues of trend reversals. Nerves of steel are required to watch these trades unfold as you need to stay with that 5 minute trend, despite the 1 minute vacillations often turning against you. KEY INDICATOR - STOCHASTICS The stochastics on the 1 minute charts serve as an entry point. I recommend this key entry indicator using the 80, 20, 6, 5 settings, slightly modified from the defaults. When I see the fast line (green) cross over the overbought line (80), heading down, it s strong to the short side and possibly a good entry point. Likewise, when the fast line rises out of the oversold (20) line, it s likely good to the long side. Watch this with the related macd. In the second case, the slow line (red) is also at or below the oversold (20) line and following along, as if to give the fast line a push up. When the fast and slow lines are in the same direction and positioned as such, the move is almost guaranteed. Once in the move, I follow the macd on the 5 minute chart and let that take me out when it rolls back over. Watch the 1 and 5 minute charts together for optimum entry and exits.

12 c) Exit Point: There are a several ways to exit a position. But before I embark on a trade, I ensure that there is ample room for the stock to grow into before it hits the next major support or resistance level. In the example below, we see a significant difference between resistance levels, should the price of SPY break to the up side. Exit Plan A: Should that happen, I look at the delta's. A rule of thumb: an option costing about $1 has a.50 delta, which means that if the stock rises $1, the option would rise $.50. As the option goes 'into the money', the delta increases, so it will actually work in your favor. Therefore, considering that this stock will likely rise.32, an option costing about $1 should rise the delta x change in price, or.5 x.32 =.16. On an option costing $1, that.16 represents a 16% profit. As it turned out, as indicated in the following chart, the price did rise to the occasion, and rather quickly at that. This trade would likely have been worth the effort, considering there may have been a sizeable gain, as estimated beforehand.

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14 Clearly, a quick calculation prior to placing the trade can pay off handsomely. Incidentally, this example netted 17% in less than 15 minutes. You would have been done for the day long before 10 am. Exit Plan B: Statistically speaking, SPY will make this move virtually every time. I never want to say it's fool proof because there is always the outside chance that the trade will turn against you. There are never any guarantees in this business. However, a fairly safe target price is 8%. So, once you re in the trade on the above setup, set your target price to profit 6% - 10%, depending on the strength of the move, much of which comes from gut feel, based on experience and knowledge of the stock. Put your sell order in immediately and walk away. Come back later to find the money in your account. If you re watching it, don t get spooked should it go against you. In all likelihood, that negative direction will not hold. Stay with the move. For safety, I like to buy the next week out, at the money or one strike out of the money and set a 'good to cancel' order. Then let the market work its magic. Usually it will give you your gains the same day. Sometimes you may have to wait but this system works time and time and time again. Exit Plan C: Once you are in the trade, follow the 5 minute macd. Stay with it, stay with it, stay with it... until that macd starts to pull back around to its slow line. This often takes a lot of courage as you will likely have to tolerate much noise on the 1 minute chart. In fact, it can be downright spooky as so often that 1 minute will come back and even put you in a loss position before it regains its strength back up. Most often, this exit will deliver much greater profits but it can, on occasion, turn on you as well. Either way, always, always practice good money management. d) Money Management: I do not use stop losses for this trade. Chances are that a stop loss will take you out every time, should you go the wrong direction. Of course, you will say "But that's what they're supposed to do! And besides, every course I ever took told me to use stops!" Yes and no. You would be correct but remember that stocks move up and they move down. If you did your research, used discipline and patience to enter at an appropriate price, set your target at a reasonable level, having purchased enough time and strike price to facilitate the move, then you should have no concerns. Like a bottle of fine wine, let the market come to you. Market makers are charged with removing cash from your account into theirs. They do it in part by creating liquidity in the market. In some cases, this means creating both buy and sell orders at the same time. Rest assured, if you get in a battle with them, they will win. If nothing else, they likely have deeper pockets than you and are better equipped to stay in the war.

15 Why Stops do NOT work: It happens all too often: you're in a trade and suddenly taken out with a stop, yet the price never even approached your exit point. Just what did happen? The market maker executed a trade well below the current price to take out stops. The chart below depicts the move. Had you had a stop at point A, B, C, D or anywhere in between, your stops would have executed. Fact is, the price of SPY was in range E, not below. Often times, computers may be set up to ignore these isolated incidents. So the market makers execute repeated spike orders, bypassing your controls and triggering your stops. They make millions every time they do this. You may hear others say that it's errant data. Well no, it isn't. It's a well thought out strategy utilized to separate you from your money. Don't fall for it. If you wait long enough, you ll likely fulfill your sell order some time during the day or possibly soon thereafter. Hence, let it run its course.

16 Even if you re wrong in the direction, SPY will usually provide that 8% gain eventually. If you insist on using a stop loss, use a very high limit 50% or more should keep some of your money should something major occur that does, in fact, reverse course on you. On more than one occasion, I had a loss in excess of 70% and still came back with a profit. There are ways to correct a bad situation but that's for another e-book. More on money management. One key technique I employ is this: If your trading account has $10,000, trade only a small portion of it $1-2,000. If the market drastically changes, your option will still have value but if you lose 50% over the next several days, your loss will be $500-1,000. Not good but you re still a player. Be very careful coming into expiration days. Volatility is high and the theta gets eaten up quickly. Trade the front week only if you re very certain of the move. To ease the pressure, trade the following week expiration, should you need to hold overnight. This becomes critical the closer you are to expiration day. I do enjoy weeklies for the excitement and profitability on the greater moves. The monthly options still give you 8% quite readily but also allow you to survive a plunge, should that happen. Summary: A mere 5% a day doesn t sound like much but consider this: if you only make 20 trades a month, making 5% net, without compounding, that s 100% gain a month. In other words, if you trade $1,000 almost every day in Month 1, you d have $2,000 at the end. Then reward yourself with $500 for your efforts and trade $1,500 every day for the next month. By the end of Month 2, you should have $3,000. Reward yourself with $1,000, leaving $2,000 to trade for Month 3. By the end of Month 3, you should have $4,000 in your trading account. Another $1,000 reward at the end of Month 3 leaves you $3,000 to double for Month 4 for a $6,000 gain. Do it again and you ll have $10,000 at the end of Month 5. You get the drift. In about 8 months, this technique will turn $1k into over $100k, faster if you're actually good at it. Earning 5% a day is not that difficult. In fact, you should be able to pick that up quite easily before lunch. Discipline and patience pays off in this strategy, which incidentally, is ideal for the person who is otherwise occupied for most of the day. This is one case where watching it can actually hurt you. It s best to buy it, set the sell and forget it. On my Recent Results page, you ll see some returns much greater than 5-10%. Should you like to discuss these further, it may be wise to book some solid one on one time together. A note on a U.S. federal rule that could impact your trading: you are considered a pattern day trader if you are in and out 4 or more times in a 5 day period. If that is the case, you need to carry a minimum of $25,000 in your trading account. Otherwise, you can only trade up to 3 times in a 5 day period. This is not a requirement on Canadian accounts.

17 There are other indicators I also use but what I provided here should enable your daily bread and butter trades. The other indicators I refer to will provide you with greater wealth. I invite you to use this methodology as a good starting point in your day trading career. We offer enhancements to this program and, at the risk of sounding like an up sell, it is noteworthy that those who profit the most are those who engage wholeheartedly with our programs. We offer Inner Circle membership, where clients can log in to the web site every morning at 9:20 to see what trades I am looking to place. Along with a follow up report later in the day, including screen shots of my actual trades, the Inner Circle provides a good starting point to 'get your feet wet'. You would be wise to partake in some of our various training opportunities, including live and recorded group sessions held quarterly, providing a complete training package from entry level to experienced traders. Our personal 'one on one' coaching facilitates learning at a very personal level, engaging on anything you require. When folks walk away from these sessions, they usually me back reporting exceptional profits. One 'must have' tool is our custom written software. Using sophisticated algorithms, they provide very predictive triggers on SPY using the Launch Pad and Launch Pad Plus. The KISS Indicator notifies the user of any short term imminent moves on 15 great stocks, including SPY, DIA, IWM and QQQ. Our recent addition, the Batter's Box, has proven to be the hottest tool, racking up a virtually perfect score on longer term, swing trades, ideal for those unable to watch the market during the critical morning hours. Lastly, you wouldn't want to miss our exclusive Live Trading sessions, Tuesday and Thursday mornings. Three pro traders host these events, narrating the premarket, through to trade setups, purchases and sales, using our own real money. Follow along to learn and earn or just sit back and observe. In addition, these interactive webinars are a lot of fun, from 9:20 to 11 am ET. I hope you join us! Hugh July, 2014 Disclaimer: The information hereby given is for educational purposes only. Past performance does not guarantee future results. Option trading is inherently risky. While trading can be profitable, you can lose it all too. Trade at your own risk. While I disclose my intentions, I may end up trading differently as conditions change. Copyright 2014 estockoptiontrading.com/bestchoicedaytrader.com/optionstrainingonline.com