Trade Secrets! (SLV,DIA)

There are two principles that have served us well over the years, and we feel now’s as good a time as any to elaborate on them.

 

Options trading is generally a matter of getting current direction right.  It doesn’t matter if you end up right in the long run.  With an option you just have to be on target by expiration.  That means first and foremost you’re a trend follower.  Nothing more.  You don’t have to call the top and bottom of any particular move, you just have to climb aboard midstream, ride the motherhumping SOB for a brief jack and then get the hell off with your money.

 

But it’s not as easy as it sounds, particularly because getting current direction right is not an easy task – even if it is, in the end, a 50-50 proposition.

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What makes the job difficult is the everpresent ‘noise’ that resounds daily from every direction.  That includes the financial news media, the shouts and hollers from family, neighbors, friends and colleagues, the bellowing of the elite class, including politicians and the so-called money experts that haunt the media, and last, but certainly not least, the ever-present din inside our own heads.

 

And it’s by far this last realm that’s most difficult to tune out.  Why?  Because it’s generally on receptor mode far too much of the time, getting jammed full of needless information and useless hype, and for the most part never getting to quietly contemplate the essence of things for more than a minute or two a day, if that.

 

Call it modern life.  A person runs from morning to night, falls into bed exhausted and wakes up the next day to start anew.  This continues without surcease for decades on end, and is it therefore any wonder that so many fortunes are lost along the way?

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Without some way of tuning out all the crap and concentrating on the objective essentials, everyday investors are plain doomed.

 

Which is why we at Normandy have focused our studies on 1) the simple, technical structure of the security we’re trading and 2) the overall sentiment picture at the time we execute.

 

Let’s look a little deeper at both these aspects.

 

Technical Structures

 

The first step in successful trading is recognition of the long term trend; that is, are we in a bull or bear market.  With that in mind we can better play the long and short side and capitalize, too, on any intermediate counter-trends.

 

Without an understanding of this first principle, little is possible.  We’ve been bullish from the get-go of the current market rise that began in the spring of 2009, and that’s been the single most important reason for our trading success these last seven years.

 

With that in mind, consider the next step –

 

Almost all our long trades are predicated on the following three technical basics –

 

  1. Price should be trending above all her salient moving averages,
  2. All those moving averages themselves should be unfurled and moving higher, and
  3. RSI and MACD indicators should be trending above their respective waterlines (see chart below).

 

When all of these puzzle pieces are in place, there’s little that can go wrong in making a bullish bet, so long as enough time is purchased or sold before expiry to ensure against any short term retracement.

 

The same is true, of course, on the downside, when price is below all her salient moving averages, etc. etc.

 

Here’s a chart of a prototypical buy signal, with all of the above conditions in force.

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The above chart represents a buy signal ideal, and, indeed, FB stock went on to add roughly 70% over the next two years.

Sentiment Prisms

 

When we refer to ‘sentiment prisms’ we don’t want you to conjure up images of McAbby in college gazing into kaleidescopes and singing ‘Crimson and Clover’.

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Rather, we’re referring to a host of market indicators that individually and collectively paint a picture of where investor sentiment resides vis-à-vis equities.

 

That includes a host of popular and not so well known data points that we’ve employed for over two decades to gather the mood of the public.

 

We’re talking about the following – the CBOE’s Volatility Index (the VIX), Put-Call ratios from all the options exchanges, ‘Investor’s Intelligence’ numbers, the American Association of Individual Investors (AAII) Weekly Sentiment Survey, Open Interest data, the ARMS Index, and a variety of other volume and market internals that we’ve fashioned into our own proprietary ‘Sentimeter’, a helpful guide to understanding whether the mass of traders are overwhelmingly bullish (and therefore indicative of a market top) or bearish (indicative of a buying opportunity).

 

Conclusion: between the technical setup and overall sentiment levels, we can get a fairly accurate picture of where the intermediate trend of the market is headed, and with that information we can then zero in on individual sectors or stocks that we believe will move most favorably.

 

And there you have it.

 

Everything you needed to know about trading in one fell swoop.

 

And Now We Make Money!

 

We’ve one trade to report before we get on with it, and it looks like this –

 

On June 21st we wrote a letter called Gulping Up the Silver wherein we advised the purchase of an SLV September 30th 16.50 PUT for $0.95.

 

Had we set the trade to expire even a week or two later we might have come away with something, but as it stands, we lost the entire initial premium.

 

Today, alas, SLV trades for $16.85.

 

Onward, Ho!

 

Who you callin’ ho?

 

Notwithstanding all the foregoing, what happens next in the broad market is difficult to determine – precisely because the technical set-up is so unclear.

 

Have a look here –

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This is the Dow Industrials for the last half year.  Our problem is essentially how to read the pennant pattern at the far right of the chart.

 

Pennants are continuation patterns, so our question is whether this pennant comes to inform us of a continuation of the prior uptrend through early summer (in blue) or of the latest drop that began in mid-August (in red).

 

Not easy to tell.

 

RSI and MACD indicators are riding flat and very close to their waterlines, offering little indication of a trend (in green).

 

There will be a move, and it will likely be significant, but we can’t know which way.  The latest bearish moves in the precious metals could be indicating a positive turn for equities, but without any more in our bag, we have to hedge this one.

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Many happy returns,

 

Matt McAbby

See what people are saying...

  1. Johannes G Hospel

    I have used the system you talk about and have been moderate successful, by keeping my principal at about the same level year after year, and remove some needed money for large purchases, unexpected support to my children’s needs, college costs, house purchases, etc. These money needs were helpful and I as a father felt good and helpful. My retirement income has been ok in receiving SS and pension payments. My house is paid for and so are my cars. It was always a high priority to have no debts. My wife an I feel the same way. It has lowered the taxes to minimum and we have been able to keep our life out of financial trouble. I have been a subscriber to Business Week for 30 plus years and have received great information on trends in the financial and business world. I am an engineer but my financial education came from reading the journals of finance. I made mistakes but learned from them. If you like the rainbows, you have to expect some rain.

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