Trading Rule #2

Rule #2:  Never cost-average your position unless the signal is at least as strong as your previous entry.

Which would you rather trade?

For your interest, I have computed the 1-min Green/Red bars transition matrices for NDX & RUT.  The result is:

RUT

R G

R 67% 33%

G 26% 74%

NDX

R     G

R 48% 52%

G 44% 56%

For RUT, if the current bar is red, it is about 2/3 of the chance the next bar will be red as well, green to green about 3/4.  The trend is much stronger than NDX where the transition matrix has entries basically random.

My Trading Rules

From time to time you get burnt because you have no tight risk management and your greed and fear take over.  After so much suffering, you establish some solid rules and try to force yourself to listen when the greed and fear are taking over.  Most traders have common rules for themselves to follow, I am no exception.

Rule #1:  Trade with the trend, at least 1 to 2 timeframes above should point to the same direction you are trading.  If I am trading the 1-min time frame, I should look at the 3-min, 5-min, 15-min for example

Oh that was the bottom! ... maybe not ...

WTotD

It feels like a dagger in the heart when you missed a trade and gain was supposed to be juicy.  Today I missed both!  The arrows are the places ideal to open positions and have tolerable risks.  Imagine how much was the gain if you use the Ultra ETF's?

The Fall of EUR/USD

I want to point out the recent fall of Euro against the USD, my charting program does not have Forex pairs so instead I will use the ETF FXE.  This ETF long Euro and it is purchased with USD funds, so it is quite similar to EURUSD Forex pair.

Notice at the beginning of August was the time Euro began to fall against USD, the MACD has never come back from bottom of the sea ...

Worst Trade of the Day

Introducing "Worst Trade of the Day", I will post up my biggest trading mistakes if it happens daily so others who read this will not make the same mistake.

Here it is, the two blue arrows denote the trades I took today which were punished.

NAMO

NAMO is the Nasdaq McClellan Oscillator which measures the overbought/oversold degree for the Nasdaq Composite, looks it is back in the neutral trading channel region.

S&P/TSX 60 holding mid term 50% retracement

XIU.TO is the chasing stock for the S&P/TSX 60, and it is holding its 50% bullish retracement.  Are we going to see oil & gold higher?

Major Indices holding off the 61.8% mid term retracement

Are we going to hold it or break it?

NDX Middle Term Status

How is NDX doing lately, It has rallied and then came back down but it seems like its price held above the 61.8% Fib ret.  Index futures have bee up at the moment, are we going to have an up date or down day tomorrow?

Block Trades & Smart Money Accumulations???

Beside focusing on NDX related instruments, I also spend time on the XIU.TO, which is the S&P/TSX 60 ETF for the Canadian market.  We can clearly see in the Friday session there were a lot of up volume surge bars in the 5-min chart.  Are those mass accumulations?

EEM vs EEV Emerging Markets ETFs

It looks likes EEM/EEV provide profitable opporunities back in June 2008, stay tuned for analysis.  EEM is a regional ETF focusing in emerging markets, in my opinion it can be categorized as medium risk.  Russia, India, Chile, etc would be considered higher risk.

Blue arrows indicate the place that short positions can be entered, if we are not comfortable w/ shorting or we want more leverage, we can enter long positions on EEV instead of shorting EEM.  EEV is theorectically the double inverse of EEM.  So our everage enter price would have been around $65 w/ stop just under the red 50MA.  We see that the range of bar started to expand quickily, the risk is quite high to enter positions on double inverse leverage shares when the range expanded so much.

If you notice in late Oct the EEM's PPO indicator had a bullish crossing but still below zero.  However the EEV's PPO indicator had a bearish crossing AND it has also entered negative region!  Shorting EEM would give you approx. 60% gain max, but longing EEV gives you approx. 220% gain!

NDX uptrend or counter-trend retracement?

There is really nothing we can draw a line between the two, one thing I find it helpful is looking at time-independent charts.  MACD is one of the most used technical indicators and often traders rely on its crossovers to determine reversals and some wait for the crossing of centre line.  However crossevers tend to produce much false signals and here is why.  MACD line belongs to the class of first order derivative of the price action, its histogram describes the second order.  The first derivative of price with respect of time is the velocity, note that I use the word velocity not speed since we have directions here.  When MACD crosses up above the signal line in the negative region, it is experiencing acceleration to the opposite site.  It is changing its velocity, however it does not necessarily mean it is reversing.  A car with its speed decreasing does not mean it is going in reverse directino.  It is simply slowing down.  Therefore more often than not, when there is sideway action in the market, the MACD tend to be very close to the zero line.

To get more insight from its actually rate of change, we can look at non-time-depedent charts such as Renko charts or even tick charts if you hare the expense in subscribing to those.  Below is an example of a Renko Chart on daily NDX.

Note the quicker MACD did cross up above the zero line so it looks like it might be supporting the short-term bullishness suggestion with other indicators also pointing up.  Also note that we have a higher high.

NDX November 4th, 2008

Today I want to show a very interesting finding on the NDX intraday chart.  First note that the longer MACD has crossed up and became bullish just after 3:30 on Nov 3rd and note that its low prior to the MACD cross was 1322.43.  First thing this morning was a gap up to 1363.31 and then it retraced down towards the blue 5-min 20EMA and reversed at 1342.30.  Using the Fibonacci retracement tool (can be found anywhere online, I use 

http://www.fxtsp.com/fibonacci_retracement_calculator.htm?value1=1363.31&value2=1322.43&Submit=Calculate+Retracements+!

I entered the high and low as (1363.31,1322.43), then it gives 3 retracement amounts, the 50% retracement is 1342.87!  How close can it get?  It seems to be a good tool to determind if it is a correction or a reversal!  I was banging my head to my desk after it surged another 3%, that is 6% on the leveraged ultra QLD!

Where will the market be heading tomorrow?!

Most of the major indices are near its 20EMA which usually serves as resistence ... but where will the market be heading ...?

Stocks vs Options

Is options riskier than stocks?  The answer is ... it depends.

I spend most of my time of market research into NDX-100 related instruments.  The ETF QQQQ is a NDX tracking stock and it has an option chain.  Let's look at the QQQQ Nov 2008 Calls, the following graph shows the percentages of extrinsic value of the option contract's premium based on the last best bid price on Oct 31st, 2008.  The last price of QQQQ on that day was $32.89 and we see that the option premium with their strike price near the stock price has the highest extrinsic value to it.  The extrinsic value decreases as the strike prices are farther away from the stock price.

Choice 1:

Suppose I wanted to own 100 shares of QQQQ and I can obtain the shares at the price $32.89, the transaction excluding comissions and fees would be $3289.  

Choice 2:

On the other hand, I could have purchase 1 QQQQ call option contract deep in the money, say 25% deep where the extrinsic value is less than 0.2% of the option's premium.  The last price for the Nov 2008 call 25 option has its last bid as $7.87.  The transaction cost is $787 excluding comissions and such.

As we all know, the market can go up, down or sideways.  Let's analyze the outcome for each of the 3 scenarios after 2 weeks.

Scenario A)  QQQQ price goes up by M dollars.

Choice 1:  You have gained $Mx100 in your account, rate or return = 100M/3289

Choice 2:  You have also gained $Mx100 in your account, return = 100M/$787, which is about 4 times higher.

Scenario B)  QQQQ price is about the same, let's say it is the same.

Choice 1:  Zero gain, nothing to lose.

Choice 2:  Zero gain, option about to expire, sell the option and pay the extra $1-2 comission.

Scenario C)  QQQQ plunged by M dollars.

Choice 1:  Your loss = max(100xM, 3289), your risk is  $3289

Choice 2:  Your loss = max(100xM, 787), your risk is $787.  However you will likely loose less capital because as QQQQ price decreases, it moves closer to the strike price of your option contract and the extrinsic value of your option contract will actually increase, the intrinsic value will be decreased by $100xM but the intrinsic part will increase by > 0.  Therefore even if M <>

It does look like in all scenarios, the choice 2 seems to have less risk.  The only major draw back is you don't earn any dividends and voting power of the underlying stock, but that may not be the most important?

Options with high extrinsic value will likely to loose most of its premium by expiry.

Please note that options trading can carry substantial risk and may not be suitable for everyone, please consult your professional financial advisor and determine the suitability for yourself.