“Average investors who try to do a lot of trading will only make their brokers rich.” --Michael Jenson, Finance Professor, Harvard University
"Buy on the cannons, sell on the trumpets." --Old French Proverb.
We are all swing traders in the stock market. It’s just that not all of us are good at it. Some swing trade over a period of years while others swing trade over a period of hours or minutes, but they all do it in a very similar way. A swing trader's goal is to buy stock when it’s price is low and sell stock when it’s price is high. They use every advantage of technical analysis to find their particular edge for their style of trading. They swing in and out of stocks according to their own level of trading comfort.
Since swing traders make trading decisions based upon price, volume and a few of their favorite momentum indicators, and since these same indicators are independent of the time frame of the chart being used, swing traders at all levels of the trading spectrum are conducting their business similarly. The one thing most swing traders have in common is that once they become comfortable trading in one time frame they use the chart of one time frame lower to support their trading decisions. For example, a swing trader who is comfortable with executing trades on a monthly basis will generally use the weekly charts to make their decisions. Personally I like to trade weekly so I obtain most of my data from the daily charts to make my decisions. Those traders that feel comfortable trading on a daily basis will use hourly charts and intraday traders will use 15-minute or 1-minute charts. These last two examples of swing traders are generally referred to as day traders.
A successful swing trader enters a stock when it’s oversold and exits a stock when it’s overbought. He’d then short the stock when it’s overbought and cover his short once it becomes oversold. A true swing trader wouldn’t be able to trade an extensive list of stocks because the time required to concentrate on and monitor more than a select few volatile stocks would be overwhelming. Buying a stock and only checking on it’s earnings, profits and dividends every three months can only be done by an investor that swings over a period of years or decades and relies on the stock’s P/E ratio as his swing trigger. It’s not something a short term swing trader does and it’s definitely not what a day trader does. A swing trader only uses the information provided by price, volume and a couple of indicators to make his decisions.
I use many of the same ideas and methods that a swing trader uses when I’m buying and selling options. For the most part I’m swinging on a weekly basis when I’m buying and selling those options.The information I’m looking at is price, volume and a couple of indicators I like to use to make my trading decisions. The main difference is where a swing trader would go long by buying stock, I’d go long by selling puts. Where a swing trader would go short by selling or shorting stock, I’d sell covered calls on the positions I already own. The swing trader is always buying and selling equity while I’m always selling premium. The result is that in a fast moving market the swing trader may make more money than the options seller while in a flat market the option seller will make more money because of the deteriorating premium. I’ve learned over the years that there are vastly more flat markets than volatile markets so the probability of success is with the option seller.
For the most part and for the biggest part of my portfolio, I’m a buy and hold type of investor which is a swing trader with a trading time frame consisting of years or decades. I’d like to think of myself as a swing trader but the fact is that I spend so much time trying to decide which stock to buy that once I finally make the decision to purchase a stock it becomes hard for me to sell it as long as it continues to perform as I had originally expected. The price of the stock may become overbought or oversold at times but if revenue, profits and dividends continue to increase over time, I have a tendency to simply hold the stock and collect the dividends rather to buy and sell the stock and pay the taxes on the trades. This becomes even more important to me as I get older and dividends become more and more important in supporting my investments.
I never advise anyone about swing trading. I can only say what my intentions are and what I’m doing in the market. I’m old enough to understand that the excitement of short term swing trading is often addictive for the beginning trader but this short term trading often ends in disaster for many of them. Older traders know that the big gains are made over a period of years, not days. The traders that become really successful are the ones that are still trading decades after their first trade. They are the ones that understand the difference between trading for today and investing for the future.
If you haven't been over to PerfectStockAlert.com yet you might think about it. I'd like to say I check that site everyday but in reality I check it about three times per week. It's a great site. You can find a link for that site in the right hand column on this page under the heading "additional resources". Immediately below you'll find their assessment of the various markets ending Friday, 27 Sep, under the heading "Markets for the Week Ahead 09-27-2013". It's worth the time to watch the video since weekends were made for research anyway. Enjoy your weekend.
"There seems to be some perverse human characteristic that likes to make easy things difficult." --Warren Buffett, Investor, Billionaire.
The key to making money in the stock market for me is not only knowing which way the market is being pushed but specifically which way a particular equity is being pushed. The resultant decision to either buy or sell is ultimately dependent upon that knowledge. If a stock is being pushed up then I want to be long. If it’s being pushed down I want to be short. For me, it’s that simple.
Going long to me means I’m either buying stock or selling puts. They’re basically equivalent trading positions. Going short to me means that I could either short (sell) stock or sell covered calls. These two are also basically equivalent trading positions. The difference in these trades for me is that I never ever sell stock short. There’s nothing wrong with doing it but I’ve made the personal decision not to. The other option is to sell covered calls. This is my preferred choice as long as I own the underlying stock (which is why they’re covered calls).
If my understanding of a particular chart starts telling me that a stock is poise to move up, I need to determine how high it will move and how quickly it will move, at least for the short term. That knowledge will allow me to determine which strike price and which expiration date I’ll sell against. If I can get very close to a return of at least 1 percent on my money in one to two weeks then I’ll probably go with selling the put, especially if it’s an out-of-the-money put. If I can’t get that type of return, then I’ll try to determine if I can get a similar return in a similar time period by simply buying the stock. If I can’t expect to do that with either selling the put or outright buying the stock, then I’ll move on to another candidate stock.
If I see that a stock that I already own is starting to roll over I have two choices. One is to sell covered calls and another is to simply sell out the entire position. If I don’t want to sell out the position because of an upcoming dividend payment or for tax reasons, then I’ll sell an out-of-the-money covered call. I will sell that call regardless of the percent of income I’ll receive. This is just free money to me and I’ll take any free money the market decides to send my way. This is not a time to get greedy.
So my strategy of trading stocks is based on a structured trading plan that tells me to go either long or short. Which way I decide to trade is based on a fundamental understanding of whether the market is being pushed up or being pushed down. Once I determine this, I trade in the right direction and constantly monitor my positions because if I’m wrong, I need to immediately exit and reverse. Cutting losses is critical to my success in the markets. I intend to continue trading the markets well into my 90s.
The Relative Strength Index (RSI) is another of my favorite market indicators. It's an oscillator because it travels back and forth across a center line with a maximum of 100 and a minimum of zero. The RSI is considered overbought when the RSI is above 70 and oversold when the RSI is below 30. The default setting on the RSI is 14 periods. For me I find that the default setting is too slow so I normally use a setting of 10 periods. By decreasing the number of periods I in essence increase the volatility of the oscillator which in turn provides me with more signals. The disadvantage is that it also increases the number of false signals. This is really a personal preference determined by each individual investor.
If you'd like a more thorough explanation of how the RSI is calculated, please see the article in StockCharts.com titled Relative Strength Index. It goes into great detail on the calculation and use of this indicator. The way I use this indicator is as a confirmation of other indicators, specifically my favorite indicator, the MACD. As the RSI indicator moves into overbought or oversold territory it provides me with a signal that the stock that I'm looking at is in an extreme trading area. It has either been pushed too high or too low by investors. That alone is not a buy or sell signal for me, it just tells me that the stock has been or is being pushed in one direction or another. What I look for is a turn in the direction of the indicator.
In the case of a stock I am interested in buying and has become so oversold that the RSI has fallen below 30, I wait and watch until the indicator begins to turn up and move above the 30 line. The reason for this is that I have learned over the years that stocks that are oversold with an RSI below 30 can remain below 30 and continue to go lower for some additional time. I really don't want to buy a stock until it has completely exhausted all of it's downside pressure. I want to buy stocks as they turn and start to move back upward. The result of this strategy is that I rarely buy at the exact bottom. It's usually a day or two later. The other option would be to buy earlier and watch my investment continue to fall while the stock looks for a bottom. That's not a desirable situation for me financially.
The opposite occurs when I'm seeing one of my stocks topping. Simply going above the 70 line is not an automatic sell signal for me. I've learned that stocks can continue to move higher for quite some time after moving above the 70 line. Once again I look for the turn in the indicator as it rolls over. The result is I never sell at the very top but instead a day or two later. The other option would be to sell earlier and have the stock continue to rise causing me to be out of a stock I had owned. This is not maximizing the efforts I initially put in to discover the stock in the first place, and it's contrary to the old adage of letting your winners run.
As with the previous posting on MACD I realize at times I'm not smart enough to absorb all the information in a written explanation like the one in StockCharts.com so I've included below a video explaining the RSI from the website PerfectStockAlert.com that provides an excellent visual explanation. I hope you enjoy the video.
"The intelligent investor is likely to need considerable will power to keep from following the crowd." -- Benjamin Graham, Author, Investor.
I've written several articles on my use of the stock market indicator Moving Average Convergence Divergence (MACD). It's one of my favorite momentum indicators. In my articles I discuss how and why I use this indicator but when it comes to actually explaining what it is and how it functions I generally refer to the website StockCharts.com. That site does a wonderful job at explaining in writing exactly what the MACD is and what it does. I realize, however, that sometimes when I'm reading something very technical that it just doesn't sink in very well. It is at those times that I wish I had a visual explanation. I found these tutorials produced by PerfectStockAlert.com that do an excellent job of explaining these difficult concepts.
The videos below are a two part explanation of the MACD. The first tutorial explains all the parts that make up the indicator. The second part explains how I trade using the indicator. I think they present an outstanding explanation of how this one indicator improves my success at trading.
As I've pointed out before I never trade based on only one indicator. I use several momentum indicators and oscillators for confirmation before I put my hard earned money to work.
Hopefully you will find these videos worth your time.
"Life is inherently risky. There is only one big risk you should avoid at all costs, and that is the risk of doing nothing." -- Denis Waitley, Author, Consultant, and Motivational Speaker.
Risk and Reward, Fear and Greed
I wish I could invest without risk. I wish I could get a guaranteed return on my investment. I wish there was no such thing as inflation. But wishing for things is simply the desire for things that I have no other way of getting. Risk is everywhere and inflation has been around longer than I’ve been alive. Unfortunately both are here to stay.
Risk is dangerous. Risking anything means I could lose it. Purchasing a stock could result in a loss of equity in my account if the stock goes down. But the risk of doing nothing could be just as damaging because inflation will eat away at my purchasing power. To avoid this risk of simply doing nothing I’m forced to take the risk of doing something. It is this realization that I am being forced into accepting risk whether I do something or nothing is what resonates at the core of my financial existence. If I do nothing I am sure to lose and if I do something there is a serious potential for loss. I have no choice. I’m forced to accept risk. Risk itself is inherent in life as life moves through time.
Once I come to terms with risk and this fear of financial loss, I come to understand that I must take on risk in order to at least keep up with inflation if I am to maintain the purchasing power of my savings. If all I want to do is maintain that purchasing power then I look for the minimum risk that I’m required to accept. For me risk is defined as the probability that my trade will end in a loss. It’s the chance of losing money when I buy and sell stocks and options. For me it’s also directly related to the chance of making money in the market. The more risk I take on, the more reward I expect to make.
This risk and reward are simply fear and greed. They’re the same fear and greed that move the markets. They’re the emotions that excite and paralyze every investor and are the cause of so many mistakes in trading. For most traders the fear of loss is a greater emotional event than greed and will drive trading decisions to a greater degree than greed, but both emotions will interfere with the logic of trading and ultimately interfere with an investor’s trading plan.
It’s because of these two emotions that a trading plan becomes an absolute necessity. A good trading plan will describe the conditions for entering a trade, exiting a trade, and the subsequent transactions when the trade goes sour. All three parts of the plan are necessary because of the existence of risk. The minute I enter a trade I’m putting my money at risk. I could be completely wrong in understanding the situation or I could be exactly right yet my timing could be completely off. Because of risk the trade may immediately start to lose money. Since that possibility always exists, I need to know what to do even before I enter the trade. Without a plan I’m immediately subject to my emotions and I end up doing either nothing or the wrong thing. Both of these decisions would have a disastrous effect on my accounts.
With a trading plan I simply execute the plan whether everything is going great or everything is going terrible. My plan tells me what to do regardless of the developing situation. Emotions are not involved in the decision making process. Fear and greed are controlled and risk is successfully managed. Success ends up being the result of allowing the winning trades to occur while limiting the losing ones.
Understanding the debilitating effects of risk and the need to control the emotions associated with risk by developing a trading plan was the beginning of me becoming a successful trader.
In order to be a successful investor in the stock market an investor needs a plan. It’s nice to have a goal, but it’s absolutely critical to have a plan if you want any success at all. When I started investing I didn’t have a plan. No one does when they start investing. But I had a goal. It’s the same goal every new investor has - to make a million dollars by the age of 30 and retire to a nice sunny beach somewhere. For me that didn’t happen. What did happen was I took $100 down to a trading desk and bought stock in some company I can’t even remember any more and immediately lost all of my money. That day I was devastated but at the same time even more determined to learn how to successfully trade the market. Today you might not think that would be such a big deal but 40 years ago that was a large sum of money for a kid in college to lose.
A few weeks and a few trades later I had experienced a couple of successful trades and a couple of unsuccessful trades. I thought about the successful ones and decided I now had a plan for getting rich. Even today it’s hard for me to believe how naive I was back then. Over all these years I’ve slowly gotten better at developing a strategy and figuring out the ebb and flow of the stock market to the point that I actually have a strategy in place.
In the eighties option trading finally took off and I spent most of my time trying to learn how to trade those. It took a few years to master the basics of options trading but looking back on it that was time well spent. Today options are an integral part of my overall strategy of trading and it wouldn’t be if I hadn’t had those years of trading and learning.
In the nineties I discovered momentum indicators and oscillators. Learning how to successfully use those also took quite a while. The math behind the indicators is a rather simple exercise but learning to use these things to the point that they’re second nature and not a mathematical equation anymore takes quite a bit longer than most people would realize. It took years of success and failure to determine which indicators I had the most confidence using while trading.
Along the line somewhere every trader learns methods that he feels comfortable with and confident using. People not familiar with trading would probably call these methods “tricks of the trade” but I very much dislike that phrase. They’re not tricks, they’re just things traders learn to rely on and check before they make a trading mistake. One of the things I learned early on was trading in multiple time frames. I’ve pointed this out in an earlier post. Another thing is the use of multiple moving average crossovers. While Daryl Guppy uses a dozen or more, I prefer just the 5, 10, and 20 day moving averages.
Over the years I slowly became pretty good at determining when a stock had bottomed or found support but I got nowhere trying to figure out when a stock was topping out and starting to rollover or finding resistance. Today these things seem obvious but then it was something I just couldn’t seem to figure out. This occurs to a lot of young traders and I’ve never understood why but it happened to me. Traders that want to go long need to learn how to buy low and traders that want to short a stock need to learn how to sell high. The only thing I could come up with is that there’s an inherent aversion to shorting and that going long is a more natural way to approach the market. The problem with this type of investing is that an investor will be able to get in low as the stock begins to move up but without knowing how or when to sell the investor will lose all the gains as it falls. This is definitely not a successful plan.
I had to come up with a novel idea for determining when to sell. Since I felt that I was fairly capable of determining when a stock was turning up I had to figure out a way of improving my ability of determining when a stock was turning down. But how? I eventually realized that everything I knew about a stock turning up would apply to a stock turning down if I thought of it as turning up rather than turning down. I had to fool my brain into thinking that turning down was really turning up. I had to think upside down. I came to realize that if I inverted the chart then I was looking at the stock upside down. Suddenly the fog lifted and the light came on. It all started to make sense. When I saw a chart turning up it was actually turning down. What a revelation!
Below are two charts of the Dow Jones Industrials. The first chart is right side up and the second is upside down. For me it was easy to see the industrials turn up in late June and late September in the right side up chart even in real time. But I had trouble recognizing in real time the chart topping out and rolling over in early August. After inverting the chart it became obvious to me that the industrials were turning up in early August (which when turned back right side up is actually rolling over). Suddenly I could identify resistance levels as well as I could identify support levels.
If other investors are having this same problem this may be the solution to their mental prejudice toward identifying support levels. In the Windows world this vertical flipping of images can be performed rather easily with the included MS Paint program. In the Mac world there’s no similar program but in both worlds there’s a number of third party photo editing software programs that will invert images quite easily. Just remember that these images have not been rotated, rather they have been vertically flipped.
“It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.” -- Charles Darwin, English Naturalist.
Stocks don’t go up or down forever. They go up as long as investors push them up and they go down as long as investors push them down. In each case they will eventually reverse and head in the opposite direction. They do this for many reasons like product cycles, earnings surprises, buying seasons, management changes, fed policy, wars and more. Every company and every stock will rise and fall for its own reasons and investors may never know why until days or weeks later. Recognizing where a stock price is headed will greatly enhance your returns and recognizing reversal points will tell you when to get in or out.
For those stocks that I just want to buy, hold and collect the dividends, I want to be able to get in at the best possible price. I look at the charts for reversal patterns where the stock is oversold and about to turn up. The best way of doing that is by looking at the momentum indicators and oscillators and seeing the momentum shifts in investor sentiment. I also look at the longer time frame chart (weekly chart) for support levels and identify the level that I think is the best possible price I can get. I then go back and look at the daily chart to determine the specific reversal patterns I like to use.
If both the daily and the weekly charts are bottoming out and beginning to turn up, this is the best possible time for me to maximize my buying. This is the point I want to accumulate as much stock as I can afford. Buying at this point doesn’t affect the dividend amount paid per share but it does affect the number of shares I am able to buy and therefore increases the income paid to me at the next dividend payment date. This could be considered my “buy low, hold, and live off dividends” strategy. If I got into my position by selling puts in the first place then the strategy is even that much better!
I’ve used this strategy over and over again to build up a portfolio of stocks that pay nice quarterly dividends. But stocks reverse on the top side also. If I own stocks that I want to continue to hold simply for the pleasure of receiving those nice quarterly dividend checks, I sell covered calls off those positions as I see the stocks begin to roll over and reverse. Covered calls are a great strategy for increasing your income above and beyond receiving simply that quarterly dividend. And since options are usually sold with monthly expirations they provide a nice monthly income supplement to those quarterly dividends. I guess this could be called my “sell naked put, buy stock low, hold, live off dividends, sell covered calls for additional income” strategy.
For the most part, this is how I run my portfolio. This strategy is a fairly simple and straight forward plan. I do, however, have a very small portion set aside for the sole purpose of selling covered options. I do this for the purpose of generating income to finance that larger portion discussed above. It is here that I use my knowledge of stock reversals to sell covered puts and calls. This strategy is based on finding high beta stocks that show definite patterns of reversals. This strategy also requires the extensive use of momentum indicators and oscillators to determine when stocks are either overbought or oversold.
My strategy is to sell covered puts on stocks that appear to be oversold and turning up. I generally sell puts at-the-money or in-the-money with the expectation that the stock will turn up and the put will expire worthless. I then simply keep the premium or fee and look for another candidate. Occasionally I misgauge the amount the stock will move up after the reversal and I end up having the stock put to me. In those cases I sell calls at the same or slightly higher strike price so I can collect the largest premium possible as I exit the stock. Once back in cash, I look for another put candidate.
This portion of my account is relatively small but I like to turn it over quickly and continuously to keep a constant flow of income. This is the fuel that feeds the larger portion of my account. In order to do this, I prefer to sell options that expire weekly. I like being able to go completely to cash at the end of the week and then having the weekend to review the charts.
I guess this would be my “sell puts on Monday and they expire worthless on Friday” strategy. My target return for this strategy is 1% per week. That’s not always possible but it’s the goal I use in comparing the returns on various options. For instance, on a $50 stock option ($5,000) I would like to make $.50 ($50) for the week. Doesn’t seem like much but percentage wise, it is. A 1% gain per week is a 52% gain per year. And while I can’t do that on a consistent basis, if I can get even half that amount it’s still outstanding by any measure. But as I mentioned above this is only a very small portion of my account because this is an extremely risky strategy and the possibility of total loss of equity is always there.
Remember to always do your homework before you invest. Always invest with a plan and always have an exit strategy.
“The market can stay irrational longer than you can stay solvent.” -- John Maynard Keynes, Economist and Investor.
Learning to be a good investor is learning how to read the market. It’s learning how to look at a chart and trying to understand what the chart is trying to show you. A good investor doesn’t predict where the market is headed, he simply learns to visually read the chart and react to its movements. An investor cannot will the market to move in any direction he desires any more than a pilot can will the wind or a sailor can will the sea. In the end the market is always right.
If I had only one thing to look at to determine the future direction of a stock’s price, I would want a chart that had only the daily closing prices over a period of time. That’s really not much to go on but if I held the chart out at arm’s length or farther I could quickly grasp whether the stock was going up, down, or sideways. And I could trade on that information. My success rate may not be outstanding but I could generally tell what the stock had been doing. If it was going up I would want to buy and if it was going down I would want to sell. This would be a rather crude trading strategy but it would still be better than having no strategy at all. Fortunately I have never had to trade under these types of conditions.
Beyond price, everything else found on a stock’s chart can only confirm or refute my interpretation of the direction of the stock’s price. The easiest to see and interpret would be a moving average indicator. Simply interpreted, if the stock was above the moving average I would consider buying the stock and if below I would consider selling the stock. Not a great Improvement but it is a giant leap over using only the stock’s price. Multiple moving averageswould be even better. Darryl Guppy, an Australian Investor and financial market educator, has written several books and operates the website guppytraders.com in which he discusses his method of investing using Multiple Moving Averages in order to make buy and sell decisions.
Beyond these I’d bring in Bollinger Bands, the MACD, the RSI (Relative Strength Index), Full Stochastics, the ADX (Advance Decline Index), and the Parabolic SAR (Stop and Reverse). Occasionally I will look at others but by the time I look at these I’ve identified whether or not these momentum indicators and oscillators are telling the same story. If they all agree, I act. If they don’t, I move on to another candidate.
Once I’ve acted that’s when the real work starts. I then have to monitor that stock to ensure that the price continues to move in the direction that the chart was telling me and that the momentum indicators and oscillators continue to confirm. When they don’t, then the stock may be getting ready to reverse. If I’m in I may want to get out. If I’m out, I may want to get back in.
The one thing I have to be conscious of constantly is that the market will not go where I want it to go. It will go where the universe of investors push it. If I buy a stock and it goes against me, I have to exit immediately. I have to admit that my decision was wrong and I need to cut my losses before they get bigger. When an investor starts to think that he’s right and the market is wrong, it’s the beginning of the end for that investor. The market is neither right nor wrong. It’s simply the market. It’s just people making decisions and then acting on those decisions. And a good investor is one who learns how to look at the charts and understand what they are trying to tell him. And then take what the market is willing to give.
I am an Individual Investor with specific interest in long term growth and then enhancing my returns with income from dividends and derivatives. I don't recommend stocks to anyone (it's a good way to lose friends) and no one reading this should misinterpret my blog as a recommendation for any type of investment. I am writing this solely for myself and my kids.
DISCLAIMER I am not a licensed investment adviser, and I am not providing investment advise for you on this site. Please consult with an investment professional before you invest your money. Any opinion expressed here should not be treated as investment advice. I am not liable for any losses suffered by any party because of data or information published on this blog. Past performance is not a guarantee of future performance. Unless your investments are FDIC insured, they may decline in value.