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You'll Never Make Big Money Trading Unless You Understand This

I'm currently staring at my charts and it's green across the board.

The Nasdaq, Dow Jones, and S&P 500 are all hitting all time highs. Smallcaps look like they're about to play catch-up.

Momentum is clearly to the upside, and it doesn't look like it's slowing down any time soon. Any kind of correction is short lived and rotational in nature.

Investors are complaining that this market lacks breadth, that somehow only a handful of stocks like AMZN and GOOGL are "propping up" this market.

Yet we have over 100 stocks in the S&P 500 that are up 20% for the year.

And truly objective breadth measurements are still very strong.

Are You Holding Back?

With that backdrop, let's talk about trader discipline. For those market participants that have a timeframe in weeks, not years.

The most tired line of thought I hear is about how nobody knows how to respect risk.

That it's OK to not fully participate in a rally because once the turn comes, all those undisciplined traders will get runover.

You know... Johnny trader with 6 months under his belt is ripping out thousands by buying calls in NVDA, NFLX and FB.

But don't worry, you tell yourself, because you just have to wait for the Fed to sneeze and they'll get runover.

Here's the thing...

Have you ever thought about the other side?

Discipline in the market runs both ways. Sure, you focus on the downside risk, but what about the upside risk?

Do you really have the discipline to know when to press your bets?

You've been counting the cards, and you know the shoe is stacked with face cards.

Are you going to take advantage of it?

... or just keep complaining about how the market is "rigged?"


Ignore The Political Idiots to Avoid Costly Losses

Today we've seen an obscene amount of hypersensitivity to a small selloff.

At the time of this post, the S&P 500 is off about 1.5%. A pretty good move, but not unprecedented.

Personally, I've felt that it's been a long time coming.

But the reasons being floated out for this selloff have been absurd.

You're really going to try and push the blame on Washington? When it's been months since we've seen a proper pullback?

It's absurd. And frankly, it's dangerous to try and put risk into the markets trying to bet on what's coming out of the White House next.

Because that's not what is driving the markets.

I know what you're thinking...

"Well, if you're so smart? Why are we selling off?"

I got some news for you, it's not going to be one major reason. I'll give you some ammo, but the more important part is you understand the approach.

1. VIX Options Expiration Squeeze

VIX options expire the Wednesday of options expiration.

And if there's one indicator that's been beat to death over the past few weeks, it's been this one.

We've seen historically low VIX levels, which at the time were justified... until today, the market hadn't been moving around a whole lot.

Think about a trader who has short exposure coming into expiration. They're pretty confident they can let their options hang out into expiration.

But then something shifts. On Tuesday, the market comes back into support. Being a smart trader, you pick up some hedges in the VIX futures market, or some other instrument.

Well, when you do that, the market maker has to take the other side, and eventually you get this cascade of short volatility exposure that starts to unwind. This easily ends up being a case of the tail wagging the dog, where a squeeze in vol leads to a selloff in the markets.

That squeeze moves to other durations, and it's what can take the $VIX 10 to 14 in a day.

2. The 2400 Shake and Bake

When there is an obvious level of support or resistance, often times the market breaks that level, only to reverse hard and head back to the lower end of the range.

And this one was obvious. The market was "flirting" with that level for weeks, and made headlines once it broke. Dumb money came into the market a bit, and then ran out of steam.

Stops get hit, which leads to more stops getting hit.

3. We Ran Out Of Good News

Setting aside the US political narratives aside, what has been driving this market?

Remember, we operate in a market of stocks. With low volatility has been low correlations, so individual stocks can help to buoy an index, especially if they're large cap stocks.

We just finished up earnings season. If you look at some of the mega-cap tech stocks like AAPL, GOOGL, NFLX and other have been running hard.

Well, there's no more "good news" to come out of these stocks. No more catalysts for the hot money to chase. When we run out of that, then traders pull their money out waiting for the next setup.

Get Prepared for A Normal Market

If you're freaking out about a 1% selloff... boy do you have a short memory.

The average market pullback since this rally started off in 2009 is around 5%.

That level is around 2,250 on the S&P 500.

And that's AVERAGE.

Can you imagine the doomsday scenarios that will get floated out if we have a normal, run of the mill pullback?

It's always going to look ugly, especially for those that get paid by the pageview.

What Do You Really Want?

If you're trying to trade based off political headlines, you need to make a decision.

Are you going to focus on market structure and the actual setups the market provides?

Or are you going to obsessively follow the poltiical flotsam that gets pushed out of Washtington?

Guess which one will allow you to be a consistent trader.

When Should You Buy the Dip in NVDA?

NVDA is off over 7% today, headed back to the lower end of its range.

The stock has been one of the largest movers over the past two years, so should we look to buy the dip or just let it collapse back down to 50? Let's take a look.

The "Why" Behind The Move

Relative to the past month's volatility, NVDA saw a 4 standard deviation move.

That's pretty big.

Normally when you see a move like this, it's related to a fundamental shift in the company. Earnings or guidance.

But the news today?

A downgrade.

Here's the thing... big moves related to analyst coverage stink. They have a much higher odds of reversion.

So until we see the actual company coming out with some fundamental catalyst, this has the chance for a bounce.

What Are The Odds?

Going back over the past year, the stock has a tendency to drop 10-15% during a 10 day timeframe.

In a one-month window, we're looking at about an 18% drop.

Now let's take the most recent swing highs at 110.

A 10% cut from that is about 99 per share.

And an 18% cut is about 90 per share.

Assuming normal volatility, dropping into the low 90's should be a floor. Earnings is coming up but that is a risk you'll need to consider.

The Obvious Support

When using technical analysis, I ask myself two questions:

  1. Who are the market participants?
  2. Where will they get screwed?

NVDA is a momentum darling and has plenty of high-risk individuals looking for upside. The fact that it was so sensitive on this analyst downgrade tells me that those momentum players are probably using too much size and are getting impatient.

Now there's a very clear level right at 95, the support level from February.

Think about how many traders are using it as their stop loss level.

We know that the statistical odds put a "stretch" target in the low 90's, and if we clear 95 we'll probably see a bit of a stop run.

Into that is where I want to look for a trade.

Take The Trade

A good strategy here is a put credit spread. This is a limited risk, limited reward trade that profits if the stock goes higher or sideways for a while.

With credit spreads, you can be Proactive and anticipate price levels, plan your trade, and use GTC LMT orders so you can walk away from the screens.

The May 85/80 Put Credit Spread currently has a price of 0.45, but if NVDA heads to 93, then it will be at 1.00.

So you can put a limit order to sell that spread at 1.00, and you become a tiny market maker, providing liquidity to the markets.

There is earnings risk with this trade, so if you need a little more safety you can look to the May 80/75 put credit spread.

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Don't Overthink It - Podcast Interview With Sean McLaughlin

I had a great luncthime chat with my good friend Sean McLaughlin, talking a ton about options.

We go over:

  • the simplest options trading strategy-- it's not what you think!
  • why focusing only on odds or theta is a recipe for disaster
  • how the execution of an idea matters just as much as the idea itself
  • some insights on how to allocate your portfolio
  • why going delta neutral on your portfolio is stupid
  • and much more!

You can listen to the chat here, we start at about the 7 minute mark

Want to learn more about our spread trading service? Click here to see how you can become a consistently profitable trader.

Profit From a Simple Overbought Trade in BA

The recent rally in stocks has been relentless.

We've nearly had 95 days in a row since the market has pulled back over 1%. That kind of streak hasn't happened in over a decade.

Yet underneath the surface the rally hasn't been evenly distributed. Tech stocks like NFLX, GOOGL, and FB haven't moved much, while large cap financials like JPM and GS have seen massive moves since November.

One stock sticks out in particular as I am seeing key signals from my indicators.

Boeing (BA) has moved from 120 to 185 in the course of a year... that's well over 50%.

And much of that movement started when the stock broke out of a range back in October.

A massive amount of value has been added over a short amount of time... but should we expect the stock to top out anytime soon?

Let's look at some numbers.

Quantitative Levels To Watch

The two indicators underneath the chart can give us a more objective view of how the stock has traded in the past.

The first indicator is a Moving Average deviation. It simply looks at how stretched we are relative to the 50 day moving average.

Currently we are 12.5% above the 50 day moving aveage. This is towards the higher end of the readings that we see in this stock.

The second indicator is the IWO Turning Point indicator. This shows us percentage movement relative to previous volatility.

Over the past 20 days (1 calendar month) the stock is up over 12%. Again, we're coming into levels that are exceedingly rare.

But here's the kicker...

Normally when we see elevated levels on the Turning Point Indicator, it usually is after a strong selloff in the market or an earnings catalyst in the stock.

Within our one month window, it has been a consistent markup higher without any kind of reversion whatsoever.

The next question is... what should we expect?

How this Stock Will Trade

Markets can correct 3 ways:

  1. Price
  2. Time
  3. Momentum

That means, if a stock is this overbought, there is no guarantee that it will selloff. It could simply go sideways, or it could rally but with a lower rate of change.

If you're going to try and step in front of this freight train, you need to make sure that you structure your risk the right way.

How to Trade It With Options

Here is a setup to consider:

Sell to Open BA Apr 195/200 Bear Call Spread

This is a limited risk, limited reward trade that makes money as long as BA stays underneath 195 by April expiration.

To put this in context, the 195 strike is currently 10 points higher than the current market price of Boeing.

You'd need to see another 5% higher for the outcome to be unfavorable to you.

Now is it possible that we rally 5% higher? Sure.

But is it probable for a 5% rally without some kind of sideways action or a pullback? No-- and that's where we make our money.

There are a few things to get you a slightly better edge in this trade...

Perfect Execution For Faster Profits

Too many traders treat credit spreads as a "set and forget" strategy. That opens you up to a lot more risk than you should be.

After all, the goal of financial speculation is to earn as much money as quickly as possible. You don't need to hang around in a credit spread for another month trying to milk out that last 0.10 in a trade.

This is why it makes sense to trade like a market maker.

Scale in, scale out.

The current mid on this spread is 0.75.

If you enter here, then add at 1.05 and 1.35 then you won't be as concerned about getting runover by a strong, strong move.

It's even better if you aggressively take profits on those adds to continue to cut your basis down.

And the final thing-- scale out of the trade, say at 0.25 on that first round.

To get an exit of 0.25, you'd need to see a move to 176 today... about a 5% pullback.

But in two weeks, you'd only need to see a pullback to 179. That's pretty reasonable, don't you think?

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Twice a week, you get a newsletter going over exactly what stocks, price levels, and spreads to trade over the next few days.

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