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My Best Methodology
My Best Methodology is to buy the nearer term, near the money stock options of high capitalization, high volume, high volatility stocks that have displayed many tradable Market Detective Indicator (MDI) signals over the prior several months, and are still volatile today. The average length of time an option position is held with this method is just one to several days, not weeks or months. This neutralizes the time decay component of the option premium, and makes the profit to risk ratio of this methodology quite possibly the highest in the stock trading world. Call options are bought when the MDI of the underlying stock projects a significant short term move to the upside, and put options are bought when the MDI projects a similar move to the downside. Seeking only momentum moves that are corroborated by increased volume and the other standard studies available in MD is a further enhancement to this methodology.
Please review my disclaimer and my list of specific best methodology rules that follows, and then read my long winded narrative below describing my frustrating adventures in the realm of intraday stock option trading. I believe you will become as convinced as I now am that trading stocks or options in a short term, daily time frame is far superior to intraday trading, where the risks, false signals, and confusing noise are multiplied many times over.
My Disclaimer Concerning Stock Option Trading
If you have no experience trading stock options, it is my responsibility to warn you that there are inherent risks in options purchases that does not exist in direct stock purchases. Stock options are a constantly depreciating asset that can expire worthless when held near to the expiration date with the option strike price at or out of the money. The commissions and the spread between the bid and ask prices also add a significant cost, and must be overcome to make a profit. In general, buying options of low volatility stocks on a short term basis is almost always a losing proposition. Then again buying options of high volatility stocks with your entire bankroll is also a high risk proposition that can cause you to lose much of your investment capital in one trading day as easily as it can allow you to double your invested money in one trading day. To trade my Best Methodology you first need to understand the basics of stock option buying. You also need to read my List of Rules below, and never deviate from the bankroll restrictions described therein. If you decide that this option buying methodology is not for you, then I recommend that you simply purchase stocks directly using the Market Detective Indicator as your primary study.
My List of Rules for Maximizing Profits and Reducing Risk using My Best Methodology with the Market Detective Indicator.
(1) Have a bankroll in your account big enough to allow you to risk only a fraction of it to prevent the emotion charged syndrome of “scared money”. Scared money will make you overly emotional, cause you to recklessly chase any recent high percentage losses out of pure frustration and anger, or cause you to miss the next good move due to a loss of confidence in your trading system.
(2) If your account bankroll is $10,000 cash, never risk more than 20%, or about $2000, on an option transaction at any given time. It cannot be emphasized enough that an ample bankroll, that is always 80% or more in cash, is of crucial importance in options trading, for the simple reason that it will keep you emotionally neutral and disciplined. It will be easy to sell a losing position with a small loss, rather than letting the loss grow out of hope for a price recovery that will restore your bankroll. Using this bankroll strategy, catastrophic loss, while not impossible, is highly unlikely to ever happen. This bankroll strategy will also protect you from those rare, but real, overnight price gaps against your position, that occur because of unexpected after-market news bombs.
(3) Trade online only with a brokerage firm that charges commissions in the one dollar range for an option contract. Interactive Brokers (IB) at www.interactivebrokers.com is the firm with which I have an account. A round trip option trade of one call or one put with IB costs me $2 in commissions, while with Ameritrade it used to cost me $25 (that was $22 for a roundtrip commission plus a $1.50 option purchase fee each way). This means that if you trade only in one option contracts, you get 12 trades with IB for the price of 1 option trade with Ameritrade. This is just another preservation of capital technique…
(4) Trade the nearer term (one to two months until expiration), near the money stock options of high capitalization, high volume, high volatility stocks that have displayed many tradable MDI signals over the prior several months, and are still volatile today. High capitalization stocks and ETFs like GOOG, VLO, XOM, BA, DIA, SPY, etc., have displayed lots of short term trading volatility for months. On many occasions I have witnessed 2 and 3 dollar options of these volatile stocks double in a single day of trading. Such high returns within a few days are not possible with any other form of stock trading on a regular basis. Given that an average option position held with this method is just several days, not weeks or months, the profit to risk ratio has to be the highest in the stock trading world. You never hold an option anywhere near to expiration (unless way in the money) or even long enough for it to lose significant time premium. You can also take your profits after any large percentage move without waiting for an R reversal signal, as large percentage moves are often followed by retracements. If you get too nervous about holding a losing position, you can also cut your losses after a small percentage move against you without waiting for an R signal. Capital preservation is, after all, more important than capital appreciation. Staying in the game forever must be the goal. Do not worry about an occasional missed opportunity. MDI will signal endless opportunities well into the future.
(5) Become proficient at using the real time quote streamer and real time charting programs that are provided by almost all the internet brokerage firms. (You'll need to have a DSL or similar broadband internet connection for this.) This feature is an important adjunct to the MDI and the Market Detective daily charts for the following reasons. If the MDI of the previous day shows a strong “R” reversal, then during the first hour of the current day, as displayed by the brokerage firm's real time streamer or charts, the stock might experience a technical price retracement. You can then choose to enter an option order at a more favorable price later in the day. For the same reason, with an hour or less left in the trading day, a strong new R signal may have been generated, and would indicate a good option buying moment. This is where the manual Build Intraday Bar feature of MD will come in handy, as explained next.
(6) Use the MDI daily graphics as your primary signal generator, and the manual Build Intraday Bar (BIB) feature of MD in conjunction with your online broker's real time charting or quote streamer programs to monitor the price action within an hour of the close. In general, never bet against the prior day's short term trend signal as defined by the MDI, unless an R signal is generated using MD's BIB feature based on the last hour or less of today's real time online brokerage's real time quote, or you will be sorry much more often than not. If the last hour's intraday price crosses the R signal point with momentum and increased volume, then this is a better time to enter or exit a trade than waiting for tomorrow's open. Avoid making more than that one intraday trade to enter or exit a position. As I explain in my narrative below, making multiple intraday trades multiplies your risks, requires several hours of your undivided real time attention every day, and transforms you into a gambling addict instead of a thinking businessman trying to achieve a realistic profit goal on a monthly basis.
(7) Since you're buying near the money options within one or two months of expiration, don't bother seeking low option premiums. High premiums suggest current high volatility, which is desirable here, while low premiums suggest low current volatility. Your mission, should you choose to accept it, is to seek out high volatility stocks that produce historical charts showing many series of MDI compatible, and profitable, short term trends. History does repeat itself more often than not, and this is why the MDI excels as an indicator. Since the bid and ask spreads are wide on volatile options, after a MDI reversal signal I place my buy orders at a price right in between the bid and ask prices. I usually get those orders filled.
(8) For beginners and people like me with a smaller bank roll, it is most prudent to perform some due diligence research regarding the underlying stock, whose options you wish to trade. If a stock is determined to be in a longer term uptrend for good fundamental earnings and sentiment reasons, as was the case with the Google (GOOG) and Valero (VLO) options that I traded most often, then buying puts on downside reversals is an unnecessary gamble. I found this out from my intraday experiences as described below. Had I just used the MDI reversal signals to go long and bought one call option on each stock, and avoided buying puts altogether, and just sold the calls on reversal signals to go short, and repeated this process as often as the MDI indicated, I would have made several thousand dollars in a couple of months. Instead I lost a few hundred dollars along with some pride and confidence by being the clever contrarian and betting against the trend in anticipation of that big technical sell off that never materialized.
(9) In order to help you determine the predominant long term trend for your stock, you can apply the 50 day or 200 day Moving Averages to the specific stock's chart, and also to the DIA (the DOW tracking ETF) and the SPY (the S&P tracking ETF). This study is the standard point of long term reference used by institutional traders. As long as the current prices are above the 50 day moving average, then the more conservative short term traders should trade only in the direction of the long term trend when exiting and entering a trade on an R signal, and not switch from buying calls to buying puts and vice versa with every R signal. Conversely if the prices are below the 50 day average, then buying only puts would be the conservative approach.
(10) In order to find the best optionable stocks, indexes, or ETFs to trade short term, there are numerous internet sources that can be useful. You can subscribe to Investor's Business Daily online with an eIBD account. IBD provides much more than just business news, as IBD is a truly excellent stock market research tool. They list the 100 best performing stocks, provide their own SmartSelect Corporate Ratings, IBD Charts, an IBD Table that shows Where the Big Money's Flowing, other important IBD tables, and a whole lot more. You need look no further for MDI compatible stocks to trade. With a small bankroll all you need is just a few volatile stocks from the IBD list to keep you busy for weeks. Another good source offering free stock analysis information can be found at www.thestreet.com. Jim Cramer's daily CNBC Mad Money stock market show is another source of good and highly specific stock advice and information.
(11) If you don't understand the basics of stock option trading, you need to seek out the appropriate internet sites or your own online brokerage site for tutorials on option trading. Of course, if you have a large bankroll, and options scare you, then simply use the Market Detective Indicator to purchase and sell stock shares directly.
My narrative about the trading activities that preceded the formulation of my best methodology.
Here I describe my real time, trial and error, intraday trading experience with a small bankroll, and how it brought me back to short term end of day trading.
My decision to trade stock options on a very short term basis was a methodology born of necessity, due to the large amount of debt I rid myself of once and for all in mid 2004. I was carrying this debt for too many years, and paying over twenty four percent interest on it. I was no longer gainfully employed anywhere as a C++ language programmer, so I had to target my stock trading capital to pay off all my creditors. This, however, left me with very little capital to play the markets. In fact, although I was never a big money trader, I did go from risking as much as $50,000 on several open stock positions to having only $1,200 to risk in January, 2005. Getting a computer programming job to guarantee a steady income was no longer what I wanted to do the rest of my life, so I decided to put my long hours at home to more efficient use by becoming an even shorter term, real time, intraday trader. I figured that intraday trading not only would fine tune my trading skills, but it would give me something more exciting to do during the day than creating web sites or other software. Programming in these my senior years had become a tedious and boring endeavor. My new life interest and passion was now short term stock trading, in the pursuit of the kind of monetary returns that only intelligent risk taking could provide. Besides, I needed the action and stimulation of the markets to add some drama to my dull programmer's life. So after contemplating the meager risk capital with which I was left, I decided that stock option buying was the only vehicle left on the lot for me to drive. Now the question became "Could I make a weekly profit trading puts and calls in a real time intraday environment"? I never read of anyone else doing exactly that intraday, so this called for a trial and error experiment by no one else but me. Since I had an account with Ameritrade, I also had free use of their Advanced Analyzer charting program that allowed the viewing of stocks in real time 5, 10, 15, etc., minute Japanese candlestick bars. Hence I could look at the prior day's MDI action with my own Market Detective program, and use its daily trend information as a guideline for trading with today's real time Advanced Analyzer charts. I understand Japanese Candlestick theory well, and although Advanced Analyzer cannot generate my explicit SRL characters, I can see , in my mind's eye, the SRL patterns of my MD Indicator on the real time 10 minute bars of the Advanced Analyzer charts. However, I was aware that trading in and out of options more than once a day would take a significant toll on my equity because of the commissions. Ameritrade's commissions of $10.99 per transaction plus a $1.50 fee for each contract amounted to a loss of equity of $31 for a three option contract round trip. A $22 dollar roundtrip commission on 20,000 shares of any price stock is phenomenally low, but $31 on three options that cost $200 each that you buy and sell on the same day, or within two days is just too darn high. Between January and March, 2005 I made scores of put and call trades intraday, the vast majority of which I sold within 24 hours. The commission costs on these trades was over $600 and after two months I was just under breaking even. Given my original paltry bankroll of $1200, I was disappointed. I was hoping to double that amount the first month, but those low Ameritrade commissions were still way too high for trading options intraday with my bankroll. I then discovered Interactive Brokers, a firm that only charges a $1 commission for one option contract. Had I traded through them I would have saved over $500 in commissions and thus would have been at least a few hundred dollars ahead after two months. I opened an account with them and immediately felt about 20 pounds lighter knowing that the excess trading fees were off my back. Now if a trade went against me intraday I could sell immediately and lose only a very small amount on commissions and whatever was my equity loss. When I started to trade with them I became more relaxed and felt more in control. I made money more steadily as I kept my losses small and let my profits run longer. However, I soon found myself trading more like a gambler than the disciplined technical trader that I exhorted other people on this site to be. What was happening to me intraday was that I was becoming bored with the small action and small amount of profits that my thousand dollar bankroll was providing me. Sitting at the monitor watching 5 and 10 minute bars non-stop all day was frustrating and downright annoying. So every now and then I would cast caution to the wind and ignore the Market Detective Indicator signal of the previous day. That every-now-and-then act of going against the prior day's MDI cost me. Even though the MDI might have been projecting a daily long trend based on the prior day's bar, if I saw an intraday candlestick reversal in a 10 minute period, I would often take the contrarian role and bet against the daily trend. I'd buy a put just to catch a 30 minute drop in the stock price and a $50 increase in the put. While this act made me money once in a while, more often than not it cost me money, as the downward move would often stall, and I'd wait all the rest of the day for resumption. All too often, near the end of the trading day, the daily trend, as indicated by the MDI, usually would reinstate itself, and I'd have to sell out at a small loss. I was buying puts and calls on just Google (GOOG), Valero (VLO), Diamond Trusts (DIA), and Exxon (XOM). When you don't have a big bankroll you can't diversify, so I picked just a few of Wall Street's more notable, high volume, volatile stocks with volatile options to match. Google of course was the most volatile, so I'll use it as the representative example of what I consider an important turning point experience in my trading methodology. I bought puts and calls often in Google. They were expensive, so with my bankroll I could only afford to buy one near the money call or put for about $800. I made money and lost money about equally with GOOG over a two month period. So I did a study of why I wasn't getting the steady profits that I expected. As an intraday stock option trader I hardly ever held an option position overnight just to avoid those scary gap moves that can occur against your position. With the $1 commissions charged by Interactive Brokers, I felt it was more prudent to exit at the end of every day and sacrifice a couple of bucks to commissions rather than take a gap down hit the next morning. But after two more months of this style of intraday options trading, I began to appreciate the simplistic logic and beauty of End of Day trading, overnight gaps and all. I also now understood why all the statistical research indicates that the vast majority of intraday traders lose money consistently. Using the Market Detective Indicator as a reference tool, I backtracked over my intraday trading activity and compared it to what I would have done had I simply bought options on a short term daily basis using the signals of the MDI as displayed on the charts. I experienced an epiphany, coupled with the usual regrets one has for deviating from the master plan. My MD daily candlestick charts for Google and Valero and Exxon clearly showed how successful my trading would have been over that two month period, had I simply avoided all that intraday noise, and remained in the short term daily trading camp, and not the real time intraday camp. I pinpointed at least three major moves that I missed because of my hyper intraday activity. By exiting before the close I would sustain either a small profit or a small loss. On the next day, if Google gapped in the direction of my current daily MDI trend, I would be afraid to enter a trade because of the natural fear we all have of buying into an exhausted market move. Sure enough there would often be exhaustion, and a flat market for that day, but then on the next day Google would inevitably resume its move. By being an intraday trader, I missed out on several major MDI projected moves in Google and Valero that could have brought in over $5000 per call contract from Google and about $1500 from Valero, and all in just a few weeks time. View the charts on GOOG and VLO below. By avoiding overnight positions, and thinking that I could quickly get back into a position the next morning due to the low $1 commission rates of IB, I shot myself in the foot. If I had lost some money the day before, I would be too cautious about getting into a new position today, and would miss out on a good MDI projected move that way. If I had made some money the day before, I would want to enjoy my prior day's success by again being overly cautious about jumping into a new position, and thus miss out on a good MDI projected move that way. Intraday option trading made me too hyper, anxious, and emotional. With all the head fakes and whipsaws in intraday trading, I had my finger on the online sale trigger all the time. It was not a pleasant experience overall, and it made me commit a grievous sin – I found myself ignoring the very daily indicator, the amazing Market Detective Indicator, that I tell you, the visitors to this website, to follow so closely. While this story of my unsuccessful intraday trading may not be the best way to promote my software, it works in a somewhat backhanded way to confirm the importance of the daily MDI as a truly effective and important tool in predicting short term moves that can run anywhere from two days to several weeks.
For illustration purposes, let's take a look at my program's daily Google chart below. Note that on 4/19/2005 GOOG made a strong reversal to the upside at about $190. The R was a gap move above the previous S signaled candle. If I was not in an intraday don't-hold-anything-overnight trading mode, I would have gotten onboard an hour before the close of the R day. I would have seen the momentum build in real time on my 10 minute Advanced Analyzer chart of GOOG at about 3 PM EST. Instead, I thought I'd wait for the next day's open to see what other clues the market was providing. The next morning was another gap up day, that was further confirmed by increased volume. However, since I was ignoring the daily mechanical signals and using intelligent anticipation and 10 minute candlestick graphics for my intraday trade decisions, I anticipated a pull back and stayed out. Hence I missed two up gaps as an intraday GOOG trader. I later bought a June out of the money call on April 22 with GOOG at about $215, and road it up to $220, nervously holding it for several days this time. I made about $250 dollars on that one call option, and having decided that GOOG was way overbought, I decided to wait for a retracement before buying another call. The MDI soon showed a few consecutive S signals that were very flat at the start of May, and were quickly nullified by another up gap R that preceded a huge three week long trend from about the $230 area to $290. I missed that R signal, because while waiting on GOOG I had switched my focus and money to VLO options to try and catch some oil market related profits. Intraday on May 12th I decided to focus on GOOG again because of the May 11th R reversal signal. However, I got faked out again by a small intraday move to the downside, so I stayed out. I waited a couple more days in the mistaken belief that this up trend wouldn't last more than those two days. Once again, the daily MDI clearly told me I was wrong to use my emotion tainted intellect, which was being further confused by the intraday ups and downs. Obviously I'm not the best intraday stock player around, and somebody with a more disciplined personality than mine may have caught some of those multiple intraday trends. But, I can't think of a better illustration of the perils of intraday trading than this Google experience. Two intraday head fakes in a row, and most of us would become very gun shy to take on a position for the next couple days. And as a typical consequence, supported by Murphy's Law, those are the days that produce the 200% option gains.
As if Google's intraday volatility wasn't frustrating enough to handle, I played the Valero (VLO) oil service stock's options interchangeably with Google's. Since oil has become such a bullish commodity, I was hoping to catch the upside moves in oil with VLO call options, and any downside retracements with VLO puts. Since March, 2005, VLO was quite the volatile stock. In general, I made profits buying calls on an intraday basis, but took mostly losses buying puts, even when the intraday price of oil would move downward. Yet when oil moved between $60 to $49 and back to $58 in the April to June, 2005 time frame, the daily MDI would have been the best friend and financial advisor I could've had. Just look at the profit making MDI patterns of the VLO chart below... Oil moved in small but clear increments on a daily basis, while the intraday oil movements against the daily trend were just noise, directly causing similar intraday VLO stock noise. I played this intraday noise too often, sold off the calls or puts before each close, and took many small losses that kept adding up and reducing my meager bankroll some more. I regretfully admit that I traded VLO intraday in a completely disconnected way from what the daily MDI signals for VLO suggested. Such is the penalty for those who stray from their appointed task, and forget to practice what they preach to others. “I'm guilty as charged your Honor, but I promise never to do it again, and I really mean it this time…”
I hope these vignettes regarding my intraday experiences convince you, as they have me, that intraday stock or option trading is a losing game for the vast majority of traders. Using your online brokerage firm's real time charting or quote system to monitor the intraday activity is very helpful and important, especially at the open and near the close of the day, and I recommend doing that. Just remember that the best way to filter out the intraday noise from the real daily trend is to rely on a good, short term, daily trading method . In my slightly biased opinion, no indicator can accomplish that task better than the Market Detective Indicator. Furthermore, short term daily trading provides plentiful opportunities for profits with much less risk taking, false signals, and confusing noise than intraday trading.