Author: Jim Williams

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Position Characteristics #1 Stock

An examination of buying and shorting shares of stock.

In the last article we talked about Technical Analysis and that the main purpose of it is to develop expectations for what the price is likely to do. And to use these expectations to develop a trading plan.

Part of the process of developing a trading plan is to select the type of position that will be best suited to meet the expectations that were determined from the Technical Analysis. If the charts are showing a probability that the price is going to move higher, then you want a position that will increase in value as the price moves up.

Today we are going to begin by examining shares of stock.

I am not going to give a dissertation about the history of stock certificates and what they represent. What we are going to focus on is what they are used for, and that is to buy and sell to make money! Even if you follow the mantra issued by the brokers or “buy and hold” the object is to make money when you (or your heirs) do finally sell. You know that when you buy a share of stock you are “long” and looking for the price to move up. After the market declines since the end of the 90’s just about everyone has heard about “shorting” stock, where the shares are borrowed so they can be sold, with the expectations that the price will fall where the shares can be bought back at a cheaper price. When you purchase or short shares of stock, you have a constant profit/loss ratio. For each point the stock moves in your favor you earn a point of profit, and each point it moves against you is a point of loss. But with the higher cost of the stock, your return on investment is low. Such as if you buy a $50 stock and it moves $5, you have a 10% return.

One very important thing about buying or shorting stock sticks out at us.  And that is the price MUST move in the direction you select for you to be able to make a profit. This brings about the first characteristic about buying or shorting stock, and that this type of position is best suited to a trend and a move with momentum.

We will begin by looking at different situation when you would want to purchase stock. The first is at a support level. Support is simply a level that prevents the price from falling any lower. And for the price to be at a support level it has either been falling down to the support, or is in a sideways move. The advantage of buying a support level is that you are getting the best possible price for that stock. And it would become evident very quickly if the price falls thru the support level that you are wrong about your expectations on the stock, and that you need to stop out of the position to prevent it from becoming a large loss. The disadvantage of buying a support level is that you do not have upwards momentum, and the price can remain in a sideways move as people have just lost interest in the stock, and sometimes it can take some time for an accumulation phase to build a base to launch the stock into an upwards move. While a sideways move is not decreasing the value of the position, you are losing the interest that those funds could be earning, and it is not very heartening to produce returns that are below what a savings account, bond or T-bills position would return.

The best times to take a long position in stock in when the price is in a trend, preferably when it is just beginning a new trend. A trend is simply a progression of moves that takes the price to new highs. In this progression you have 2 events that take place that you want to look for.

After making one of the upwards surges, the price will pull back. You are looking for it to form a higher low, to represent just a dip in the upwards action. As the price forms this higher low and begins to move up, you can buy the dip with the expectations that the price will move up to the highs it was just at.

And when it reaches those previous highs you have the second event that you are looking for, a breakout to new highs.
Both of these events show that the price is moving with momentum, and this is precisely what you need for your long position to create profits.

When the price stops setting new highs, then you have lost that momentum, and you are facing the prospects of a flat sideways move, or the start of a downtrend.

A short position uses the same principals, just in reverse. You want to take advantage of a downtrend. After the price falls, you look for a bounce up that forms lower high, and when it starts to turn down, that is the signal to sell that bounce with expectations to return to the recent lows. And when it gets back to the lows, you are looking for a breakdown that sets new lows. And when the price stops setting new lows you have an indication that a sideways move or uptrend could develop.

On the chart pictured above, we have the first event that took place, the price dipped down, and starting moving up towards the previous highs. Then it paused for 4 candles. When it paused it raised the question of whether the upwards move was coming to an end and creating a double top. You would want to examine the indicators of this single time frame chart to gauge the strength of the stock, and this is also where other time frames would come into play. You would want to look at a larger time frame to see if it is still showing strength and upwards potential. And you would also want to look at the smaller time frame to see if it is starting to create a downtrend, or if it is remaining in a sideways range and starting to breakout of that range.

Stock can be used for any time frame trade. We will look at these time frames and some interactions between them to help show what to look for to place a good entry.

For a day trade, the entire idea is to get in, capture a move and get out, and a day trade is one that will be closed by the end of the day, or in the after hours trading. It is not a position that is to be held overnight. The position can last for a few brief minutes up to a few hours. A common day trading set up would use a few intraday time frames for the entry and exits, along with a daily chart perspective to have an idea of which way the primary direction is headed. Some people prefer to use 2 intraday time frames, others choose 3.

A short term, or “swing trade” is one that last between hours up to a week or two. For a swing trade it is best to know what the weekly and daily chart perspectives, and to use an intraday chart for the signal to enter and exit.

A long term trade is one that will last between a week to a couple of months. And a very long term trade is for multiple months, into one lasting for years.

Each one of these has a range of time that the position is likely to be held for. That is because some moves are stronger than others, and with a position you do need to monitor it and adapt as conditions change. The phrase “let your winners run” is one that is very true, as you will capture the best profits with a longer term move. But, you also have to keep in mind the objectives of the time frame the trade is based on. The shorter the time frame of the trade, the more aggressively you have to take profits when a move does happen. And there is no rule that says once you take profits that if it sets up to continue the move that you can’t re-enter a new position for the continuation of the move.

The general idea is to use multiple time frames to help gauge strength and to signal when a move is starting, as most moves will cascade thru the different time frames as they develop. If the longer time frame is overbought, or is showing potential for a downwards move then the prospects for the shorter time frame breakout to new highs is decreased. And this would also show less potential of the price making a strong move up if it does breakout. If the longer term has successfully held a support level, or is successfully forming a higher low, and is showing potential that it is ready to turn up you have the best prospects for an upwards move. You then look to the shortest time frame to try to get the best possible entry, whether it is forming support or for a momentum signal on it, where it is either also forming a higher low, or starting a breakout. This gives you the indication that the price is starting a move, and the best prospects for placing a trade that will take advantage of that move.

The same philosophy applies to short positions. If the longer time frame is oversold or showing potential for an upwards move then the prospects of a successfully short position are diminished. The best prospects come when the longer time frame and shorter time frames are all showing downwards potential, and the shorter time frames are starting a momentum move.

Position Positive CharacteristicsNegative CharacteristicsBest opportunity
Long StockDirectional.  Price must move up to make a profit.Reward is equal to the move made in the stock  Not constrained by time.Higher cost of entry.  Low return on investment.  Loss of interest income when the price is moving sideways, with prospect of paying interest on margin used.  Risk of large loss from catastrophic event.Any time frame. Trend and momentum 
Short StockDirectional.  Price must move down to make a profit.Reward is equal to the move made in the stock.  Not constrained by time.High margin requirements, with unlimited loss potential. Any time frame. Trend and momentum 

This article did not look at how to protect a stock position.  That will be explored in a future article, once we have covered the characteristics of some of the different options positions.

calls puts

Position Characteristics of buying Calls & Puts

You should have already read the previous article on the Position Characteristics of Stock before proceeding with this article on Calls and Puts.

The basics

A call is a contract that gives you the right to buy a stock at an agreed upon price (the strike price) during a set period of time.
An example would be our favorite stock XYZ is at $50. You think that the price of it will move up, but you really don’t want to spend the $5000 to buy 100 shares of the stock. Most option contracts are for 100 shares of stock, so you could buy 1 call contract for the $50 strike for about $200. The $50 call is at $2, for 100 shares for a total of $200. Tonight XYZ announces that they have developed a cure for cancer, and the price of the stock opens tomorrow at $75. You have 2 things you can do. You could exercise the contract, and buy the 100 shares of stock at $50, and then sell the stock at $75 for an immediate profit, or hold the stock with the hopes it would go even higher. Or you could sell your call to someone else for around $25, netting yourself a tidy gain on that $200 investment.

A put works the same way, it is a contract giving you the right to sell a stock at the agreed upon (strike) price during a set period of time. If XYZ is at $50, and you buy the 50 put for $2, you would spend $200 to have the right to sell 100 shares at $50 each. Tonight XYZ announced that their new drug failed to get FDA approval, and it has been determined that instead of curing cancer, the drug actually causes heart attacks! So tomorrow morning XYZ opens at $25. Once again, you have 2 choices, to exercise the contract, sell the 100 shares of stock at $50 and have a “Short stock” position. Or you could sell your put to someone else for around $25 and pocket a tidy profit.

Sounds pretty easy and good, doesn’t it? The above example is one that will occasionally happen, but not very often. And in the above example the news came out right away. There is one major issue with buying calls and puts, and that is the issue of TIME!

Unlike a stock position, when you buy a call or put, it will lose value if the price is just moving sideways. So not only do you under perform the return a savings account would give you for your money, you actually wind up with less money. So with options, you not only have to pick the right direction, but you MUST have the price move in your favor.

There are some advantages of buying a call versus shares of stock, or a put instead of shorting shares of stock. The first is the leverage that you gain. If XYZ is trading at $50 share, to buy 100 shares it would take $5000. Depending on what strike is selected, and how many weeks are left until expiration, you could buy an At The Money call or put for around $2.00. An investment of $200. We will look at a more feasible move in the price of the stock, say just $5 in your direction. That would represent just a 10% profit for a stock position, but for the option position, after that 5 point move in the stock, you would be able to sell that contract for around $6, 3 time more than what you paid for it! So this leverage gives you a phenomenal return on your investment.

The other advantage of buying a call or put is that your risk is limited to the amount paid for the option. At the beginning of this article I laid out a scenario where news came out and had a very drastic impact on the price of the stock. What would happen if you just happened to be on the wrong side of this news? If your position consisted of stock, and it moved 25 points against you, that would result in a $2500 loss for a position of 100 shares. If you had spent that $200 for one options contract, and the stock moved 25 points against you, your total loss is just $200, the amount you paid to buy that contract.

If buying options is this easy and is so good, why do so many people lose so much money with options?

There are a few factors that come into play to answer this question. But mostly it can be summed up with one word, GREED. People are not content with the phenomenal results that are possible, and want even more. So they buy super cheap options. Instead of buying an At The Money option (or at least very near the money), and one with plenty of time left until expiration, they will buy one that is Out of The Money, and has very little time until it expires. Sure they may only pay 25¢ or 50¢ ($25 to $50 total expense) for this contract, but this selection leaves them with about the same prospects of making a profit as if they had went to a store and bought a lottery ticket.

Add to this, they will hold that position while the price is moving sideways or against them, and before long they can not “stop” out of it because there is no value left. It is primarily in the last 2 to 3 weeks before the contract expires that the time value will drop like a rock, especially if the strike price is out of the money.


Buying a call or call spread is a position that will take advantage of an upwards move in the price of the underlying stock or index. Because you are basically buying TIME when you buy an option these positions are not well suited to the very long term positions, UNLESS you are using a calendar spread, which will be looked at in a future article as it is an advanced and complex position. Buying a put or put spread takes advantage of a downwards move in the price, and is also effected by time, so is not well suited towards a very long term position. Options can be day traded, but it is difficult as most of them do have a wide spread between the bid and ask prices, so the underlying stock needs to make a significant move to overcome the spread and make the day trade worth while. This leaves the short to medium term trades that this type of strategy performs best in.

Due to the time value issue, you want to buy an option that has over a month before it will expire.  This will allow for a few days for it to move sideways without losing a lot of the time value.  And it will also allow the potential for a strong move to develop on the underlying stock.  But even if the move only last for a few short days, a relatively small move of just a few points in the stock can translate to a 35% or better gain in the price of the option.  I don’t know about you, but I think that is pretty good.

Position Positive CharacteristicsNegative CharacteristicsBest opportunity
Buy CallsDirectional.  Price must move up to make a profit.Lower capital requirements to enter position, and high return on investment.  Maximum loss is defined.Higher potential for a loss due to time value.Short to medium term. Trend and momentum 
Buy PutsDirectional.  Price must move down to make a profit.Lower capital requirements to enter position, and high return on investment.  Maximum loss is defined.Higher potential for a loss due to time value. Short to medium term. Trend and momentum 

position-characteristics-3-selling-premium

An examination of selling call and put spreads.

The last 2 articles examined the characteristics of buying stock or calls for an upwards move, and selling short stock or buying puts for a downwards move. The one thing in common is that for those positions the price MUST make the expected move to generate a profit for those positions.

There are times though when the price just seems to be stuck in the mud and is not making a good up or down move. There are other times when the price has already made a large move and is showing indications that a top or bottom is forming. These are prime occasions where you can sell options.

The basics

The writer (seller) of a call is agreeing to sell the stock for the agreed upon (strike) price for a specified period of time. The writer (seller) of a put is agreeing to buy the stock for the agreed upon strike price for a specified period of time.

When you sell an OTM (Out of The Money) option you are primarily selling TIME. There is no real value to an option that is OTM, the value that it holds is in the potential that the price has to move In The Money within the allotted time of the contract. This is how you make the profit on selling options, you let it just sit in the mud, or form that top/bottom that it is forming and just eat away at that time value. As the time decreases, and while the price remains OTM, the value of that option also decreases. And when you sell an option, you would like to see the value of it drop to 0 so you can keep all of the premium that you sold.

How it work

If our favorite hypothetical stock XYZ is trading at $47, and there is 4 weeks to go before the next options expiration, the $50 calls could sell for around $2.00. So if you were to sell 1 contract of the 50 XYZ calls for $2.00 you are agreeing to sell 100 shares of that stock at $50 per share at any time during the next 4 weeks. What happens if XYZ remains below $50 for the 4 weeks? On expiration day that contract will be WORTHLESS! Why would anyone want to pay you $50 per share when they can buy it cheaper on the open market? That is right, they wouldn’t, so that contract expires, and just goes away. And that $2.00 (total of $200 because one contract represent 100 shares) is yours to keep. The trade is over and you have made a profit.

With XZY trading at $47, with the same 4 weeks to go until the next expiration, the $45 puts could be sold for $2.50. So if you sell 1 contract of the 45 XYZ puts you would collect $250.00, and you are agreeing to buy 100 shares of XYZ stock at $45 per share for the next 4 weeks. What happens if the price of XYZ remains above $45? The person that wants to sell XYZ will not want to sell it to you for $45, he will want to sell it on the open market for more than $45, so the contract will not be exercised, and it will expire worthless, meaning you keep the $250 that you collected when you sold the puts.

The catch

In the above examples the price remained below $50 for the calls that we sold, and it also remained above $45 for the puts that were sold, so that each one would expire worthless, resulting in a nice profit on the trade. That is just what you want to see happen when you sell that premium. But, that is not how it will go each and every time. What happens to the calls if XYZ announces tonight that they found the cure for cancer? Tomorrow that stock will open for $100 per share. The person that bought the call you sold comes to you and exercises that contract, meaning you have to sell him the stock at $50. If you already owned the stock, then you sold a covered call, and you can deliver the stock to the buyer. But if you do not already own the stock, then you have to buy 100 shares of stock on the market. This will cost you $10,000 to buy the 100 shares at $100 each. Then you can honor the contract and sell the stock for $50 per share, resulting in a $5,000 LOSS!

Or tonight XYZ could announce that they have been cooking the books, and tomorrow the stock opens at $5. The person that bought the 45 put from you will be knocking on the door asking you to honor your contract and buy that stock from him for $45 per share. You are now the proud owner of 100 shares of XYZ stock that you just paid $4,500 for, but it only worth a measly $500. So overnight you just suffered a $4,000 LOSS!

Basically when you sell an option, you have a defined reward, and an UNLIMITED risk. Ok, when you sell a put, the risk is also defined, the stock price can not go below 0, but this still leaves you with so much risk, that you take the chance of losing your entire account and could wind up owing your broker from just one bad trade. It would depend on just how many contracts you sold, and how bad the price went against you. The example above involves selling a naked option, one that is not covered to give you some protection. This is very easily remedied. Instead of selling a naked option, you sell a spread.

Spreads

There is nothing complicated to a spread.  We will begin with a call spread.  XYZ is trading at $47 and the 50 call can be sold for $2.00.  The way that we protect this position is to buy the 55 call, which can be bought for 30¢.  This does 2 things.  The first it reduces the amount that you collect.  You now get $1.70 for selling the XYZ 50/55 call spread, so your reward is reduced.  The second thing it does it that it defines your maximum loss at $5.00 minus the premium collected of $1.70, for a total maximum loss of $3.30.  If XYZ cures cancer and the price skyrockets to $100 overnight, you will still have to honor the contract on the call you sold, and you will have to sell the stock at $50.  But instead of buying the stock on the open market at $100, you will exercise the call that you bought, and you will make some other poor sap sell you 100 shares of XYZ at $55.  Thus your maximum loss is $500 minus the $170 you received when you sold the premium for a total loss of $330 for selling 1 call spread.

And we do the same thing with the puts.  You sell the XYZ 45 put for $2.50 and you buy the XYZ 40 put for 50¢.  You collect $2.00 in time value premium, and if the worst case situation happens, your maximum loss is only $500 minus the $200 premium collected for a total loss of $300 not $4,500.     

I want to interject one thing at this time.  I do NOT believe in selling a naked option, any time I talk about selling time, selling premium, or selling calls or puts, I AM referring to selling a spread!

The defined risk is the difference in the 2 strike prices, and the profit is defined by the amount collected when the spread is sold.  Normally a spread is sold that has 4 or more weeks until it expires, which does lend itself to using the longer term weekly and monthly charts to gain a good perspective on the position.

Lottery ticket

In the previous article on buying calls and puts, I made a reference that buying an OTM option that has very little time left has about the same odds as buying a lottery ticket.  If a lottery ticket is so bad for the buyer, then that tells us that it favors the seller.   This is a shorter term trade, one that would be entered with 2 weeks or less until expiration, and the further OTM the option is the better.  There is one thing about selling lottery tickets though.  The reward is small, you may only collect 50¢ and still have that $5 difference between the strikes on the spread.  So while many lottery tickets do expire worthless, it would not take very many that wind up In The Money to do some damage to your account balance.


The biggest advantage to selling a spread is that you are taking advantage of the natural tendency of the price to stagnate.  When the price is forming a top, and you sell a call spread, you are in essence saying that the price will NOT go up past the strike price that you sold.  You don’t care if it moves sideways, and you don’t care if it moves down.  So instead of being in a position where the price must be moving down, you just care that it does not move up.  The same applies when you sell a put spread, you are saying that the price will NOT go down past the strike price you sold.  You don’t care if it moves sideways or up.  This allows you to enter a position where you just sit back and let time work for you.  You will want to periodically check on the position to make sure the price has not moved thru the strike price that you sold.  This can take all of 5 minutes a day.  While the price remains OTM, you leave the position alone and let the time value drain away.

Selling options work best when the price is not in a trend.  They are great for when a trend is ending, and for when the price is moving sideways.  The most premium will be received when you have plenty of time before the option expires, and the nearer the stock price is to the strike that is sold.  When the price is in a trend, you are taking a higher risk that it will move past the strike that you sell.

With this strategy you do NOT want to sell a strike that is ITM (In The Money).  Because when you do that, instead of having 2 ways for the price to move and give you a profitable position, you have reduced yourself to a directional position where the price MUST move in your favor to get OTM and allow you to keep the premium sold.  And with the limited reward that comes with selling premium, if you want to sell an ITM option, you are better off to just buy a call or put to take advantage of the move in the selected direction.

Position Positive CharacteristicsNegative CharacteristicsBest opportunity
Selling Call spreadPrice can move sideways or move down to make a profit.Takes advantage of the loss in time value that occurs with options.  It is also a position that does not require a lot of work to maintain.  Maximum loss if defined.Maximum profit is defined and can be lower than the risk.  Is not appropriate when the trend is moving up.When a longer term top is forming or when the price is moving sideways in a small defined trading range.
Selling Put spreadPrice can move sideways or move up to make a profit.Takes advantage of the natural loss in time value that occurs with options, along with the tendency of prices to stall.  Is also a position that does not require a lot of work to maintain.  Maximum loss if defined.Maximum profit is defined and can be lower than the risk.  Is not appropriate when the trend is moving down.When a longer term bottom  is forming or when the price is moving sideways in a small defined trading range.

We have now covered the basics of positions that take advantage of when the price is moving up or down, and also when it is not moving.  Now that we know what the characteristics are of these positions, in the next article we are going to start to look at some charts to show situations that will let us know which position is showing the best prospects of making a profit.

Charts and Positions

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Charts and Positions

Today we saw the markets dealing with some shorter term time frame issues. Yesterday and this morning I pointed out that the intraday charts were getting oversold. We did see some follow thru on the djx and spx for part of today, but this afternoon those oversold conditions lead to the start of an intraday relief bounce.

Over the past few weeks I have covered the characteristics of a position that requires a move to make a profit (Position Characteristics of Stock, Position Characteristics of Buying Calls) and also how to take advantage of selling premium (Position Characteristics of Selling Premium) when the price is not moving in a particular direction. This evening I wanted to use the 3 indexes to show how they can give us clues as to what type of a position is showing the best prospects.

For the ndx we will start back on the 13th of Aug (#1 on the chart). The price was at the lows, but we have the daily chart candle turning green, which is showing some strength in the price. This follows that green up arrow, a warning that the price is trying to move up. On the following Monday the price did turn up, which turned the trend ribbon that is below the price to green. We had a green candle and green trend, this is showing strength and momentum, and that the price is starting an upwards move. This is a key point. On this daily chart it is showing the price is NOT moving down. That means for a trade based on the daily chart time frame you would NOT want to be “short”, you would not choose a position that is short stock, nor would you be buying puts. With the price starting to move up, you would consider buying stock or buying calls. As to selling put spreads to take advantage of the price NOT going down, you would need to take the weekly chart into consideration. At this stage, I want to keep things simple, so we are not going to look at the multiple time frames, just bear in mind, both the shorter intraday and longer weekly time frames do have an impact on the daily chart.

The #1 did signal the start of an upwards move, and that move continued to near the end of Aug. when it started to show overbought pressure, and the candles started turning yellow and blue. #2. At this time, the price was weakening, and we see that the trend lost the solid green color, this signified that the upwards move was ending, and that it was time to either take profits on the “long” position, or at least use a very tight trailing stop. The box that stretches from #2 to #3 is showing a sideways move, where the price is not showing strength, and the weakness was not enough to get a downwards move started.

At #3 the price turned up again. The candle turned green to show strength, and the trend also turned green to show an uptrend. This was a very short move as the next day it became overbought (the dot above the price) This was a warning that this move was one to be very cautious with, and it did not take long for the price to falter and lose the upwards potential #4. From #4 to #5 we have another sideways move. One thing that is interesting about that sideways move, is that the last 2 days of it the candles turned blue and the trend was turning green, showing a weak upwards potential. The price was trying to set new highs too. This created a situation where the strength was not the best, and this was coming very soon after being overbought, so there was still the risk that a double top was trying to form. Had the price broke out, it would have been showing a high risk proposition for a “long” position where the risk of the price being able to sustain the move would be very questionable. The strongest moves come when you have both the trend and strength (green color) on the candle and trend ribbon.

And this brings us to #5, the drop in the price yesterday that turned the candle and trend red, showing a strong downwards potential. This is showing the price is NOT moving up, so we certainly do not want to be buying stock nor do we want to be buying calls. As to selling calls to take advantage of the price not moving up, that would require knowing the perspective that is shown on the longer term charts. With the price showing downwards potential, and the trend ribbon showing a downtrend we have expectations that the price is likely to move lower, showing a “short” position (short stock or buy puts) would be the position that would show the best prospects. Should the price move above the 1415 to 1420 area, then we could be seeing another sideways move develop, we would need to re-evaluate the chart at that time. And should the price move above 1435 to 1440 area, then we could be seeing an upwards move developing. We look at those 2 possibilities to identify levels that tell us the expectations that are currently showing on this daily chart are not happening. (Can you say “stop”).

On the djx we have the upwards move that started at #1 as the price candle turned green along with the trend ribbon. At the end of this move, the trend was still green, but the price turned blue, showing it was losing strength, this was a warning that the move was stalling. The candles turned yellow and the trend turned black to show it was neutral.

At #3 the price did shoot up to a new high, but the trend was still neutral and the candle was just blue, not green. This was not a move that was showing good potential for an upwards move. Yes there was a breakout above 102, but it was one that was showing a “long” position would be a higher risk position. I want to spend a minute here talking about the prospects of a move and entering a position. The whole idea of trading is to make a profit. The best way to do this is to enter a position that is showing good prospects of taking advantage of what the charts are showing you. This means there will be some moves that do take place that are not showing strong prospects. You have a choice to make on these high risk situations. You can take an aggressive position, one that you accept ahead of time the higher risks and the probability that the trade will not work out. There will be times it will work out, but with a high risk entry, there are going to be many times that it won’t. So you have to use a very tight stop, one that tries to keep the loss to a bare minimum. And when you take the aggressive position, you have to be prepared to place far more trades, and accept a lower win/loss ratio.

That breakout above 102 quickly became overbought and at #4 the candles turned yellow, giving us a strong indication the upwards move was coming to an end. Once again, as to selling a call spread, the weekly chart perspective would need to be considered.

At #5 the candles turned red, showing a downwards potential, and we also saw the trend turn red. This was showing a downwards move was trying to begin. The price stalled, and the trend went back to neutral, though the candle remained red. This continued to show the prospects that a top was forming, and the possibility of a sideways move, but still with potential to move down. And that is what happened at #6, the trend turned back to red as the price started moving down again.

Which leads us to where we are now, #7. The price candle and trend are still red. But we are starting to see some oversold pressure (dot below the price). This is giving us a warning that this move is getting extended, and that the possibility of a bounce or sideways move is increasing. So for a “short” position to take advantage of the downwards move, we would want to tighten the stop and be prepared to lock in or take profits if the price quits moving lower. There is still downwards potential, so we don’t want to jump too soon, the oversold warning is just that, a warning to pay attention and be ready.

In the middle of Aug. the spx also started an upwards move that became overbought and lost the strength in the price before the end of the month. The action that took place in the white box is a perfect example of what I spoke about concerning a high risk position. Even though the candles did not run red, and the trend was alternating between up and neutral, the price did move up from 1108 to 1130. But at the end of that box, the price did move sideways between 1120 and 1130, adding to the warnings that the upwards move was struggling and threatening to end. Yesterday the price fell below that 1120 support as the candle and trend turned red and we did get some follow thru to the downwards move today.


This is the daily update, that uses the daily chart of the indexes. The daily chart is a good tool for shorter term trades, ones that generally last for a few days, and for the occasional strong move up to a few weeks. For longer term positions the weekly and monthly charts need to be examined to get a better perspective of whether a daily chart move is just a reaction to, or part of a longer term move. It is when you combine the time frames together that you can develop a more accurate perspective.

The purpose of the articles on the position characteristics is to help show that there is a time and place for each type of position. There are times when the price will move up. When it is you don’t want to be “short”, and if you have sold a call spread, you have the risk of the price rising up thru the strike sold. When the price is moving sideways, you want to examine the longer term charts to see if they are also showing potential for the price to stall, and if so, then selling call or put spreads show the best potential. And when the price is moving down, you do not want to be “long”, and the risk of selling a put spread is that the price could move below the strike sold.

Charts & Positions #2 Selling Premium

Some charts to show situations where you would consider selling premium.

A couple of weeks ago I discussed the Characteristics of Selling Premium. Thursday afternoon I showed some daily charts and how they related to some shorter term “directional” positions. This evening I am going to show some longer term charts and how they relate to selling premium. The reason you must use the longer term charts, is that in most cases you are entering a position that you will be in for at least a few weeks, perhaps more than a month. And for this long of a duration, you need a longer term perspective that is not provided on a daily chart.

To be able to show the longer term perspective, I am going to use the Time Frame Analysis charts. The top left chart is the monthly chart, a very long term outlook. Top right is the weekly chart, bottom left is the daily chart, and bottom right is a short term intraday chart.

We are primarily interested in the longer term perspective that is shown on the top 2 charts, the monthly and weekly chart, but we can also use the daily chart to help “fine tune” the longer term outlook.

The top left monthly chart became extremely overbought at the end of last year and beginning of this year. The price stalled and that was one opportunity to sell the 40/45 call spread. (Sell the 40 calls and buy the 45) The price did fall below 30 and has since bounced back up to near that $40 level. But this bounce has been on a neutral trend, and the candles did not turn green to show strength, which is showing that we have a very high probability that a double top is forming on this monthly chart, giving us another opportunity to sell the 40/45 call spread.

During the month of Aug and the first ½ of Sept. the price was trying to move up but just did not show any real strength. Last week it started to turn down, turning the candle and trend red. This week it has been bouncing back towards 40, but the candle is remaining red, showing that there is a high potential that this bounce will falter and remain below 40.

Now to use the shorter term to “fine tune” the overall perspective. On the daily chart the price had been trying to hold the 38 neighborhood as support. The candles and trend were red, so the gap down was not a surprise. That move became oversold, and we did get a strong and fast bounce back up to test that 38 neighborhood as resistance. The price stalled at this level and is turning that previous support into resistance. And that short term chart is poised to turn down, which is giving us the potential that the daily chart could form a lower high.

This presented an opportunity to take advantage of the shorter term bounce that brought the price back towards 40. by giving us the expectations that a top is forming, and that selling the 40/45 call spread would be a fairly safe trade. IF the price moves to a new high above 40, then the trade is “stopped” to keep the loss to a minimum. A move above 40 would be showing a top is not forming, and that cancels the perspective that this trade would be based on.

You might have also noticed that on the weekly and daily charts the price has been staying above 35 for quite a few weeks. So couldn’t we enter an Iron Condor and also sell the 35/30 put spread?
That is a possibility, but there are 2 things to think long and hard about. First the price is pretty far from that 35 strike that would be sold, so the amount of premium (juice) that you would get is very low. The second factor is that we have both the monthly and weekly charts showing potential to turn down, so they are showing there is a risk the price could fall to and possibly below 35. You need to determine if the few drops of “juice” is worth the risk if the price does make that move.

The above chart is showing what appears to be a fairly safe opportunity. Now we can take a look at a more aggressive situation that developed on BRCM on Sept. 8th.

The monthly chart had made a strong downwards move, and had reached the bottom retracement line at 25. This retracement line is a level that could act as support.

The weekly chart had made a long downwards move and was showing a lot of oversold pressure. This along with the monthly chart retracement line gave us a warning to watch very closely.

The daily chart was also oversold, and the candle was changing colors to give us a warning that the downwards move could stall. Then we look at the short term that was trying to form a bottom and start a relief bounce.

Putting all of this information together, and we had the charts telling us that we wanted to consider selling the 22.50/25 put spread.

Not only did the price remain above 25 for the Sept. expiration, but the current weekly chart is showing a stronger potential that the price is likely to remain above 25 thru the Oct expiration. And “just in case” it doesn’t remain above 25, then a new low below 25 would cancel this perspective, and “stop” the trade to minimize the loss.

The key to selling premium is that you want to have the longer term perspective that the price will not move thru the strike that you sell. This is where you need to know the longer term support and resistance levels.

Trading Time

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trading time

This week a “Members Only” article was published that presented a strategy that can generate a profit if the price of a stock or index moves sideways, moves up, or moves down. The position is not risk free. The risk characteristics were examined in detail with some possible ways to reduce or eliminate that risk were also discussed. This evening I want to discuss a longer term strategy that can generate a profit if the price moves sideways or in the “right” direction by using a Time Spread, whether it is a Diagonal spread or a Calendar spread.

In previous articles we have discussed the characteristics of buying calls and puts and we have examined selling premium. The Diagonal and Calendar spreads involve both types of positions. But first we need to look at the minor differences between these two types of spreads. The one thing they do have in common is that you BUY an option that has a lot of time, usually a few months to a year or more with the use of LEAPS. The second thing that they both have in common is that you sell a current month strike. The difference between these 2 spreads is that the calendar spread involves using the same strike (such as Selling a Jan 35 call and buying a May 35 Call) while the Diagonal spread involves different strikes (Selling a Jan 35 call and buying a May 30 Call).

A time spread is a good way to take advantage of a long term trending move. Here is a monthly chart of the QQQ tracking stock to show some of the longer term moves that have taken place.

What this monthly chart shows is that on the Q’s from the end of 2018 to the end of 2019 the price made a 20 point move. In 2020 there was another very long term move that took place that covered more than 12 points.

In this article we are going to examine ways to profit from moves such as this by using a Time Spread position.

The 2 moves that are highlighted above lasted approximately 1 year each. And because this is a “trending” type of strategy you are unlikely to catch the exact top and bottom, your goal though is to catch as much of the trend as possible.

Philosophy of the position

With a time spread there are two objectives, and I am going to discuss these separately to help break down the complexities of the Time Spread position to the basics of the position so we can see what will be taking place as time goes by.

The first part of a Time Spread position is the purchase of an option that has a lot of time until it expires. Basically you are buying a call or a put, depending on which direction you feel the stock or index will go, and you do want the price to make a large move in that direction. On the above chart we have the price that fell from 40 to 20, and has bounced back to near 40. For this next part of the article, we are going to take the perspective that the price will fall back to 20, and that it could take 12 months for the price to make that move. At this time we have the 2020 options available for March and June. Neither of which gives us the 12 months that we are looking for, so we look at the very long term options and see there are Jan 2006 options. When we look at the option chain for Jan 2020 we see that the 39 Put would cost $3.40. This strike is ITM (In The Money) and does have almost $1 of real value to it). The 38 Put would cost $2.95 and it is ATM (At The Money) and all of this is in time value. We also have the 37 Put that would cost 2.55 which is 1 strike OTM (Out of The Money). Arguments could be made for the selection of any one of these strikes. What it will come down to is that you will select one of these strikes to purchase.

Once the strike has been selected and purchased the trade has begun, and your primary objective with this part of the trade is for the price of the q’s to move down where the put that was purchased will gain real value.

IF the q’s move up instead of down, then you will have a problem as the put you purchased will not have any real value, and it will be losing time value. A move above the 40 area would start to seriously impact this part of the position, with the higher the move goes the more damage that is done.

The long term option that is purchased also servers as “collateral” so you can place the second part of the position, the selling of the near term premium. In theory you want to use time to your advantage and sell the near term puts enough times to pay for the put that you bought. For this particular position we are looking at buying the Jan 2020 option, this gives us all 12 expiration cycles in 2019, plus the Jan 2020 expiration AND also the Dec. 2018. We have 14 expiration cycles that we can sell premium in. Because you already own the Jan 2020 put all we are looking at doing is selling a Dec. put. When it expires we will then sell a Jan. 2019 put, and so on each month until we reach Jan. 2020.

The most expensive put that we could have bought was $3.40. If we take that amount and divide it by 14 (the number of months that we can sell) we find that we only need to collect 25¢ each month to collect enough premium to pay for the put we purchased. There is one other factor that we need to take into consideration, and that is the cost of trading. Somewhere along the way we will need to collect a little more than a quarter to pay for all of the commissions on the trades that are placed with this strategy. There is one thing to keep in mind, is that the near term put we sell will need to be far enough OTM that it expires worthless, because if the price does move beyond that strike where it is In The Money, it could take us out of the position before the year is up, or wind up costing money that will ultimately eat into the potential profits, or turn the overall position into a loss.

We will start by looking at the Dec. 2018 puts. We have the Dec 2018 37 put at 40¢ and the 36 put at 20¢. Now the fun begins as we enter the complicated part of the position. If we sell the 37 put we collect more than our quarter, and we are well on our way to paying for the put we bought. If we can get this much in premium every month, we could wind up with a decent credit at the end of the trade. This would be extra profit on top of any real value gains in the price of the option we bought! Or if the price of the q’s is at 38 in Jan 2020, at least we would have a small profit from the near term premium we have sold.
But, if the q’s drop below 37 before that Dec contract expires it will cause us some pain and problems. While the 36 put is at 20¢ and not quite the quarter we want every month, it is a little bit safer, but not completely safe as the monthly chart of the q’s does show a move of 2 to 5 points per month is quite normal.

There is one other small issue about this part of the position where we sell the near month option. It is going against the underlying basis of the option you bought. The first part of the Time spread is buying an option and wanting the stock or index to make a strong move in that direction. The second part of the position is basically saying “just don’t make that move right now”.

While the philosophy of this position is very simple, you want to buy an option that will gain in real value as the price of the stock or index makes a long term trending move, and to offset the cost of the option you bought you want to sell the near month premium each month. What will make or break this position is whether you correctly pick the direction of the trend, and how well you do with selling the near month premium each month.

We have examined what a Time Spread is, and the individual parts that make up the position. We have also looked at the philosophy of the trade and what we want it to do. And we also see that there is a twist with how one part of it is going against the other part, which does add to the complexity of the position. In the next article we will look at some actual charts and show how the TimeFrameInvestor time frame analysis feature can help you with the issues that pertain to this type of a position.

Is the “juice” worth the squeeze?

An examination of whether the reward is worth the risk.

In previous articles we have discussed the characteristics of different positions, and have looked at some charts that show when those different types of positions would be appropriate to take advantage of what the charts were showing. Today I want to go a step further, and talk about the risks and rewards of a position, and examine a situation that does ask the question of whether the “juice” is worth the squeeze.

To begin this discussion, I want to use a stock that I came across today when I was looking for a Stock To Watch. I looked at the charts on PAAS, and found them to be quite interesting. Here is the charts and the comments for the different time frames. The monthly chart is on the top left, weekly chart top right, daily chart bottom left, and a short term intraday chart on the bottom right.

The very long term chart was extremely overbought as this year began, and the price did have a swift pullback to the lower teens. The price has since bounced back up, and while it is showing some strength with the green candle and trend, we are seeing overbought conditions developing, showing a possibility that a very long term top could form.

The long term weekly chart did break above the July highs. It very quickly became overbought, and is now showing some extremely overbought pressure. This is a stronger warning that this upwards is getting extended and could come to an end.

The medium term daily chart did move up from 16 with overbought pressure, and became extremely overbought. The price pulled back to test that broken resistance and has bounced up to set a new high. What really sticks out about this bounce, is that the candles did not turn green to show strength, and this move is showing overbought pressure already.

The short term intraday chart was extremely overbought yesterday, and stalled just above 17. This morning the price did continue moving up, but did not turn green, and continued to show overbought conditions. The candles are turning yellow, and the trend is turning neutral, which is a very strong indication that the upwards move is stalling.

All of the time frames are overbought, and the shorter term time frames are giving us some pretty strong indications that the upwards move is likely to come to an end, and this 17.50 area is starting to act as a short term resistance level. The longer term charts are still showing some strength, so there is a risk of an overbought rally moving the price higher, back to the highs from earlier this year near 20.

I wanted to stop the analysis at that point and take a few minutes to review what we are seeing on this stock, and compare it to the different position characteristics in the regard of looking for an entry for a new position.

We will look at a “long” position first. Whether you are buying stock, or buying calls, both types of positions have the following characteristic: “Directional. Price must move up to make a profit.” And the best opportunity is: “Trend and momentum”
On the charts above, we do have the trend on all but the intraday time frame. We also have the strength/momentum on the longer term time frames. But we do have the warning of the overbought pressure, and the resistance of the previous highs on the monthly chart. This puts into question just how much more the price will be able to move, and shows that there would be a very high risk of “buying a top”. If anything, these charts would be showing someone that is holding a “long” position that they should tighten a trailing stop and start to consider either taking or locking in profits, not looking for a new “long” position. The reason for this that while it is possible for an overbought rally to take the price upwards, it is something that can not be counted on, and the lack of the shorter term strength is a warning that the upwards move could be ending sooner rather than later.

Ok, so a new “long” position would be very high risk, and probably not a good position to enter. So we can take a look at a “short” position, whether it is selling stock short, or buying puts. The characteristics for a short position are: “Directional. Price must move down to make a profit.” And the best opportunity is when you have “Trend and momentum”.
This is very simple, the price has been moving up! It is not in a downtrend, and does not have downwards momentum. So a short position would not show prospects for a profit at this time. If we do get the monthly chart lower high, and if we see the weekly chart stall and start to turn down, and we see the daily and intraday charts starting a downtrend, THEN a “short” position would be one to consider as it would show potential for the price to move down to generate a profit.

This brings us to the third type of a position, selling premium. There are 2 choices on selling premium, either selling a call spread, or a put spread:

  • Selling a call spread.  Characteristic “Price can move sideways or move down to make a profit.”  Best Opportunity “When a longer term top is forming or when the price is moving sideways in a small defined trading range”
  • Selling a put spread.  Characteristic “Price can move sideways or move up to make a profit.”  Best Opportunity “When a longer term bottom  is forming or when the price is moving sideways in a small defined trading range”

In the “Best Opportunity” we can see that a call spread is a good choice when a longer term top is forming, which is what we have the prospects of occurring on the weekly and monthly charts of PAAS.
ok, now that we see that selling a call spread is the best opportunity, let’s take a look at some specifics.

There is no premium to be able to sell the Oct. 20 calls, and the Oct. 17.50/20 call spread is showing just 40¢ of juice, leaving $2.10 of risk. This is not very much reward, but there is not much time left until the Oct. expiration, just a week and a half. The Nov. 17.50/20 call spread only brings in around 70¢ of juice, leaving $1.80 of risk, and 6½ weeks of time. Neither of these positions offer much reward. With the strength that is still showing on the longer term charts, there is the risk that the price could continue moving up with an overbought rally, which does increase the risk potential that the price could move past the strike sold and retest the highs from earlier this year, and possibly even the 20 area.

The reason I went thru this is to illustrate that while these charts are showing a strong probability that a top could form on this stock, the only calls that could be sold are at a strike that is below the previous highs, and with the current strength, there is a real risk that the price might not stay below the 17.50 area. So while the charts are showing that on this stock for a new position you would want to consider selling a call spread, the actual options are not presenting an optimal situation, making for a very high risk trade if you were to enter it. This leaves us with a situation where at this time the best thing to do is to not take a new position on PAAS. Perhaps in the future as this top develops more a situation will arise that will present better prospects for a profitable trade. It is just as important to know when NOT to enter a trade, as it is to know when to enter one.

Back Ratio Spreads

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Back Ratio

A look at how a Back Ratio position can be used.

In previous articles we have discussed how calls (or call spreads) can be bought to take advantage of an upwards (“long”) move, and puts or a put spread bought for a downwards (“short”) move. For these directional positions the price of the stock or index MUST move in the direction chosen to generate a profit. We have also examined how when a top is forming you can sell a call spread to take advantage of a sideways move or pullback. Likewise when a bottom is forming a put spread will take advantage of a sideways move or bounce. When you sell premium (call or put spreads) you have the advantage that the price would need to move against you for it to become a loss.

Today I want to use a stock that I highlighted today and how a mixture of bought and sold options can be used to create a low risk position. First we will take a look at the longer term half of the Time Frame Analysis on this stock.

This stock is trying to turn up on the monthly chart, showing potential for the price to retest the previous highs at 45. The weekly chart is stalling a little at the highs from last week and also late June at 40. This weekly chart is making it a little questionable if the price will be able to break this resistance at 40.

I want to take a moment to examine some possible positions that could be taken.

For a “long” position we would need to see the price break thru this resistance at the 40 area, and we would then need for the price to continue moving up to produce a profitable position. If the price can not break 40, then an entry would not be made.

The price is not moving down, and is not showing any downwards potential, so we would not want to enter a “short” position at this time. There are a few “ifs” that could happen to change the expectations of this stock, but what is important is right now the longer term charts are not showing potential for a short position to generate a profit.

The price is 5 points away from 35, so there is not any premium left at that strike that can be sold, and the same thing applies to trying to sell the 45 calls, there just is not enough premium to sell. The 40 strike is right in the middle, and the risk to sell either calls or puts at the 40 strike is that the price will move to and perhaps past 35 or 45.

It did not take much to go thru the basic positions and see the only one at this time that would be showing any possibility is a “long” position, and that is only if the price can break thru this resistance at 40.

So now we can get creative and look at purchasing a Back Ratio. Specifically by selling 1 Dec 40 Call and buying 2 Dec 42.50 calls for a 45¢ credit, and a margin requirement of $200.00

What we did here was sell a call spread, but also bought an extra call. Here is the risk profile of the position as it will appear right before the Dec. expiration. Because of the time erosion of the bought calls, the risk profile of today is much different than what it would be right before this position would expire, thus the use of the profile for Dec. The Dec. strikes were selected to allow the price not just 3 weeks to make a move, but rather to allow it 7 weeks:

This is what is interesting about this position. What if we are wrong about the upwards potential, and the price can not break above 40, or if it does peek above it can not stay above it, and begins to move lower. If you have a “long” position this would result in a loss. But with this Back Ratio because it was entered for a credit, if we are wrong it will result in a $50 PROFIT!

With the 7½ weeks we have ahead of us, we want to see this stock move up to test the previous highs near 45 and breakout above that level and just run. And if it can do so, then we have a great reward potential because we bought more calls than were sold. The reward is limited to how far the price of the stock can run before the Dec. expiration.

WOW! that sounds really great, we can make a profit if we are “wrong” and the price goes down, and we can make a bigger profit if the price breaks above the previous highs, but what about that “V” that we have between 40.50 and 44.50 where the line drops below 0 to represent a loss, with a maximum loss of $200 if the price is at 42.50 on expiration day?

That 44.50 is right in the 44-45 area where we have the previous highs on the monthly chart. This position will make the best profit with a breakout above that resistance. IF the price fails to break that resistance, then the monthly chart will be forming a top, and it could be stuck between the 40 to 45 area for a period of time. So what we would want to do is monitor the price as it tests the previous highs at 45, and IF it can not breakout, then we look at the position characteristics we talked about just a few minutes ago, and we see that when a top forms, you can sell a call spread to take advantage of a sideways move or pullback.

Because we are talking about a situation of “what if” the price is near 45 (and how near it) we also have the “when”, how long before that Dec. expiration. This makes it hard to say with certainty what the option prices will be with these variables, so for the answer to this question of what we could possibly do should the price not breakout above the previous highs, we have to “guesstimate” and come up with a rough idea, and if this situation does present itself, at that time we would fine tune it with the actual numbers at that time.

IF the price is unable to breakout above the previous highs (or if it just peeks above them and falls back) AND ONLY IF the price fails to breakout to new highs, we would look at selling the Dec. 45/47.50 call spread. We would look at selling it enough times to eliminate the possible $200 loss that the above profile shows. Or at least reduce that loss to a very small amount that would be near breakeven. IF we were able to sell the 45/47.50 call spread for 40¢ we would want to sell it 5 times (5 contracts) and it would give us the following risk profile:

With the Back Ratio, and the 5 sold call spreads, we now have a breakeven at 45.50 that if the price of the stock moves above this level we would stop out and prevent a loss from occurring. But while the price remains below 45.50 (and the only reason we sold the call spreads was because the price was forming a top!) we will NOT lose any money on this position. Our worst case is if the price expires at 42.50 where we pretty much so just break even. But if the price does not expire at that level we have the potential to make up to $250.00 profit.

The purpose of this article is to show how a trading plan can be laid out. In this article we see the entry and position, and WHY this position was selected. We know where the risk is at, and we even have a back up plan IF the price fails to break above the resistance of the previous highs. This article also shows how a Back Ratio can be used if there is potential for a directional move, and it can also even generate a profit if you are “wrong”. There is a zone where the back ratio can create a loss, but by being flexible and adapting to a changing situation we were able to devise a plan of action that takes this zone into consideration.

This also illustrates the importance of know your time frame and being able to see multiple time frames at the same time. The Time Frame Analysis shows the longer term perspective that we saw in this article and also presents the shorter term charts at the same time. The shorter term charts were omitted from this article so it would not “muddy the waters”. This position is looking at expectations that are 7½ weeks in the future and require the longer term charts to be able to get the proper perspective.

trading styles to lead or to follow

I am not talking about personality traits, but rather trading styles.

There are risks and rewards associated with both styles. I will very briefly touch upon the characteristics, so that you can get a better idea of which trading style will fit you best.

A leading system is one that is more of a contrarian approach. “Buy fear and sell greed” is one of the common mantras of a leading system. Often, an oscillating type of indicator is used for the buy and sell signals, along with aggressively buying support and selling resistance.

The advantage of a leading system is that you get into (or out of) a position early, keeping a high majority of the gains for the move made. A leading system is very good for a choppy market, or one that moves up and down in the same range over and over.

The disadvantage to a leading system is the number of false signals that you can get. For example, the daily chart may give warnings that the upward move is ending. You can become overly aggressive by trying to sell the very top, but the signal may be too early and the next day the price can snap back up and cancel the sell signal. With a leading style you would want to use a fairly tight stop, so when a situation like this occurs the “damage” will be minimized and it will be just a small loss and will not turn into a large loss. I don’t know how much more I can stress the need to set and honor stops. If you can’t or won’t do that one step of the process, then you are going to be in very big trouble. As a market continues to move “against” a signal, a small loss can turn into a big one if a stop is not set and then honored.

Due to the very tight stops that are associated with the more aggressive leading style, more trades will be entered, so it does drive up the trading costs. You have to be able to change your bias almost at a moments notice. This reminds me of a statement made by Keynes: “When the facts change, I change my mind. What do you do, sir?”

A following (or trailing) system is one that better corresponds to the following attitude: “You can have the top 20%, and the bottom 20%, but I will take the 60% in the middle.”

A following system is one in which you do not try to enter at the top or bottom. Once a trend is identified, you stay with the trend until a loose trailing stop is hit. The reason it is a loose trailing stop is that you want to stay in the position until a new trend has developed in the opposite direction. The trend can be a traditional “higher high & higher low, or lower high and lower low” or it can be a moving average cross-over, or based on a following indicator such as the MACD indicator.

The main advantage of a following system is that you have fewer trades, and when a strong trend develops you can ride the trend and “let the winner run” as you are not looking for a top or bottom and allows you to ride out the smaller term “wiggles”.

The disadvantage of a following system is when the price is trendless, range bound, or making small moves. When this occurs, and you use a following system, you often wind up buying the middle and exiting at a loss at the top and bottom.

There are advantages to both styles, and also disadvantages. It depends on the situation and time frame that you are looking at as to which style would be “better” than the other. Which brings me to the Time Frame Analysis and the custom charts that I use. I spent years creating and testing all types of different indicators and formulas. The Time Frame charts are the result of that work, and incorporate characteristics of BOTH types of styles, and the power of these charts is apparent when you look at the multiple time frames.

Every situation is different, and the Time Frame Analysis with the custom charts found at TimeFrameInvestor can help you decide which trading style is right for you.  The Time Frame Analysis can also help you identify which positions can help you achieve maximum results using your trading style. See how you can benefit from all that TimeFrameInvestor has to offer.

Matching the time frame to the Trade

Knowing the correct time frame to focus on is one of the most important aspects to managing a trade. If you are a daytrader, the monthly chart will not do you any good. And if you are a longer term trader the 3 min chart will be nothing but noise.

At the top of the Market Analysis Report, I have the following posted:

  • Very Long Term (Monthly chart) is a move that will last for many months into quarters and years.
  • Long Term (Weekly chart) is where a move will range from a week into multiple months.
  • Medium Term (Daily chart) is a move that can last from a couple of days into a few weeks.
  • A Short Term (Intraday chart) is one that will take place over a couple of hours into a few days, which is also referred to as a “swing trade”
  • An Intraday trade is also referred to as a Daytrade, that can take place over a few minutes or last as long as a couple of hours, and will not span one day into another. You can have multiple Intraday moves during one day. This very short term time frame will not be reflected on this page, because of how fast it changes.

Sometimes after seeing the same thing in the same place for so long, it become “invisible”. Today I wanted to speak about these different time frames and relate them to strategies and positions.

One thing I do firmly believe in, is that a single time frame by itself is not very meaningful. It is when you examine the time frame above and below it (longer and shorter term) that a picture will evolve that does tell a much better story. That is why the Market Analysis and Bottom Line reports view 4 time frames each and every day!

One strategy that many people like to use is selling premium. This is a strategy that normally will be a position that can be held for up to 7 to 8 weeks. This involves the longer term, weeks and months. These longer term charts are used to gauge the prospects of the risk for the price moving in a certain direction. Let’s take a look at the situation we were in just a week ago. The djx monthly chart were trying to show some strength, BUT were in a situation where they had to set new highs to show an upward potential, otherwise we would just have a top forming. hmmmm ” a top forming ” that is one of the things we look for to sell call spread. But we also need to know what the other time frames were saying to know when the risk/reward situation would be favorable.

On the weekly chart we also had some strength showing up, but the price was approaching previous highs, a resistance level. On the weekly chart, we started to see a situation similar to the monthly chart, where the price needed to break that resistance, or it would be forming a top.

Then we drop down to the daily chart. Last week the price was making that weak move up, not showing good strength, and also showing overbought conditions. When we added that to the potential longer term top, it gave us a much better risk/reward situation that a top was most likely to form, and that the time had come to seriously look at selling those calls, and to watch the shorter term charts to help in the timing of the entry. On Thursday the price started making a shorter term downward move from that resistance, and that is when the small time frames came into play, to help with the timing for an entry.

The objective of that position is for the price to remain at/below the strike sold, preferable at/below that resistance if the sold strike is above it. And to remain below that level until those options expire, which would result in a 100% profit as you would keep all of the premium that was sold, and for this we revert back to the longer term charts. The price did move down from that resistance, and is remaining below it. The intraday bounce that began on the djx yesterday does not change that longer term perspective, and so far that position remains in good shape. So the intraday action on the djx yesterday and today is nothing but noise.

We can take a look at another strategy, one that is a little more complex as it more heavily involves the use of both the longer and shorter term charts. We can use that very same situation just described on the djx, to show how a time spread / diagonal would work. For a time spread you are buying a longer term option, with the objective that in a few months when it is nearing it’s expiration that it will have some real value. Another objective is that you will sell the near month option to help pay for that one you bought.

By using the time frame charts, there is the prospect that a person could be more aggressive, and leg into the position. A prime example, is that a week ago we had the longer term that was showing potential to form a top. If a top does form, then it becomes very likely that a pullback (downward move) could develop. With this in mind, last week we were watching the shorter term charts for the indication that the price was getting ready to start moving down from those highs. On Thurs we did get that shorter term confirmation, giving us the indication that buying that longer term put was presenting a favorable risk/reward situation. Like the calls that were sold, for this part of the position, while the price remains below that resistance, there is the potential for the put bought to gain in real value should a pullback develop over the next few months.

Now comes the complexity of a time spread / diagonal position, selling the near month puts. On Thurs the price gave the indication that the shorter term charts were turning down. This downward move continued thru Tues, when that hard and fast decline took place. The short term intraday chart became extremely oversold, raising the risk of a shorter term relief bounce. And yesterday the price did confirm the bounce was starting when it moved above the highs of the first 1/2 hour. That could have been used as the signal to sell the March puts. With the daily chart still showing considerable weakness, and the daily chart was not oversold, so the risk/reward situation was not the best. In this situation, if the near month puts were sold, then the intent is most likely to buy them back when this relief bounce falters, as the prospects of continuing the longer term downward move are still high. The best prospects for selling the near month puts would be when the daily chart is forming a bottom, and the intraday chart is starting to form a new uptrend.

With that time spread, it involves 2 parts, a longer term part of the position and then the shorter term part. What makes a time spread so interesting is how the shorter term part of the position is in conflict with the longer term goal. You are in essence saying you want to see a longer term large move take place, but when you enter the shorter term part of the position, you are saying you just don’t want to see that move take place right now.

Those are 2 positions that deal with longer term perspectives. We can also look at some shorter term styles. Because these positions, which are commonly called “swing trades” are not meant to be held for many weeks, but are rather for a few hours, and if there is a very strong move that develops it can be held for multiple days up to a week or two. For these types of positions a more directional approach is taken, where you deal more with the “long” or “short” bias. For these types of trades you use the longer term charts to help judge the trend, and most likely direction that the price will move in. You then use the daily chart to show when the best risk/reward scenario is beginning to develop, and when it is getting close, you then go into the intraday charts for the timing of the entry or exit. The selling of the near month puts that I spoke about earlier could also fit into this style of trading.

Then as you go into the more active intraday and daytrading style trades, the longer term charts become unimportant. For these types of very active traders, a daily chart would be viewed as the longer term. For these types of trades, the same principles apply, the smaller time frame chart is used for the timing of the entry and exit, and a larger time frame is used to judge when the time is getting close, and for directional bias.

With the interactions of the different time frames, you will also be dealing with the leading and following style issues. When a trend has emerged, or is developing, then for that time frame you want to use a following style, and for the smaller time frame a leading style would be used for the timing of the entry or exit. If you are looking for a reversal, then for the time frame you are watching you would want to use a leading style to be ready for the more aggressive approach that is called upon for a reversal, and for the smaller time frame you would use a following style for the confirmation that the reversal is taking place. Such as on the daily chart we did see the price move down from a longer term resistance level and set a lower low. The bounce that started yesterday and continued to day has brought the prices up to a resistance level, and we are seeing the intraday charts showing some extremely overbought conditions. A leading style of the short term chart would suggest that this bounce is in jeopardy, and on the daily charts, if the price stalls here and turns down, it will be a lower high following a lower low, and would show a new downtrend has emerged.

When you are managing a position, or looking to enter one, you must know the time frame that you are looking at, and how the other time frames will interact to help you define the best risk/reward situation, and also to help time when to make that entry or exit.