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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • 6 Exceptional Swing Trading Reversal Signals
    The whole concept of swing trading rests on the premise that short-term price movement (especially in reaction to news, rumors or surprises) tends to be exaggerated. It also tends to self-correct within two to five sessions. So a swing trade usually lasts for this duration and is based on making a move counter to the emotions of the market.

    Swing traders rely on three primary reversal signals. These are:

    1. Reversal day. A fundamental rule about reversal is that you have to have a short-term trend to reverse. An uptrend is defined by swing traders as three or more consecutive sessions, with each session opening higher than the previous open, and also closing higher than the previous close (higher lows followed by higher highs). A downtrend is the opposite, consisting of three or more consecutive sessions with lower opening prices than the prior, and closing lower (lower highs and lower lows).

    So once these conditions are in place, a reversal is possible. A "reversal day" is just that, a downward-moving session after an uptrend, or an upward-moving session after a downtrend. This is the most basic of reversal signals, and also the least reliable. You need confirmation from another reversal signal before you can rely on the reversal day.

    1. Narrow-range day, or NRD. This is a session with an exceptionally small span between opening and closing price. Candlestick chartists call this a doji, a Japanese word meaning "mistake." The most extreme NRD is a session opening and closing at the same price, and on a candlestick chart this is a horizontal line rather than a rectangle. This is a very strong reversal indicator, a signal that momentum has shifted from buyers (in the uptrend) to sellers, or from sellers (in a downtrend) to buyers.

    3. Volume spike. The third swing trading reversal signal is the volume spike, any session on which volume is considerably higher than previous days. This is a very strong indicator and should not be ignored.

    Whenever you find two of these three signals at the same time (like a volume spike on a NRD session, for example), the likelihood of reversal is very strong. Never act on a solitary reversal signal, but rely on indicator and confirmation.

    Beyond the standard swing trading reversals are dozens of other possibilities. These include:

    1. Traditional Western reversals. Look for double tops or bottoms, head and shoulders, and price gapping runs to spot potential reversal. An actual reversal is most likely when price approaches and tests resistance or support. Even if price does break through, look for price or momentum weakness to foreshadow likely retreat.

    5. Momentum oscillators. Among the great reversal signals are changes in momentum. Indicators like RSI or MACD reveal when momentum is declining for the side in control. Thus, when buyer momentum is weakening, an overbought signal is going to pop up, and when seller momentum is weakening, you will find the indicator moving into the oversold range.

    6. Candlestick reversals. The candlestick chart is one of the most important of technical tools. Dozens of reversal signals involving one, two or three sessions are likely to lead to better than average timing of both entry and exit. Swing traders benefit greatly by using these.

    (click to enlarge)
    May 26 11:46 AM | Link | Comment!
  • 3 Options Defensive Strategies
    The traditional view of options is that these are speculative and high-risk trading tools. But a more important and valuable use of options is to protect equity positions in your portfolio. Three specific strategies are useful in limiting or eliminating market risk, for little or no net cost.

    To reduce risk, three strategies may be considered:

    1. Protective puts. The most basic defensive move allowing you to continue holding stock is the long put, also called the "insurance" put. This is also termed a synthetic long call; in the event the stock value rises, the overall stock/put long position rises as well. However a problem with the protective put is that is requires payment of the put premium. So if your basis in stock is $50 per share and you buy a 50 put and pay a premium of 3 ($300), that means your net basis in stock has to rise to $53 per share. So you need a three-point gain just to break even. For this reason, just buying a protective put leaves a lot to be desired.

    2. Synthetic short stock. The second strategy is to create an option-based position that will increase in value point-for-point if and when the stock's value falls. It consists of one long put and one short call opened at the same strike. The cost of the put is offset by the income from the call. This is a very low-risk position for two reasons. First, the net cost is zero or close to it and, in some instances, even creates a small net credit. Second, if you are trying to protect stock you own, each synthetic position provides protection for 100 shares. The put provides downside protection while the short call is covered. If the stock rises, the short call will be exercised; or, to avoid exercise, it can be rolled forward as an on-going covered call. This strategy solves the flaw of the protective put by covering the put's cost with premium from the short call.

    Collars.The collar is very similar to synthetic short stock. It involves 100 shares of stock, a long put and a short call. However, the call and put normally are opened at different strikes so that both are slightly out of the money. If the stock price rises, the call is covered; if the stock price falls, the put grows in value. And because the net cost of the two options is at or close to zero, it does not take very much movement for the long put to become profitable. Because the short call is out of the money, time value will fall rapidly as expiration approaches; so it is not difficult to avoid exercise by either closing the short call and taking a profit, or waiting for it to expire worthless.

    There are many more methods for playing defensive with options; but as a starting point, every trader needs to be aware of these key strategies.

    I am working currently on a new book designed to address the many ways of using options to protect portfolio positions. The important take-away from this is that you do not have to use the two common strategies: either hoping paper profits do not go away, or taking profits to avoid a decline in price. Neither of these are optimal if your long-range purpose is to build and maintain equity. Options present solutions to this problem.

    May 23 9:41 AM | Link | 1 Comment
  • Trends – Can You Anticipate Price Direction?

    Trend forecasting: This is an issue all traders and investors struggle with. The trend itself is likely to contain many false starts as secondary trends begin - is it a new trend or just an opposite-moving, short-term change? How can you tell the difference?

    The same problem comes up during consolidation, the sideways movement of price. Many think of this as a pause in between bullish or bearish trends; I tend to think of it as a trend in its own right, with some notable differences. In a bullish or bearish trend, reversal and continuation signals are guidelines for anticipating how trends behave. In a consolidation trend, there is no dynamic trend to reverse. So how do you identify the time and place of consolidation's end? The answer is found in a specific type of signal. How do you use the Bollinger squeeze? the M top or W bottom? or volume along with price signals?

    All of these trend-related issues are the topic of my latest book, "A Technical Approach to Trend Analysis," published by FT Press. This book will be out in July, but it can be pre-ordered now on Amazon or directly from the publisher.

    Here is a summary of the table of contents:

    Illustration List

    Introduction-Defining the Trend

    Chapter 1 The Theory of Trends-Dow, EMH and RMH in context

    Chapter 2 Statistically Speaking-Trends by the Numbers

    Chapter 3 Resistance and Support-A Trend's Moment of Truth

    Chapter 4 Trendlines and Channel Lines-The Shape of Things to Come

    Chapter 5 Reversal Patterns-End of the Trend

    Chapter 6 Continuation Patterns-A Bend in the Trend

    Chapter 7 Confirmation Signals-Turning the Odds in Your Favor

    Chapter 8 Consolidation Patterns-The Sideways Pause

    Chapter 9 Volume Signals-Tracking Price Trends

    Chapter 10 Mind the Gap-When Price Jumps Signal Change

    Chapter 11 Moving Averages-Order in the Change

    Chapter 12 Momentum Oscillators-Duration and Speed of a Trend

    Chapter 13 Volatility-Marking Risk within the Trend

    Chapter 14 Fundamentals-Connecting the Two Sides

    Chapter 15 Overview-Putting It All Together

    Endnotes

    Bibliography

    Index

    May 22 3:03 PM | Link | Comment!
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