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I received an email from a prospective subscriber over the weekend who had a modest amount of money to invest and wanted to know how to use pebblewriter.com to invest in options — a field in which he hadn’t much experience. He described himself as a passive participant who isn’t particularly interested in playing intra-day moves.
First, let me congratulate this gentleman for asking the right questions. Even the most experienced among us started out as a newb. I can, unfortunately, recall many times when I wish I had taken the opportunity to ask more questions before plunging in. Experience is a great teacher, but it can be an expensive lesson.
Second, his question made me think: what is the best way to use this site? We’ve had a great run so far [see: RESULTS.] Given the way it has evolved and the way the market is moving these days, do options even make sense? If not, then what? And, how?
OPTIONS
I’ve traded options on and off for over 30 years. I’ve enjoyed some unbelievably great trades, and I’ve had some real stinkers. In a strongly trending market where we’re going to make a big move one way or the other, they can be a lot of fun. When the market moves against you and you’re running out of time, it’s like being strapped to the front of a runaway locomotive that’s about to T-bone a nuclear power plant.
I’ve pretty much decided that unless someone has the time, experience and resources to become expert at options trading, it’s really best to stay away with any serious money — at least with directional trades.
There are all sorts of strategies that can mitigate risk, but buying at- or out-of-the-money calls and puts in the hopes of the market moving in the right direction, by the right amount and in the right time frame is like tossing your money up in the air and hoping more of it falls back down.
I can’t count the number of times I got direction and price right, but the move I expected didn’t happen until the Monday after expiration. I’ve seen many very smart people get hosed in this and countless other ways. Bottom line, unless you’re brilliant, rich, experienced and have great trade management skills, I can’t recommend them.
EQUITY STRATEGIES
So, how might someone use the information on this site to make money in the markets? If you can stay on the right side of the markets most of the time — long when it’s going up and short when it’s falling — then it turns out you can make some decent dough.
Many investors use an ETF such as SPY or the eminis to establish a long or short position. This is easiest for those who have the time to watch the markets during the day and respond relatively quickly to trade signals which, like the markets, can be unpredictable.
There’s no way for me to know whether our 2nd year will also produce an average of 10% per month. But, at even half that, I’m a very happy camper. At a quarter, we’d still be way ahead of the pack. As such, I see no particular benefit to using leverage.
In a vibrant and trending market, I love nothing more than raising all the sails and running before the wind. But, this can be unproductive — or even dangerous — in gusty, shifting winds. Then, I try to be a little more cautious.
It was smooth sailing from March to May 2012. We earned almost 25% during SPX’s 11% drop from 1422 to 1266 with a minimum of effort — a nice payoff for the new pebblewriter.com just getting under way.
Even the whipsawing rebound from the June lows to the September high wasn’t too bad. We had a big harmonic pattern to complete at the Sep 14 high of 1474, which was the 88.6% retracement of the 1576 – 666 crash. It provided a great target and we were able to generate another 36% on a 16% move in the underlying.
The decline to 1343 over the next two months, once it got going, was fruitful — earning us 25% on the 9% decline. But, thanks to the unusual structure, it took 44 trades to get it. The rebound over the following month was much easier, earning 14% versus SPX’s 7%. Then, sadly, our analog crapped out around the end of the year.
The following months were painful. Once a harmonic retracement exceeds the .886, there are oodles of possibilities: a slight throwover, a double-top, a 1.272, or a 1.618 extension. What’s worse, we had conflicting signals — with two major Crab Patterns calling for a 1553-1555 top, only 20 points below the 2007 high of 1576.
We spent much of January through March trying on different scenarios for size, waiting for a trend to emerge. It came in the form of a five month, 260-pt narrow channel whose biggest correction was about 50 points. It blew through several important Harmonic targets, Head & Shoulders Patterns, and pretty much everything else the bears could throw at it.
In the end, we did well enough — scoring 23% in the first quarter versus the S&P’s 13%. But, it’s been a heck of a lot of work — much of it feeling like we were lost in the reeds. I have used tighter stops, gone to cash more often overnight and weekends, and looked for opportunities to pick up 5-10 points on an intra-day basis.
THE CHALLENGE
But, the volume and sometimes conflicting nature of more short-term trades can make them hard to track (e.g. are we taking an interim long position in addition to our core short, or a short-term long trade in expectation of re-shorting?)
I created a new page to help folks keep track of the big picture: Current Position. But, there have been many times when a perfectly good chart pattern busted or didn’t play out as expected, and even the big picture or “core” trade got stopped out.
One long-time subscriber suggested color-coding transactions, and I’m trying to figure out whether it might work. My concern is that the nature of positions sometimes changes. For example: SPX closed at 1593 today. My current expectation is that if it exceeds 1596, it has potential to 1602. If it tops that, 1635 is on the table, etc. etc…
On the other hand, if it dips below 1592 in the morning, it has downside risk to the channel bottom at 1576 where it would likely catch a bid and start a run to 1635. But, if it fell through the channel bottom, though, look out 1500.
I’m not sure how to even begin to characterize those scenarios as long-term or short-term, much less color-code them — as much as I would like to. And, then there’s the question of you, my faithful subscribers. Are you a swing trader? A day trader? Maybe the buy-and-hold type? What’s short-term for a swing trader can seem like an eternity to a scalper.
BE THE SOLUTION
What I’m best at is figuring out where the market is likely to be. Sometimes, I can see very substantial moves weeks or even months ahead. For example, we positively nailed the July-August 2011 crash, the Apr – June 2012 correction, the June – Sep 2012 rally and the Sep – Nov 2012 correction.
But, sometimes, the long-term picture is as clear as mud — especially at key inflection points such as right now. I can make a very good case for a sharp pullback to SPX 1497, and nearly as good a case for 1823.
Those who can take this information and adapt it to fit their circumstances (objectives, resources, liquidity, risk tolerance, etc.) in a timely manner will do well as long as I can keep feeding you good information. It will mean staying pretty active during choppy, directionless markets, and less so in trending markets.
But, the onus is on subscribers to take the time to determine whether the scenarios I foresee unfolding are compatible with their needs and objectives. I’ll always do the best I can to provide a sense of the big picture. But, there will be times when we are “lost in the reeds” and alerts come more frequently — requiring more effort on the part of subscribers.
It’s not possible to repeat everything going on in a cumulative fashion. So, important tidbits discussed yesterday might or might not make into today’s post. Therefore, it will be much easier to stay up with what’s going on if you take the time to read each post.
Those who don’t have the time or the energy to follow along might find the idea of a managed fund more appealing. Or, you might check in whenever able — knowing that catching some of the moves some of the time is better than waiting for Cramer’s next brainstorm.
A month ago, many of you were kind enough to fill out questionnaires that we sent out. I’ve read each and every one from top to bottom, and there are some great ideas amongst the feedback. I’ll be working to incorporate as many ideas as possible as we move ahead.
In the meantime, please don’t hesitate to drop me a line with your thoughts. I don’t always have time to respond immediately, but I read everything that comes my way.
Good luck to all.
Note that this plunge, if it continues, will complete a rather nasty H&S Pattern around 900 that targets 840.
Which would put it in the neighborhood of the bottom of a rising wedge and the .618 of its leg up from 765.
And, the EURUSD isn’t exactly signalling a rally:
The AUDUSD, which we haven’t looked at lately, is on the edge of a cliff. Recall that it completed its yellow Crab Pattern a long time ago. It’s now pondering the white Crab Pattern to the 1.618.
But, it’s formed a triangle (yellow, dotted) that dates back to 2010…
That really looks like it should break to the downside — almost certainly breaking 1.00.
And, our old friend the USDJPY… looks like the bounce may be fizzling — if not downright reversing.
In short, the rest of the world continues to signal a downdraft in stocks. But, SPX is soaring.
We closed the short position that we adopted on the opening yesterday at the close for a small profit — even though it didn’t quite reach our 1580 target. I was worried that the ECB rate cut and predictable initial claims report would do…well, exactly what they have done.
