This week’s TWA post includes a new and improved Economic Calendar that adds international data. Good luck this week!
Relative Strength Index
The relative strength index is a technical indicator that looks at the speed and significance of historical price movements of a market or stock over a defined time frame. In it’s simplest definition, the relative strength compares the number of higher closes to the number of lower closes. A stock or market with more or stronger higher closes will demonstrate a higher relative strength index. On the contrary, a stock or market with fewer or weaker higher closes will demonstrate a lower relative strength index. The relative strength index is displayed as a ratio from 0 to 100.
The relative strength index can be used as an overbought/oversold measure. As I mentioned before, we know that if a stock has a higher relative strength index it will have more or stronger higher closes. In other words, a market or stock with a high relative strength index will exhibit rapid upward price movement. Typically, stocks that are bought rapidly will become overbought. Overbought stocks or markets can be identified as ones which have a relative strength index of 80 or above. Wilder, who is the creator of the relative strength index, said that if a stock or market is oversold, it is bound to reverse at some point. Similarly, we know that if a stock has a lower relative strength index it will have fewer or weaker higher closes which will exhibit rapid downward price movement. Stocks or markets that are sold rapidly will become oversold. Oversold stocks or markets can be identified as ones which have a relative strength index of 20 or lower.Again, stocks or markets that become oversold will have to reverse at some point.
The stochastic oscillator is a technical indicator that uses key support and resistance levels to examine the momentum of a stock or market. The stochastic oscillator compares a stocks or markets current price to its price range over a period of time. When a stock or market’s current price moves towards the price ranges upper boundary, the stochastic oscillator will be higher. When a stock or market’s current price moves towards the price ranges lower boundary, the stochastic oscillator will be lower. The stochastic oscillator is displayed as a ratio between zero and one-hundred.
Similar to the relative strength index, the fast stochastic can be used as an oversold/overbought indicator. It is not unreasonable to see a stock or market trade within a certain range over a defined period of time. If a stock or market is trading with within a certain range, you can assume that as the price reaches the upper boundary, the stock or market becomes overbought putting downward pressure on the price. On the other hand, as the price moves towards the lower boundary, the stock or market becomes oversold which puts upward pressure on the price of the stock. Generally, a stock or market is considered overbought if the fast stochastic is above 80 and oversold if they fast stochastic is below 20.
After conducting other supporting types of analysis, I use these indicators to determine an entry or exit point with regard to a particular stock or market. Generally, I look for both of these indicators to unanimously point to oversold or overbought. In my experience I find that if these indicators both point to overbought or oversold they are extremely accurate and can indicate the start of a upward or downward trend. These indicators, when used together, can prevent you from entering a stock in a downtrend or exit a stock in the middle of an uptrend. Even though they are both accurate on their own, they are much strong when combined.
The SPY one year daily chart highlights this entry/exit technique in greater detail. The blue arrows all point to areas in which the relative strength index and fast stochastic are below twenty, or oversold. Using what I described above, we would expect that touching these levels would be followed by a moderate to significant upward price movement. As the chart illustrates, this held true.
You will also notice that if the indicators do not agree, they are not as powerful and often have price movements inconsistent with what I described above.
|Johnson & johnson||JNJ||22-Jan||$1.17|
|Proctor & Gamble||PG||25-Jan||$1.11|
|Report||Date||Time||Estimated Level||Estimated Percent Change|
|Existing Home Sales||22-Jan||10:00AM ET||5.1M||1.19%|
|Jobless Claims||24-Jan||8:30AM ET||360k||6.94%|
|PMI Manufacturing Index Flash||24-Jan||8:58 AM ET||54||-0.37%|
|EIA Petroleum Status Report||24-Jan||11:00AM ET||–||–|
|New Home Sales||25-Jan||10:00AM ET||388K||2.92%|
For those of you that do not know my history with regard to trading the financial markets, I’ve delved into a variety of different asset classes: equities and equity options from November of 2008 to August of 2010, futures from August of 2010 to December of 2011, and foreign exchange from January of 2012 to March of 2012. Following my short stint with foreign exchange, I decided to step my game up and train under the phenomenal proprietary trading firm SMB Capital this past summer; I can honestly say that without that training and my constant drive and motivation for trading success, I would not be anywhere close to where I am today. I gained a valuable set of skills from SMB Capital that I needed in order to truly understand how to navigate my way through the markets on my own, and over the course of my writings with The Invisible Hand, I’ll be showing all of you how I utilize these skills to trade successfully.
If there is one market I’d like to specialize in outside of college, it’s the futures market. This particular market is dynamic, and in my opinion, is one of the most interesting and challenging markets to follow and trade. The futures market allows you to spot trends on a macroeconomic, technical, and short-term basis that lets you to determine with accuracy where the markets are going. My year and a quarter length trading the futures market, as some of you may know through my posts on Young Guns Trading, was grueling: I started with $6,000.00, turned it into $11,000.00 in a few short months, and after getting some additional capital from my brother and my father, I took a $20,000.00 account and destroyed half of its wealth throughout 2011. It was atrocious and damn well drove me to insanity. I had no idea what I was doing wrong, and I was clueless as to how to get back in the game and be profitable; the problem, however, was not what I was doing wrong but rather what I wasn’t doing at all. I had some pieces of a developing strategy that could have been a force to be reckoned with, but it wasn’t a complete strategy and because of that, I lost ten stacks. In hindsight, that destructive behavior was a part of my tuition to market education and I wouldn’t change the way I lost that money for the world. I not only learned about myself, but I also learned about the erratic nature of the markets that I traded: stock indices, metals, and energy. After moving back into this space at the beginning of this year and combining it with my equity trading, I’ve added the 10-Year Treasury Note futures to my arsenal of markets that I concentrate on, giving me an edge to cover the largest, most voluminous “slices of the pie.”
Enter the top right monitor seen in the picture above. My strategy within these markets does not use simple moving averages, it doesn’t use an RSI or MACD crossover play, and it doesn’t focus on waiting for the price to bounce off a Bollinger Band in order to make a trade. In an upcoming post for my readers at Sang Lucci, I’ll be discussing the idea behind Ten Thousand Hours and in that post, I cover a conversation I had with a Wall Street heavy hitter regarding the advantage of time and information. Timing is everything when it comes to making a trade, and my strategy focuses on exploiting price discrepancies from futures market to futures market, comparing how they move in relation to each other using two correlation studies on my thinkorswim platform. The strategy is designed to be simplistic, looking at only the raw data from the level two and time/sales to determine the supply and demand of buyers and sellers in the markets I watch and compare them to each other, attempting to spot inter-market abnormalities and capitalizing on them. In short, it’s a discretionary tape reading arbitrage strategy that has been flawless since the beginning of 2013.
Let’s go over an example from the overnight session of Monday into Tuesday of this past week. I was looking at Copper (HG), the 10-Year Treasury Notes (ZN), the S&P 500 (ES), and Gold (GC) in order to determine what kind of overnight activity we’d see after watching the S&P 500 drop back to it’s important 1465.00 technical level that it has continued to hover around for the past week. The technical levels I was paying close attention to were for HG to hold 3.64 support, ZN to hold 132.02 support, ES to hold 1466.50 resistance, and GC to hold 1670.00 support. My initial trade was to get long HG based on my thought that ES was going to trade higher, but after watching ES sell off into the Asia cash open, I decided to change my bias to a short market outlook. After watching the price of GC fluctuate, I was anticipating a breakout in the price and began looking at trades to pair nicely with that breakout and what it meant to the other futures markets. I came up with the following biases to support the information the market was giving me:
After coming up with these trade biases, I began to look for clues on the tape to help me with my decision and found them when ES started getting sold on the bid, initially moving the prices in HG and GC lower. This is where the first bias came to fruition, as a bidder in GC stepped up and held the price nicely around 1670.00, cluing me in that as ES and HG continued selling off that GC was most likely looking to move higher. The paired trade came with ZN, as there is very rarely a time that ES and ZN trade in the same direction. With the seller on the tape in ES and HG present, the buyer showing his cards and holding the bid in GC, and ZN holding steady with traders beginning to pay up, I added GC and ZN longs at 1670.90 and 132.055, respectively. My risk:reward on both trades were approximately 1:3.5, and with the correlation in HG and ES holding up, the trade made sense. I walked away with seven handles in GC and ten ticks in ZN, with this trade becoming the highlight trade to review this week.
Paying attention to all of these markets at once may seem like a daunting task: it’s a 24/7 trading style, it’s very detail-oriented yet incredibly basic, and during times of heavy market activity takes an extreme amount of focus and understanding of how all of these markets connect. In my next post this week, I’ll be bringing another example and more discussion regarding the Pair Correlation and Pair Ratio indicators thinkorswim has to offer traders looking at capitalizing on price inefficiencies across markets. We’ll also be taking a look at the tape of one of the markets to breakdown how it moves and its idiosyncrasies when trading during “in-play” time periods.