A few Non-Decision Strategies

May 23, 2007: 8:31 PM CST

If you are fed up with trying to guess the direction of the market and being wrong, try experimenting with these trading ideas:

  • Place stops on alternate sides of technical decision nodes

By this, I mean find a spot where the market reaches a known barrier and forces itself into the difference between two outcomes.

Place a buy stop slightly above the barrier and a sell short stop slightly below the barrier.

This occurs when the market touches a well-traveled (or well-established) trendline. Either price will penetrate it and continue further, or reverse off it and validate the trendline further. Either way, the market is unlikely to stay stagnant at that zone because so many trades are watching it.

What makes this strategy work is that people with positions are forced to take an action, either by their stops being triggered, or fresh entries being triggered. The cumulative effect often serves to trigger a ‘snowball rolling’ phenomenon where price will move stably in one direction, although the direction of penetration is often unknowable until the ‘snowball’ actually is in motion.

Rather than establish a position at the top of the mountain, relax and place entries on ‘both sides’ of the mountain so that you’re (almost) guaranteed to capture a small portion of the move.

By the way, exit stops would be the other side of the technical boundary should your entry be triggered. Profit targets will be set by your risk-tolerance (aggressive = large target and conservative = small target).

  • Use option spread strategies in an observed uptrend

By this, I mean find uptrending stocks and then wait for a pull-back (or not even wait for it if you are aggressive) and then sell a put either at the current strike or slightly below the current strike (reduced premium) and then hedge by buying the next lower put (if the stock is in an uptrend).

This is known as a “bull put” spread and is a credit spread. This allows you to collect the entire option premium when two of the three possibilities occur:

  1. The stock continues to rise in its established uptrend (you collect full premium)
  2. The stock pauses and consolidates (you still collect your full premium)
  3. (BONUS) The stock retraces (declines) a bit but not enough to cancel the premium you collected

What this means is that (technically) you could be wrong about your decision and still collect the full option premium!

Let’s say a stock is rising and is currently at $53. You sell a put option at $50 and buy a put option at $47.50 or $45 (this acts as a hedge). As long as the stock DOES NOT decline (or close) below $50 (actually, $50 minus the premium you collected) then you will collect the full premium. The stock could actually decline $3 and prove your initial thought wrong, but you still make money.

Obviously, you’ll make money if the stock closes at $53 (flatlines) or rises to $55. I am assuming you hold the spread until expiration Friday (Saturday).

I will let you ponder your thoughts on these strategies before going deeper.

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