The Only Indicator I Use

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Keep it simple.

I stated this same sentiment on Monday. Pick a few indicators and follow them forever. I can't tell you how many traders that I know that want to follow bull flags, bear flags, candlestick patterns, Fibonacci retracements - the list goes on and on. They will try and teach you about their long list of indicators to make themselves look impressive, but in reality most are horrible traders and unsuccessful over the long-term.

The Options Advantage strategy uses the RSI model plus a few of my proprietary models to take advantage of sentiment and technical extremes.

Today, I would like to share with you a few of the technical indicators I use in my proprietary model to give you a head start on learning how I trade the strategy.

One of the most powerful technical indicators I use in my proprietary model is RSI Wilder.

The Relative Strength Index (RSI), developed by J. Welles Wilder, Jr. is an overbought/oversold oscillator that compares an entity's performance to itself over a period of time. It should not be confused with the term "relative strength" which is the comparison of one entity's performance to another.

RSI allows me to gauge the probability of a short to intermediate-term reversal. It does not tell me the exact entry or exit point, but it helps me to be aware that a reversal is on the horizon.

Knowing that a short-term top/bottom is near I am able to increase the probability of a potential trade. Conversely, knowing that a reversal is on the horizon I am able to lock in profits on a trade.

I use the trading guidelines mentioned below and have added my own proprietary twist:

Buy when the 5-day RSI closes below 20.0
Sell when the 5-day RSI closes above 85.0.

I am a contrarian at heart and I prefer to fade an index whether overbought or oversold when the underlying index reaches a "very overbought/very oversold" state. Fading, just means to place a short-term trade in the opposite direction of the current short-term trend. We're leaning into the wind a little with the expectation that we'll catch the next big gust going the other way.

Of course, other factors must come into play before I decide to place a trade, but I do know that, in most cases, when an index reaches an extreme state a short-term reversal is imminent. Again, I will keep all of you abreast of the overbought/oversold condition in the Options Advantage weekly report.

So now that you have the basics of the strategy let me go over a few examples.

The following trade is an example of the type of trade that occurs my High-Probability Strategy.

Background : The market surged for eight straight days starting at the end of June. The surge lasted until the July 7th at which time QQQ (the Nasdaq ETF) had pushed into a short-term overbought extreme.

If you look at the RSI (5) reading below the chart you will see a short-term overbought extreme had been hit. At that time, I want to make sure my other proprietary indicators line-up. If so, I will fade the move.

I discussed what fading means earlier, but for those of you who do not recall it is basically placing in a trade that opposes the current trend. In this case the move was higher, therefore I bought puts. If the market had declined sharply and moved into a short-term oversold extreme I would have bought calls. 

QQQ Powershares Trust


The trade: When entering in the trade I always look for a delta between .50 and .70. This means that for every $1 in the ETF I will make $50 to $70 per contract. Moreover, I look for a price around the $2.50 - $3.00 area. If you are unfamiliar with delta and the greeks in general please reference my special report on the greeks.

The reason I chose a delta in the .50 - .70 range is for risk-management reasons.

Choosing an option with a delta of $1 would be way too risky and potentially fatal if the underlying ETF moves in the opposite direction of your position. A delta lower than .50, say .30, would require a large move in the underlying ETF and I do not want to wait for an extended move.

Remember, the strategy takes advantage of short-term extremes. I do not want to be in a trade for longer than a week if I have to. My average trade lasts 4.7 days in the High-Probability strategy so choosing an option that would require a large move over 5 days is unrealistic.

So, back to the trade.

With QQQ moving into a short-term extreme on 7/7 I bought QQQ puts for $2.77. Two trading days later I sold the QQQ puts for $3.23.

Again, I keep it simple, very simple. Why would I attempt to create a complex options strategy when the High-Probability strategy has a win ratio over 89% with an average return of over 8% per month?

Simple = boring and often that does not entice traders, but I am not here for excitement, I am here to provide a sound options strategy that makes people money over the long haul and that is exactly what the Options Advantage options strategy has succeeded in doing.

Until Tomorrow,

Andrew Crowder
Editor and Chief Options Strategist
Options Advantage
Wyatt Investment Research

Disclosure: None



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

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