Markets I Trade: December 11, 2018

In my non-registered investment account I am developing my trend following strategy continuously. I don't pretend to have all the answers; I am always exploring and learning and I am sharing that journey with you on this blog.

All I know for sure is that I want every trade to end in three ways: a small loss, a small gain, or a large gain. I predetermine my risk on each trade and aim to make sure that risk is never exceeded.

Due to account size, my brokerage, my location, and my experience, I am somewhat limited in what I can effectively trade at this time given my risk tolerance. I recently have done a lot of self education on options and have begun to use LEAPS options in my strategy.

I try to limit my investing process to the most liquid markets that have the highest potential for bigger price movements. This generally means ETFs, certain leveraged ETFs, the USD/CAD currency pair, and certain emerging market currencies against the Canadian dollar or U.S. dollar.

Thankfully this covers a large portion of the investable market. ETFs track many different markets and also can provide exposure to currency movements (unhedged country ETFs).

With long call options and long put options, I can very effectively access markets with a relatively high degree of leverage and great risk management. I use only LEAPS options—options that expire more than one year from the entry point.

To monitor each instrument I trade, I look at moving averages and volatility measurements. Although there is no holy grail indicator, looking at these tools can help paint a pretty solid picture of where the markets are going.

Moving averages help identify the direction of trends and can help show turning points in direction. Using volatility measures makes it easy to size each position based on pre-determined exit points. High volatility markets translate to smaller positions while low volatility markets allow for larger positions.

In a currency pair trade, I have found that moving average indicators can be quite effective as well. However, in using moving averages alone, the trader doesn't have the same embedded exit points to help determine position sizing.

This makes moving averages most effective for trading my two primary account currencies—the USD/CAD pair. I don't try position size the USD/CAD pair as I am equally happy with my account cash being 100 percent in the Canadian dollar or 100 percent in the U.S. dollar.

I also look at breakouts, although I am not using them to enter or exit positions. Breakouts can be very helpful in confirming trends and seeing points of previous resistance.

Brazil (EWZ)

Given the current market environment, I am holding very few positions at this time.

In today's post I will provide an update on my Brazil trade.

Back in early October, I took an upside position in Brazilian stocks. I talked about that position entry several weeks ago in the November 13 post.

Since my entry point, my Brazilian stock trade has done very well. It has jumped about 15 percent and, barring a massive gap over my stop-loss, this will be a profitable trade that exceeds my initial risk.

EWZ (Weekly Bar)

Source: Yahoo Finance

Since June 2018, where EWZ was technically oversold, and September 2018 where EWZ was in an interim bottom, we saw a quick jump up. However, EWZ seems to have stalled out at the moment and I am looking for new medium-term highs to be made.

That said, I still think EWZ has a decent technical picture. A move over $42 would solidify the upside and could be a decent entry point.

Upside Optimism

  • An interim higher high was made when EWZ jumped over $37.65 in early October.
  • At current levels, EWZ is not technically overbought and is sitting roughly in the middle of the optimism range.
  • Since early October, the price is holding on top of the 40-week SMA.
  • Volume seems to be generally higher on upwards moves, indicating desire to buy and hesitation to sell.

Upside Caution

  • The price has fallen slightly through the shorter term indication—the 10-week SMA.
  • Although it is flattening, the 40-week SMA is still declining at the moment.
  • The price is now effectively in a trading range of $37 to $42 over the past two months.

If EWZ continues to bounce up from its current price of $38.70, the $47 level will be a key point to look at. That is when the prior strong upwards move stalled in January 2018. If EWZ moves past that, it would signal strength in the upside.

Right now, EWZ would have to jump more than 20 percent to hit $47.

EWZ (Daily Bar)

Source: Yahoo Finance

Looking at the daily chart, we can clearly see the trading range that has formed over the past two months. Although it would clearly be nice to see repeated higher highs, even in the daily chart, the $37.50 level has held twice now.

This chart shows an update on my current stop level. My exit on this trade has moved up and is a little over $37. The stop has really tightened up to the price over the past few weeks and is now within 5 percent of the price.

I entered this trade using a liquid 3x leveraged ETF, trading as BRZU. If I had to do this trade again, I would consider using EWZ long-dated options as they are highly liquid and a more efficient use of capital.

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Markets I Trade: November 27, 2018

In my non-registered investment account I am developing my trend following strategy continuously. I don't pretend to have all the answers; I am always exploring and learning and I share that journey with you on this blog.

All I know for sure is that I want every trade to end in three ways: a small loss, a small gain, or a large gain. I predetermine my risk on each trade and aim to make sure that risk is never exceeded.

Due to account size, my brokerage, my location, and my experience, I am somewhat limited in what I can effectively trade at this time given my risk tolerance. I recently have done a lot of self education on options and have begun to use LEAPS options in my strategy.

I try to limit my investing process to the most liquid markets that have the highest potential for bigger price movements. This generally means ETFs, certain leveraged ETFs, the USD/CAD currency pair, and certain emerging market currencies against the Canadian dollar or U.S. dollar.

Thankfully this covers a large portion of the investable market. ETFs track many different markets and also can provide exposure to currency movements (unhedged country ETFs).

With long call options and long put options, I can very effectively access markets with a relatively high degree of leverage and great risk management. In my newly started options trading, I use only LEAPS options—options that expire more than one year from the entry point.

To monitor each instrument I trade, I look at moving averages and volatility measurements. Although there is no holy grail indicator, looking at these tools can help paint a pretty solid picture of where the markets are going.

Moving averages help identify the direction of trends and can help show turning points in direction. Using volatility measures makes it easy to size each position based on pre-determined exit points.

High volatility markets translate to smaller positions while low volatility markets allow for larger positions.

In a currency pair trade, I have found that moving average indicators can be quite effective as well. However, in using moving averages alone, the trader doesn't have the same embedded exit points to help determine position sizing.

This makes moving averages most effective for trading my two primary account currencies—the USD/CAD pair. I don't try position size the USD/CAD pair as I am equally happy with my account cash being 100 percent in the Canadian dollar or 100 percent in the U.S. dollar.

I also look at breakouts, although I am not using them to enter or exit positions. Breakouts can be very helpful in confirming trends and seeing points of previous resistance.

Gold (GLD)

In mid-October I took an upside position in gold. To measure the performance of gold, I used GLD, a highly liquid gold trust ETF.

After a very strong gold bull market from the mid-2000s through 2012, the price of gold has dropped quite significantly. It seems to have bottomed out at the end of 2015.

GLD (Weekly Bar)

Source: Yahoo Finance

Looking at GLD since the end of 2015, the period where gold seems to have bottomed, we see what I would consider to be a mixed technical picture. I am trading gold very cautiously!

Upside Optimism

  • Higher lows on big drops have been made on two occasions: the first at the end of 2016 near $107 and the second more recently in August 2018 at approximately $111.
  • The price jumped above the 10-week SMA which has now turned upwards.

Upside Caution

  • We have failed to see higher highs. In 2016 GLD hit a little over $130, GLD could not break above this level in 2017 and early 2018.
  • A few months ago GLD broke a streak of higher lows and higher highs that occurred through 2017.
  • The price is currently below a falling 40-week SMA.
  • Since entering the trade more than a month ago, the price has gone nowhere.

If GLD bounces up from its current price of $115, the $130 level will be a key test to look at. That said, a move up to $130 still implies a 13 percent upside. A price break below the $111 level would be quite negative.

GLD (Daily Bar)

Source: Yahoo Finance

This chart shows the intial buy signal (green circle). I ran a very tight stop limit order on the position since I was away on vacation with no internet and got stopped out at $113.50 for a very small loss.

As the price rebounded above the initial entry point, I re-entered the trade at approximately $115.65. This time I sized my position based on a stop loss level of $112.

Although I initially entered the trade using UGLD, a 3x leveraged gold ETF, I purchased LEAPS options to get exposure to 1,700 units of GLD in the latest entry. That's equal to a standard position worth a little less than US$200,000.

Currently my overall trade is showing a slight loss thanks mostly to the timing of my move out of UGLD and re-entry into GLD options.

Selling Options vs. Buying Options

If you read a little financial news or otherwise enjoy to be amused, you may have seen this incredible video by a man who recently blew up his hedge fund!

James Cordier wrote books on selling options and was widely considered to be an "expert". Cordier states he lost ALL of his clients' money (over $190 million) due to a "rogue wave" in the natural gas market.

As is typical of these blow-ups, he was selling naked call options. This means he was making proverbial pennies selling options on futures he did not own, effectively betting that prices would not increase.

When they did rise, he had to expend many dollars when the obligations came in to sell these futures contracts to the holders of the options he sold. Dollars he did not have.

I was curious about the move that wiped out this hedge fund, so I took a look at a recent chart of natural gas (represented by UNG).

When I did, I was shocked as it was immediately clear just how foolish a trade this was. And I don't say this smugly in an arrogant hindsight view. This is a lesson to learn from!

Source: Yahoo Finance

In August, the UNG chart broke above the 50-day SMA and 200-day SMA and we saw a crossover of these two key indicators. That's two upside signals hit within days!

Then, in September the price popped above the previous resistance point of $24.50 that was hit for nearly the entire month of June and again in mid-August.

By late September and into October, the price was solidly moving higher and rapidly pulling away from the key moving averages.

To affirm the upside, this was a classic case of higher lows. Looking back in the chart, since December 2017 every low point was higher than the previous one. As you can clearly see in the six month chart, the September low was again solidly higher than the July low.

True, no one could have predicted the upside price explosion in November. But all the key signals were saying that natural gas was moving up. It was certainly not the time to expose clients to theoretically unlimited losses if prices continued to go up!

If an investor were bearish and traded contrary to these indicators, the best bet would have been to purchase put options—hoping prices would fall below $24, maybe retesting the September lows around $23.

This whole debacle is yet another perfect example of why people should not sell options, particularly naked options. This exact same issue wiped out several hedge funds in February who sold naked call options on VIX futures contracts.

My point is simple: don't be an options seller. If you want to bet the price is going to go up, buy call options. If you want to bet the price is going to go down, buy put options. This way your losses are always limited and your upside can be enormous when "rogue waves" hit.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.