Rick’s Picks Education Page

About Hidden Pivots

From Douglas R: “Can you explain the term ‘hidden pivots’ to a new subscriber?”

Answer: I’ve just posted the material on this topic below, but to further explain, “hidden pivot” is a catch-all term that describes reversal points I can identify using proprietary methods. I look at ABCD patterns, where AB is an impulse leg – i.e, one that starts a new trend, usually on the lesser intraday charts; BC is the correction phase, and CD, the follow-through leg. Ideally, CD will eventually come to equal AB in point distance. The method was first described by Charles Lindsay and taught in seminar form by Larry Williams, but it identified just a single entry point: with-the-trend, 25% along the length of the presumptive CD leg. I’ve modified the method extensively over the last ten years to identify risk-averse ways to get long at Points A and C and short at D and several other swing points that can be precisely predicted. The key to the whole system involves is the BC “correction” leg, which has some very useful properties. Read properly, it not only yields tradable swing points but also reliable clues concerning trend strength.

See the Hidden Pivot Webinar page for more detailed description of The Hidden Pivot Method.

Backspreading

A backspreader buys options while simultaneously entering an offsetting position in the underlying trading vehicle or in other options. For example, let’s begin with an out-of-the-money call option with a “delta value” of 25. This means that owning this particular option would produce profits or losses roughly equivalent to those of someone holding 25 shares of stock. Furthermore, the option should be expected to rise by about 25 cents when the underlying stock rises by 1.00. One could create a theoretically neutral hedge by shorting 100 shares of stock while simultaneously buying four call options whose delta value is 25 (100 = 4 x 25). If the stock you’ve shorted is selling for 65 and you’ve bought four October 70 calls with a delta value of 25 against it, you are said to be “delta-neutral” at 65.

But if the stock should move up to 73, you will no longer be delta-neutral. In fact, you will have automatically gotten “longer” without making any changes in the initial position. This is because the delta value of the calls will have risen with the stock, since those calls will have become deeper in-the-money. With the stock trading at 73, the October 70 calls might carry a delta value of 80, meaning they will each rise by about 80 cents if the stock goes up another dollar. Since the stock that you are short in this hedge will have a constant delta value of 100, you would be net long the equivalent of 220 shares of stock at 73, as follows: short 100 deltas of stock, long 320 (4 x 80) deltas worth of calls = net long 220 deltas.

Buying a straddle, puts versus calls, would be another way to backspread. A put and a call purchased simultaneously might leave you theoretically neutral when each option has a delta value of 50; but if the stock rallies five points, the delta value of the put would fall while that of the call would rise, making you longer in delta terms.

Backspreads are profitable if the underlying vehicle moves sharply in either direction. If it sits still, however, the puts or calls that you have purchased against stock, or against each other, waste away due to time decay. That is the drawback of putting on backspreads. In practice and much of the time, the puts and calls you buy are very knowledgeably priced and discount the odds of a sharp move in the underlying vehicle.

That is why professional option traders make most of their money by selling premium. Since margin rules make this strategy prohibitive to most retail customers, we must be very careful, in trading from the “long-premium” side, to buy options only at good prices. This means estimating what the professionals themselves will be bidding for those options when the underlying vehicle is topping or bottoming. Our frequent goal is to buy puts precisely when the underlying vehicle is at the top of a rally spike, or calls when it is about to rally after being pounded to a targeted low.

Day Traders in Finland

Here’s a link to an academic paper on day traders that you might find interesting:

http://tinyurl.com/54xhj

And here’s the abstract: This paper examines the complete trading records of all day traders in Finland. A typical day trader is a male in his late 30s, who lives in the metropolitan area and trades in larger quantities than an investor in a size-matched control group even after ignoring day trades. These traders day-trade stocks that grab their attention, that they own, or that they have day-traded before. They pay close attention to the state of the limit order book, are very active near the end of the trading session, and are strongly deterred by losses. Day traders do not earn better returns than investors in the control group. Their realized returns from day trades are high, but these returns are not representative of overall performance because of their strong reluctance to realize losses.

‘Dynamic’ Trailing Stops

In my recommendations, I sometimes suggest using “dynamic trailing stops”. Below is a detailed explanation of the technique. This and other educational material can be found by selecting “edu” in the “All Picks by Stock” field near the top of this page.

Some successful traders say it matters less where one enters or exits a trade than how one manages its risks. One way we can keep risk tightly under control as a stock moves up or down is to use dynamic, or risk-adjusted, trailing stops. How do they work? To illustrate, let’s take the example of a trader who buys a hundred shares of XYZ stock at $62.00, with the intention of selling it when it reaches $65.00. In this instance the expected gain is $300, or $3 per share. But how much risk is acceptable? The answer, both initially and as the trade progresses, will depend on how and under what circumstances the trader determines to exit the position.

For instance, a prudent trader might decide before initiating a position that, once on board, he will risk no more than $1 to make $3 at any point along the way. Thus, with a target of $65, if he is able to buy 100 shares of XYZ for $62, he should use a $61 stop-loss initially, limiting theoretical loss to $1. (The risk is theoretical because in practice there is no assurance the trader will be able to get out of the position at the predetermined price. In fact, stop-loss orders are often executed at prices far worse than intended.) In this example, the stop-loss at $61 is referred to as “fixed” because it will remain unchanged as XYZ moves up or down within certain limits.

But let’s suppose the stock rises straightaway to $63.50. At that point the trader would have an unrealized gain of $1.50 per share, with additional profit potential of $1.50 per share (assuming as before that XYZ reaches its $65 target). Thus, with XYZ trading at $63.50 and a fixed stop-loss at $61, the trader’s risk:reward parameters will have changed for the worse, since he would then be risking $2.50 per share to make an additional $1.50. To bring risk and reward back into proper balance, the trader would need not only to raise his stop-loss, but to shrink it in proportion to the remaining potential gains. In this case, restoring a 1:3 relationship between risk and reward would require raising the stop-loss to $63.00.

Let’s do the math. XYZ is at $63.50, promising an additional $1.50 per share of profits if it reaches $65. However, if the stock should fall back to $63.00, where we’ve placed the new stop-loss, the trader would lose 50 cents per share of his paper gains. That is the same as saying risk:reward is 1:3, so the trader is back on track. In practice, the trailing stop will need to be raised each time the stock moves closer to the target, and it will also have to be narrowed in proportion to remaining expected gains. Thus, if the stock climbs to $64.50, it will require a stop at $64.33 to maintain the 1:3 relationship between risk and reward. This is risk management at work, using a technique that can be applied to any trade.

E-Mini Index Futures

From C. Erber: “Pardon my ignorance, but what are the mini-Dow, mini-S&P, and mini-Euro? Do they have symbols?”

Answer: Minis are downsized futures contracts created by the various exchanges to facilitate direct-access trading. These vehicles are not traded in a pit on an exchange, but rather electronically and round-the-clock, on platforms such as TradeStation, by traders like you and I all over the world.

The first such product to be introduced, by the CME, was the mini S&P, which has the root symbol ES. More recently, the E-mini Russell 2000 has become very popular. The September contract trades under the symbol ER2U05. There’s also a mini-sized 30-Year T-Bond (YHU05), a mini 10-Year T-Note (TYU05) and quite a few others covering a wide variety of share indexes and commodities.

These contracts usually move in lock-step with the pit-traded contract, so targets for one are generally applicable to the other. One attractive feature of the minis is that real-time (i.e., undelayed) price information comes free from the exchanges. Another is the relatively low commissions we pay to trade them. And yet another is that they level the playing field between professional and at-home traders. Orders are executed on a first-come, first-served basis, so the big boys have no special edge.

Finding Tradable Pivots

Several new subscribers have asked me to say a few words about “hidden pivots,” my proprietary swing points. The Mini-S&P chart I’ve reproduced alongside (see inset) has plenty of them, and they’ve gifted us with two nicely tradable ABCD patterns in the last twelve hours.

The first, a bearish pattern, is labeled in red, with a ‘d’ target at 1293.25. One could have bought there, risking $25 theoretical by placing a stop-loss at 1292.75. The only drawback to this trade was that the 1293.00 cycle low occurred at 3:45 a.m. EST.

The second pattern is a bullish one, labeled in yellow. The ABCs in this instance allowed us to project a rally top at 1302.00; in the event, the actual high was at 1301.50. For some traders — though not for me — the projection would have been close enough to get one short near Tuesday’s intraday high, which occurred, as intraday highs and lows often do, in the first hour. I’d have shorted 1302.00, placing a stop-loss at 1303.25, a single tick above the next round number. The subsequent 10-point decline would have provided a profitable exit no matter what your strategy.

In practice, I have yet to find a system that is better at identifying the potentially tradable swing points that often occur in the first hour or so of the morning. You won’t have much competition trading them either, since the most opportune hidden pivots do not coincide with Fibonaccis, trendlines and support & resistance lines. However, as you know, it gets far, far more difficult to trade as the day wears on, since most traders will be attempting to exploit swings within an intraday range that becomes increasingly obvious to the herd with each passing hour.

Hidden Pivot Calculator

The Hidden Pivot Calculator found on the Front Page of the website and in the Chat Rooms and it has Two Menu Items. It works the same in both areas except the Front Page link takes you to a fixed page version of the calculator that can’t be moved. In the Chat Rooms, Click HP Calc in the menu to display. This HP Calc Window can be dragged anywhere on the screen. If you stay in that Chat Room, the window will remain in the position you set it at, even if closed and re-opened. Click in the header of the small window where “HP Calculator” is displayed and drag the window to where you want it. Click X to close.

Browser quirks – If the HP Calc menu Item wraps itself around to the second line, enlarge your browser a bit larger user the mouse wheel or whatever the method your device uses to widen the browser window. If in your browser the HP Calculator appears with scroll bars, enlarge the window with your mouse cursor until the bars disappear. Usually pulling the top part of the window up will enlarge it easier.

If the calculator does not appear right or allow entry, refresh the browser page and/or Reset the cash on your browser in the Internet tools. This should work for any browser to display it properly.

In Target Calculation, it allows you to enter the A, B, and C values of an HP pattern and when you click Calculate Targets it will display the X Entry, P and D. SD is no longer used by Rick. He states that the “SD means ‘stop differential. It is the trailing stop calculated as 0.25 times the BC leg, and it is activated at P. In practice we now use impulse leg – based stops instead. In 40 years of trading I have not found a better or easier way to manage risk.It helps avoid getting stopped out needlessly.

In Window Calculation, when you enter your k value it calculates your HP Pattern window values W, R and DIF. Take the HP Seminar to see what all these values mean.

Clicking Reset will reset all entered values so you can re-enter another set.

This HP program will only run on computers or a device running a current flash plugin. If you don’t see the HP Calculator in the window that opens, install Flash from Adobe onto your computer. Flash does not run on an IPAD.

Click here for a Hidden Pivot calculator spreadsheet that runs in Excel

Hidden Pivot FAQ

Question 1: “How long do hidden pivots last? I assumed that they represented fairly stable support and resistance and have been updating my end-of-day charts. Lately, I’ve noticed they seem to change frequently, or you’re adding new ones. Can you give some guidelines on how long a pivot is valid?

Answer: Hidden pivots are calculated using ABCD patterns, where A-B is an impulse leg beginning a new trend in a particular time frame; B-C, the correction leg; and C-D, the follow-through leg. I generally refer to all of the swing points in this pattern as hidden pivots, although the two most important are, respectively, the midpoint of B-C’s ‘c-d’ leg (the B-C correction is viewed as having its own abcd sub-pattern); and the midpoint of C-D. I’ve reproduced a chart alongside to illustrate. To answer your question, the pivot changes if point ‘C’ is exceeded by the countertrend.

Question 2: “If a pivot is breached, does it behave like conventional support and resistance and flip from support to resistance or vice versa?
Answer: Yes. Sometimes, especially on the long-term charts, a stock will spend weeks or even months oscillating around a hidden pivot after first touching it. But this behavior is useful for trading purposes only if one zooms in on lesser ABCD patterns on the intraday charts to pinpoint the breakout or breakdown when one finally occurs. The telltale sign involves price action at midpoint pivots, where we stipulate that if the ‘D’ target of an ABCD pattern is going to be reached, correction patterns should not be able to achieve their ‘d’ targets.

Usually, when a hidden pivot is breached even slightly, I infer that the dominant trend is likely to continue. Many of my trades are initiated at swing points defined by hidden pivots, and because they work so precisely when they work at all, I am able to trade against the trend with extremely tight stops. This is an important money-management feature of my method, and it implies that we can get stopped out seven or even eight times out of ten and still make money.

Many seasoned traders say that one should never trade against the trend, but I like to reply that we are actually trading with it, entering at a swing point that, a single tick later, will mark the exact spot where a new trend has begun.

Question 3: “Your methodology seems to rely on bouncing off pivots to get a trade in. Do you ever use breaching pivots as an entry point? If no, why not?

Answer: Trading with the trend is much harder. The simplest way to do this is by initiating a trade 25% along the presumptive length of C-D, then placing a stop just below ‘C’. But this is too intuitively obvious to be worth much, since the ABCD pattern itself is practically a visual analog for herd mentality. Which is to say, the herd, seeing a billboard-obvious impulse leg developing on the intraday chart, typically responds: “Oh, Damn! I missed the rally.” And what do they do next? They wait for a pullback, of course, expecting it to provide a belated buying opportunity. And how do they know when the pullback has ended? Actually, they don’t; so most traders will wait for the dominant trend to reassert itself before they buy.

At what price? Well, if you were to locate their bright idea somewhere along what will eventually reveal itself as the C-D ‘follow-through’ leg, you can probably imagine them — or yourself, for that matter, buying approximately 25% along the length of the soon-to-be C-D leg. Statistically speaking, that’s where most traders will find the courage to jump aboard — or rather, where, having been led by the nose, they will jump aboard.

If you’ve traded this pattern before, whether intuitively or mechanically, you already know what happens next: the stock will drop momentarily below point ‘C’ before it takes off for ‘D’ like the proverbial bat out of hell. Of course, the only reason it can take off at all owes to the fact that most of the bulls bailed out on the dip below ‘C’.

In practice, when buying with the trend just above ‘C’, you’ll get the best results when the expected rally from ‘C’ happens so quickly as to all but prevent your buy-stop entry from being executed at a reasonable price. And therein lies the paradox that must be understood intellectually conquered emotionally before the would-be trader can succeed.

LEAPS

A subscriber asks: “Is there a place for leaps in your method — either with covered calls, naked puts, or as part of a spread?”

Answer: Relative to shorter-term options, LEAPS increase the professional’s edge. They are less liquid, so retail customers will find it more difficult to buy them on the bid and sell on the offer. Also, because they are priced to discount trends occurring over years rather than months, they are less likely to produce the sort of windfall profits that we frequently reap via well-timed expiration plays. That said, we can still apply some of the same tactics we use to make money with shorter-term options, including the use of rolling calendar spreads. If you have a specific LEAP in mind, please let me know during the Q&A so that I can help you improvise a winning strategy.

Legging on Calendar Spread

From Gregory W: “What does ‘legging into a calendar spread’ mean?

Answer: Since this is a strategy we use quite often, I will take the time to repeat the explanation I have given here before, both explicitly and in the context of specific and numerous recommendations.

An example of a calendar spread is: long one June 40 XYZ call, short one April 40 XYZ call. We have bought an option with a striking price of 40 and sold short another with the same strike, but a different expiration date. In theory, our maximum profit would come with the stock trading at $40 the day the April option expires. Since we are short the April contract, all of the premium we received when we shorted it would be ours to keep. The spread would not be as profitable with the underlying stock above or below 40 because, if the former, the April call you are short would gain more value than the June you are long; and if the latter, the April call would have fallen to zero, while the June would continue to shed value, the lower the stock falls.

As an example, let’s say that today we buy a July 95 call in IBM for 1.30 and sell a May 95 call short for 0.50. This would leave us long a single July-May 95 calendar spread for a net debit of 0.80. That is the most we can lose on the spread, but our optimal gain would come with IBM trading at 95.00 — 4.40 points where the stock is trading at this moment — on May 20, when the calls that we are short expire. The May call would be worthless, and the $50 we received when we shorted it would become a realized gain. Meanwhile, the July 95 call would have increased in value with the stock up 4.60 points, and that would add to our profit on the calendar spread.

“Legging into a calendar spread” means executing the two sides of the spread at different times. In the example above, for instance, we would do the “buy” side first, buying a single IBM July 95 call for 1.30 (its current price). In practice, we try to do so when the underlying stock is trading at or near a targeted low. Our expectation is that the stock will rally from that low, and that as a result, we will be able to short the May 95 call for a better price than if we attempted to do both sides of the transaction simultaneously.

If our timing was very good and IBM rally significantly after we bought the July 95 call, we might be able to sell the May 95 call short for as much as we paid for the July call. This would be “legging into” the July 95-May 95 calendar spread for “even,” or no cost. Our theoretical risk would be zero, since we would hold the spread for free. (Please note that in practice, expiration day shenanigans can play havoc with this assumption if the stock totters just above the strike price on the day the May calls expire.)

In many instances, we have been able to leg into calendar spreads for a net credit. In the example above, this means we would have sold the May 95 call short for more than we paid for the July 95 call. This implies that we bought the July call when IBM was hitting a price trough, then sold the May call short after the stock had rallied substantially.

Here is Gregory’s note, with some further commentary from me:

Question: “I am checking your site out with a one day pass. I will probably subscribe on a monthly subscription but not until Mr. Ackerman returns next week after his trip. In the meantime please advise on the following if you can: I am a UK resident/citizen and all of my trading is conducted by spreadbetting, the understanding of which is a doddle compared to trying to understand options and futures especially related to the American market. I am subscribed to three other U.S. options services but most of the time I haven’t got a clue what they are talking about in their instructions so probably won’t re-new the subscription.”

Answer: Go with whatever makes you money, Gregory, even if the lingo is sometimes hard to understand.
Question: “How can I get to grips with the terminology (the workings of options and futures I understand; it is more the terminology I don’t get.)”

Answer: I’d suggest sticking with Rick’s Picks since, as you can see, I take pains to answer subscribers’ questions in detail.

Question: “What book would you recommend that would assist with the terminology. For example this is your own latest actionable advice for Amazon:
‘Since Amazon could fall to as low as 24.49 over the next 5-7 weeks, we’re trying to leg into a calendar spread, bidding 0.30 to start with for a dozen July 25 puts (ZQNSE). The order is good through today and contingent on the stock trading 34.80 or lower.'”
Answer: There are a thousand books about options, but I’d suggest perusing the reviews at Amazon to find a short, simple one that has the information you’re seeking. The thick tomes contain mostly strategies you or I will never use. Meanwhile, if there is argot in my daily instructions that you don’t recognize, please don’t hesitate to ask for an explanation during our regular Q&A sessions.

Question: “What on earth does “we’re trying to leg into a calendar spread” mean. I would like to subscribe to Mr. Ackerman’s service based on his reputation but if I haven’t got a clue what he is talking about I can’t really.”

Answer: See above, Gregory. Hope I’ve helped.

Naked Puts and Calls

From Dale D: “I realize you prefer to buy out-of-the-money options in order to get the most leverage. Are there situations in which selling in-the-money or at-the-money puts are a good strategy? For example, selling an NEM put today instead of buying the stock?”
Answer: Selling naked calls and puts is very often a better and more risk-averse strategy than using stock to get long or short. However, naked selling is subject to onerous margin requirements, requiring “Level 4” clearance from your broker, and that is why I rarely advise it. In theory, though, you could use my hidden-pivot swing points to effect naked-selling strategies at optimal prices.

Option Calculator

Here is yet another option calculator for your use. It is offered at the CBOE site, a treasure trove of options data, trading tips and useful freebies. This calculator has “greeks,” including vega, rho, and gamma. They are useful mainly to professional traders who amass large inventories of options of different strikes and expiration dates. Personally, I use only the delta value and the implied volatility — all the retail customer really needs. Here’s that link:

http://www.cboe.com/LearnCenter/OptionCalculator.aspx

And here’s a link to, among many other useful things, free end-of-day implied volatilities: http://www.ivolatility.com/options.j

Options Primer

I’m frequently asked where one can find basic information about puts and calls on the Web. Here’s a site I just stumbled on that covers the topic well:

http://www.investopedia.com/university/options/

Option Strategies

A reader who recently enrolled his mother at Rick’s Picks wants to know how to better understand my option recommendations. I would suggest first of all that you NOT start by reading a weighty tome on the subject, since it will only burden you with far more information than you will need to know. Instead, approach the learning process one trade at a time, as you might in learning how to use a richly featured software application like Adobe Photoshop. Learn what you need to know only when it is time to use that knowledge.

Most of the strategies I use and advise are idiosyncratic and flout the textbook rules. But I have found these strategies to be consistently profitable, having honed and simplified them for 25 years so that they work for retail customers. My goal is to ease subscribers into the options game by feeding them some lay-ups designed to yield easy profits. Indeed, many subscribers have written to tell me that they had never made a profitable trade before subscribing to Rick’s Picks. If your early forays are successful, as I expect they will be, try some of my more difficult trades, including calendar and vertical spreads.

In every trade, my main goal is to reduce risk to an absolute minimum, usually by taking partial profits early on. Another important factor in minimizing risk is the use of “contingency” orders when buying puts or calls. This term may be unfamiliar to you now, but you’ll get the hang of it over time simply by reading and following my detailed trading instructions. Contingency orders help preserve whatever small edge we can hope to gain by using hidden pivots to initiate trades at prospective swing points.

You should also check out my educational pages, since they contain detailed descriptions of such techniques and terms as “backspreading,” “dynamic” trailing stops, and managing risk during a trade. But your first concern should be to ease into the groove, so to speak, by doing only those trades you are comfortable with. Yesterday’s buy of Citi September 50 calls was simple enough that any subscriber could have done it. There’ll be more such trades down the road, so stay tuned if you’re eager to take that first, confidence-building step.

For more information, see my article on option strategies from the September 2003 issue of SFO Magazine.

Other Technical Tools

From Paul K: “You occasionally mention stochastics along with your pivots. How much weight or credibility do you give these(or any other TA tools for that matter) measurements in your analysis? Thanks much and keep up the great work!”

Answer: My forecasting system is based almost entirely on price action, although I use stochastic indicators for timing purposes. There are much better tools for this, though, including Pyrapoint, a Gann-based method that can predict the time of reversals as accurately as hidden pivots can predict the price.

My use of stochastics comes from a short lesson I received on the subject many years ago from my mentor, Ira Tunik. At the end of today’s session I will post to the site a primer on the subject: “Everything you need to know about stochastic indicators in 15 minutes or less.”

Position Size

From John C: [concerning order size] “I signed up for the one-day pass so I could look at your system/suggestions. I would like to subscribe sometime in the near future, but need to understand how things work there with stock purchases. I notice most of the time you give a stock amount to bid on, but I was reading some of the individual stock recommendations you made to subscribers and notice bid prices and stops without stock amounts. For example, your reply to a question about AUY was as follows:

‘Currently trading around 3.49, Yamana’s upside potential over the next 2-4 weeks is to 3.82, a hidden pivot. Thus, for the moment, on a risk:reward basis, the best odds for a trend-wise entry are already past. However, it would still be possible to enter on a pullback, using a tight stop-loss (although this strategy cannot be applied while Yamana is headed higher, as it is today). Most immediately (i.e., today), you could get long using a 3.52 buy-stop limit, placing a stop-loss at 3.44 after entry. Take profits on half the position at 3.57, then let the rest ride to 3.82 with a trailing stop that you’re comfortable with.’

What size of a purchase is this? You’re taking half off after a nickel. Are we just covering commissions with the first half?”

Answer: Usually my recommendations are couched in multiples of four — i.e., “buy 400 shares of XYZ stock, or buy a dozen XYZ January 50 calls.” I find that multiples of four work best for purposes of partial profit-taking enroute to a hidden-pivot target, since they allow profit-taking of 25%, or 50% at the first opportunity.

The initial position size is my recommended minimum, but if you want to increase it as I expect many subscribers will, then simply follow my instructions in some multiple of four. However, when I receive a query concerning a stock that we do not track here regularly, I will usually leave position size up to the subscriber, as I did in the example you’ve cited, AUY. Partial profit-taking is one of the most important tools of risk management, and I always treat it as such. When you have banked a partial gain on a position, you’ll be amazed at how much that will improve your ability to read the stock thereafter. You’ll feel like Fred dancing with Ginger, relaxed and perfectly attuned to the stock’s rhythms.

Scalping Against a Position

Two subscribers have written today to ask the meaning of the phrase “scalping against the trend,” which I’ve used in conjunction with our strategy in the E-mini S&P. We are currently short the mini from within a single tick of the March 7 top. Scalping against the trend — or, more descriptively, scalping against our short position — means briefly covering the position or getting long in expectation of a corrective rally. Thus, if we are short a single contract, buying one contract would leave us net neutral, with no exposure if the market should rally against us. If we were very confident of a corrective rally within the larger downtrend — and we are, from 1159.25 — we might be tempted to buy not just one contract, but two. That would effectively cover the single-contract short position and leave us net long a single contract.

Now, let’s say we ride the rally for a 10-point gain, then “cover” the single-contract long position by selling one contract. Technically speaking, we would be “closing” the position. But remember, we are quite bearish on the S&Ps and therefore intent on staying short for a long ride and a potential monster profit. So we would want, not merely to cover our long position and leave ourselves neutral (i.e., “flat” — neither long nor short), but to return to a short position by day’s end. To do so, we would need to short-sell one additional contract, leaving us net short a single contract at the close — just as we were when the day began. The profits thereof would be factored into the cost basis of our ongoing position and in this instance would raise the cost basis of the short by ten points. Thus, if we went short initially at 1129.50 (and we did, basis the March mini-S&P), after booking the ten-point gain we made by scalping against the trend, we’d effectively be short a single contract with a cost basis of 1139.50.

In actuality, we scalped once since our initial short — but with our position rather than against it. This is because, at one point along the way south, we were short two contracts rather than the one we started with. We covered (i.e., bought back) one of the two contracts for a gain of 13.50 points over and above what we would have made if we’d left our single-contract short position unchanged.

By scalping against our position as the S&Ps continue to fall, we can lessen our risk or even make a few extra bucks on countertrend rallies. By scalping with our position, we can effectively raise our bet size when, for one, we are confident of catching the top of a countertrend rally

Spreading to Reduce Risk

From Robert T: “With respect to your trade setup in Citigroup, why is it that you perceive the no-cost calendar spread to be ‘no-risk’? In my limited experience of option trading, whilst there is no directional risk, there is risk due to mismatch in maturities — or am I way off. Please explain asap.”

Answer: If you buy, say, a June 40 call in XYZ stock for 1.50, and subsequently sell an April 40 call for the same price (after the stock has rallied substantially, to be sure), you cannot lose, since you’ve acquired the spread for nothing. There are indeed certain risks in having the short calls exercised against you at expiration, but they are easily avoided simply by covering the calls (i.e., buying them back) on expiration day. Incidentally, out-of-the-money calls sometimes get exercised for various reasons. For instance, if a stock closed on April expiration day at 39.50, the April 40 calls, purchased for next to nothing at that point, might be exercised by someone who knew that bullish news would be out after the close. I got fooled this way once myself, when Levi Strauss announced late one Friday afternoon that it was going private. In this context, you should keep in mind that professionals can exercise options until Saturday afternoon.

Stale Advice

Question: “Is it suitable to buy positions under ‘Actionable Advice’ where the entry is several days old?”

Answer: Yes, as long as the original parameters associated with the trade have not been invalidated. When buying puts or calls, though, I usually specify a unique time and price that should be followed to-the-letter.

From Mike A: “How long are your recommendations valid? If I see the reco in “Actionable Advice,” should I assume the trade recommendation remains open?

Answer: I weed and prune the archives occasionally, Mike, but probably not often enough. If the advice looks stale, you should pay it no heed. However, if you can determine that the actionable price points are still valid, then go for it.

Track Record

Here’s a note from Jim B. concerning yesterday’s comments on the marketing of Rick’s Picks: “I don’t know who Lurker is, but I do know that several services to which I subscribe do publish their up-to-date track records. They would include the Oxford Club, Strategic Investments and Outstanding Investments, all of which are part of Agora Publishing. You might want to do the same.

Response: Agora used to market my newsletter when it was called Black Box Forecasts. The format and content were nearly identical to what you receive now for $350, except that the price was much higher: $1,800 or more per year. Agora did a bang-up job, but it used to take me weeks to pull together a track record they could use for promotional purposes. I didn’t publish a track record in the newsletter itself because many of the trades evolved over time, sometimes in ways that could have left two subscribers with somewhat different positions in the same stock.

The publications you’ve named above are geared to investors rather than traders, and I agree that it is useful for prospective subscribers to know the details of their respective portfolios. Similar information is available for each and every trade recommended in Rick’s Picks, but you must search it out issue-by-issue in my archive. My justification for making subscribers do the work is that, when it comes time to do the actual trading, you’re going to be doing the work then too.
P&L figures, drawdown stats and such are irrelevant as far as I’m concerned because every subscriber’s performance will differ from the ideal. Rather than provide you with idealized results, I prefer to let subscribers determine for themselves whether the service will work for them. Incidentally, quite a few of my subscribers are better traders than I, and they sometimes write to tell me when they’ve bettered the “official” results. One way in particular that they have outperformed me is by loosening the extremely tight stops that I often advise.

http://sitekreator.com/Optimist/stocks.html

Trading a Tight Range

From Dale D: “Given your experience as a market maker, is it feasible to find a $5 stock with a 50-cent weekly range and pick up 25 cents per round trip? Some people say a market maker will notice that kind of activity and sit on your trades. For a retail investor, it’s hard to know how these things really work.”

Answer: With range-trading that tight — especially one consistent enough to be a “sure thing” — market makers will indeed work it to effectively exclude the public. One way they can do this is by tightening the spread with relatively small bids and offers, but sizing up outside of the markets they are reflecting. It might be possible to edge them out, but the only way you’ll be able to determine this is by joining their game for a while, “riding” their markets in the hope of sharing in the spoils.

Uncanny Accuracy

From Burt R: “Your hidden pivot points are uncanny. Many times you call the turn to the penny. Do you have a tutorial or reference material for finding them? I’d like to know how the master does it.”

Answer: I use principles extrapolated from Charles Lindsay’s Trident method, although I doubt that Lindsay himself would recognize the techniques as I’ve modified them. I’ve been promising for some time to offer a course but recently decided I’d rather focus on trading than on the seminars business. If there’s enough interest, though, I would offer a one-time weekend seminar here in Denver — or perhaps in Northern California, in conjunction with my mentor, Ira Tunik. If you’re interested, please let me know via e-mail and I’ll put your name on a list. If at least 20 of you want such a course, which would include follow-up mentoring, we’ll make it a “go”.

I should also mention that Ira has been giving one-on-one seminars at his home in Northern California. The 2-1/2 day session is $4,000 and includes unlimited mentoring as a follow-up. Ira tells me that many of his “grads” are doing quite well, which would be a rare exception in the trading-school world. He and I have not compared notes in many years, so his methods undoubtedly differ from those that we employ each day in Rick’s Picks. A goal of any one-time seminar would be to combine his best tricks and mine. Also: If there are any demon-genius algorithm writers out there, I’d like to explore with you the possibility of automating the most profitable aspects of my hidden-pivot system.