When I trade options, I know my timing has to be perfect. Seventy-five percent of all stocks follow the market so that’s where I start. I use the SPY as my barometer and I compare it to other indices.
Long-Term – Monday mornings are a good time for me to get my bearings so I start every week with a long-term view of the market. I begin with a 2-Year chart and I zoom-in to a 3-Month chart. Along the way I note important levels (trend lines, moving averages and major horizontal support/resistance levels).
Short-Term – I continue to zoom-in until I reach a 1-Week time frame. At this point I’m more focused on 5-Day horizontal support/resistance levels. I look at the A/D line to determine the quality (depth) of last week’s move and the volume to gauge the level of participation.
Events – I analyze the prior week’s market action and I try to draw conclusions. I read my One Hour In blog to refresh my memory. Then, I look at the upcoming economic calendar and I try to identify possible events that could drive the market through critical levels.
Time – I always keep a time perspective. During expiration week I determine the likelihood of option related program trading. If it exists I note the directional bias. Toward the end-of-month/beginning-of-month I remind myself that the market will probably have a bullish tone. During earnings season I look at who’s “on deck” and I consider if the release might impact the sector. Throughout the year I watch seasonal patterns and evaluate if the seasonal tendencies are strong.
Opinion – I try to predict what the market will do that week and that month. I identify price movements that would change the character of the market and force position adjustments. For instance, if I have been expecting the market to stay in a trading range and it breaksout/breaksdown, I need to be aware of it and I need to know which positions need adjusting. My opinion might call for quiet, directionless trading or it might call for volatile unpredictable swings.
My market opinion affects my confidence. If the market is in a transition with volatile swings, my confidence in any trade will be low. I keep positions small and I use more conservative strategies. In that environment, the implied volatilities (IVs) should be elevated and I can sell out of the money credit spreads. That strategy allows me to take a directional trade and add a statistical edge by distancing myself from the tick-by-tick action. It helps me manage my emotions while the market is deciding what it wants to do. If the market is grinding higher in a nice predictable manner and the IVs are relatively low, I will be more aggressive and buy calls for my long positions. In this case, the orderly pace to the market allows me to “size-up” knowing I have the wind at my back”.
My market opinion also affects my timing. If I have a bearish trade near the end-of-the-month, I might hold off and use that strength to enter the position. If I have a bullish trade and we are near overhead resistance, I might wait for the market to breakout before I enter the trade.
All of my analysis starts with the market. Once that opinion has been formed, my attention turns to finding the stock. That process will be the topic start the next series of articles.
If you have techniques and indicators that help you evaluate the market, please comment.