June 26, 2005
by David Yu
I'd like to mention this before we begin. I haven't documented any losing trades yet because I haven't closed any trades that incurred financial loss yet since I started documenting my trades on the Internet trade group forum. If I were wrong technically, fundamentally, and financially on a trade that's significant enough, I certainly would share that right here with all of you. Sometimes we can learn more from our own mistakes than success although I hope the significant financial loss part would never happen.
Now, as you know, I've been bearish about the market in general, based on my own technical and fundamental takes. There's no better discipline than putting my money where my mouth is. A writer can not relate to his audience if he'd only talk the talk; he must also walk the walk. Real occurrences and emotions are what bind the writer and his audience. In any case, a good way to play the market is to play one of the market tracking indices. I chose NASDAQ 100 Index Tracking Stock (Symbol: QQQQ).
On Wednesday, 6/1/2005, I noticed this chart pattern where the CBOE (Chicago Board of Options Exchange) Total Put-to-Call option Ratio (blue zigzag curve) dropped down to 0.68, the area near 0.65. Although this is no where near the extreme complacency level defined by some experts, we must exercise our own discretion and look at this in relative terms to the recent narrow market trading range. Under that circumstance, it'd appear to be as low as it could get for now. And, from a contrarian point of view, the market (NASDAQ in this instance) is about ready to have a very short-term correction. These short-term market tops coincide with the Total Put/Call ratio's descend to this 0.65 level (blue circles).
In addition, the divergence between the rising price and the declining volume is a great topping indication. The 14-day RSI was also in the above 70 overbought territory. We don't need 20 fancy charting indicators just to see the top formation.
I bought QQQQ July 2005 $38 Put Option at $0.60 on the same day. For those not familiar with option trading, a simplistic way to look at this is that buying these Put Option contracts means buying the right to sell QQQQ at $38 by the option expiraton day, the third Friday of July. I'd make money if the price of QQQQ goes down. Each option contract represents 100 shares of the underlying stock. You can see the leverage here represents the high degree of risks as well as profitability.
Here's the chart showing what happened as of Friday, 6/25/2005. You can see to the right of the dotted vertical line, all indicators had since gone the opposite directions. The RSI and the price had gone down while the Put/Call ratio and the selling volume had gone up.
During this past 3 weeks, as you can see from the chart, NASDAQ didn't go down without a fight. That lead to some experts analysis of a so-called "summer rally". Market's resilience is what made me decide to go with July Put instead of June. Had I gone with June, I wouldn't have given the market sufficient time to work its way down, as it's supposed to.
However, I did take advantage of this resilience and added 50% more July Put at $0.55, which averaged my cost down to $0.5833. Since additional quantity of put was half the original order, the ratio between $0.60 and $0.55 is 2:1. Thus, [(0.60x2) + 0.55x1] / 3 = 0.5833. The cost per Jul $38 Put was then averaged down to $0.5833.
On Friday, 6/24/2005, just about 35 seconds prior to the closing bell, I sold all of them at $1.10 for a gain of 88.6%, before commission. Here's why.
On this 5-minut 2-day intraday chart, the rising 12-Period RSI tells me that every hour (12 periods of 5 minutes each), since Thursday afternoon, there had been more and more gains than losses. Incidentally, let's not confused this RSI, another brilliant trend indicator by J. Welles Wilder, with the other Relative Strength analyses.
While it moved below and then above the trendline, the price didn't come off the downtrend trendline (red arrow) until it leveled off at about the $37 area. That's where I thought it had broken the fall. Subsequently, the bears spent the final full hour trying to break that 37 support without much success. It did dip below 37 briefly, but that's not convincing enough to serve as confirmation of further breakdown.
And, then there's that gigantic blow-off selling volume accompanied by an even larger buying volume. That's probably the main reason I decided to cash in my chips. To me, that means the selloff was done for now. And, of course, I also didn't like the positive divergence between the RSI and the price.
Finally, let's take a look at a longer-term chart to see the confirmation I used to make that final decision with only 35 seconds left.
Here, the longer term strength of the $37 support should be self-evident. I'm sure this had been talked about by almost every analyst. My concern is the 5-day RSI. When the 5-day RSI dropped below 15, it had a very high probability that the downturn had reached an imminent end. Price stabilization could then ensue.
Instead of spending the weekend pondering about these potential technical reversal signs, I decided to cash out and have myself a nice weekend.
David Yu