Rule #1 Short Term Trading (Part Two) – Webinar #8

Webinar #8 – Short Term Trading

• Our Short Term Trading mindset is different from our Long Term Investing mindset.

• Know the 4M’s of your Wonderful Business

• NEWS makes a difference! (Events…)

• Know the TREND that you are in!

• Know the key terms of your trade.

• We use a Short Term Trading Checklist to help us consider all possibilities.

• Look for Pullbacks and Break-outs.

Two Mindsets

• As Rulers, we are long term investors and also short term traders.

• To be successful, we have to develop two different mindsets.

• Long-term mindset:-- Research until Certainty-- Load up the truck by stockpiling• Short-term mindset:-- Put Probability way in our favor-- Watch carefully; follow the rules-- Exit when needed

Step One – Know the Fundamentals

Ideally, we short term trade stocks that we are familiar with –we’ve done good research and understand the business and industry. ( The 4 M’s)

We have read the 10K’s

We have listened to the latest earnings calls

We’ve checked for recent articles at SeekingAlpha.com.

We have checked who is investing in the stock at GuruFocus.com.

We are up on the Macro Fundamentals of the government and economic issues that effect the company we are looking to trade.

We have updated our findings at www.RuleOneInvesting.com

Identifying Trends

•Something in motion in one direction, has a tendency to stay in motion in that direction:•Nothing goes straight up or down. Prices will move two steps forward and one step back.

There are three categories of trends:•Uptrends – a series of higher highs and higher lows•Downtrends – a series of lower lows and lower highs•Channeling – trading horizontally between floors and ceilings in a sideways action

Three Types of News Events

• Category One – Major event that spooks the market. Financial sector meltdown in 2008 and Europe in recent years fit this category…The FED?

• Category Two – News events that influence the market. The majority of these type of events are economic reports… Housing, unemployment, CPI?

• Category Three – News events generated by individual companies. Earnings reports are the most common type of category three event. Also, when an analyst releases a change of rating on the stock –an upgrade or downgrade...

Terms & Terminology

Review

Rule #1 Option Trading Terms

• STO – Sell To Open

• BTC – Buy To Close

• BTO – Buy To Open

• STC – Sell To Close

• Sellers have OBLIGATIONS ……

• Buyers have RIGHTS……

Rule #1 Option Trading Terms

• Bid – the price the seller gets in a market order• Ask – the price the buyer gets in a market order• Mark – the price that is right between the Bid

and the Ask price – we usually use this for our limit orders• Market Order – a trade order that gets filled at

the present market price (Bid or Ask)• Limit Order – a trade order that gets filled only

at the price you submit or better

Screenshot from Think or Swim

Rule #1 Options Trading Terms

• ITM – An option strike price that has intrinsic and extrinsic value

• ATM – The option strike price that is closest to the underlying security price at that moment

• OTM – An option strike price that has no intrinsic value – only extrinsic value (time)

• DTE – Days To Expiration

• Short Strike – the strike price being STO

• Long Strike – the strike price being BTO

• Spread – the difference between the Bid and the Ask – the market maker gets the spread

• Spread – the term also used for the difference between two strike prices being traded at the same time – like a credit spread

Screenshot from Think or Swim

OTM

OTM

ITM

ITM

Rule #1 Charting Terms(Technical Analysis)

• Support – the lower price area in a trend where the stock comes down and then reverses back up

• Resistance – the higher price area in a trend where the stock comes up and then reverses back down

• Channel – a price range of a security that is moving horizontally between a floor and a ceiling

• Trend – a price range where a security is diagonally moving up or down over a sustained period of time

• Floor – the price where a security comes down to and then reverses – at least two times in the same area

• Ceiling – the same as a floor but when the stock has gone up and then reverses back down

Screenshot from Think or Swim

Screenshot from Think or Swim

Screenshot from Think or Swim

Our Short Term Trading Check List

Step 1 – Know the fundamentals of the security being traded

Step 2 – Identify the broad market trend – $INDU, SPX or SPY

Step 3 – Identify the underlying security trend

Step 4 – Identify the floors and ceilings

Step 5 – Know the news effecting the security

Step 6 – Determine the entry point for the trade

-- Breakouts

-- Pull-Backs

Step 7 – Have a good trading strategy – credit spreads

Step 8 – Have an exit plan if the trade goes bad

Short Term Trading - Timing

• Timing a trade is helped by what is happening around Floors and Ceilings –

• Breakouts and Pullbacks.

Short Term Trading - Timing

Breakouts and Pullbacks.

Breakouts occur when an underlying Price movement trend “breaks” through a floor OR ceiling

&

Pullbacks occur when an underlying Price movement trend hits a floor OR ceiling and reverses direction.

Step Six – Determine Entry Point

• At this point we have gathered a lot of information about whether we think the stock (or INDEX) is going up (bullish) or is going down (bearish) in the near future.

– Let’s say you want to make a bullish trade on a stock. You have identified the broad market trend, individual stock trend, areas of floors and ceilings, and incorporated news into your analysis…..

– Do you just go make the option trade on the stock?

Breakout Entry Point

• You can optimize your entry point by using your knowledge of floors and ceilings.

• One of the most popular and successful trading patterns is the “breakout.”

Home Depot Ceiling Breakout

Home Depot Ceiling Breakout

Breakouts

• Breakouts are simply caused by the price “breaking out” through floors and ceilings that had previously held the price back.

• Generally, the stronger the floor or ceiling, the stronger the breakout.

– Volume can play a key role in determining the strength of the breakout.

– Weak volume on a breakout may be a sign of a weak breakout. Strong volume is a sign the breakout is for real.

Where to Enter a Breakout Trade

You have a couple of choices as to where to enter on a Breakout:

– The day the stock closes above a ceiling or below a floor. This is an aggressive trade and can lead to larger profits or more frequent losses.

– Or you wait a day or two for the price of the stock to pass the high of the breakout day (on a ceiling breakout) or trade below the low of the breakout day (on a floor breakout). IF this happens, it is known as the “confirmation” day.

– You can enter a bullish (BPS) or bearish (BCS) trade as soon as there is confirmation.

CAT – December 29, 2011

A good ceiling forms at $98

CAT – January 10 - Entry Points

CAT on January 11 - Confirmation

Possible Exit Point – at a Ceiling

Entry

BBBY 3-12

BBBY 3-14

BBBY 3-15

BBBY Breaks Out and Runs

HD – Approaching Ceiling

HD – Breakout Day

HD – Breakout Not Confirmed

Pullback and New Run At Ceiling

HD – Breakout Day (again)

HD - Confirmation After Breakout

HD – Run Up to Next Ceiling

Pullback Entry Point

• Not even the best stock goes up everyday nor does the worst one go down everyday.

– Times where a stock reverses direction may present an optimal time to enter into a short term trade.

• An entry point on a reversal at a ceiling or a floor is called a “pullback.”

– There are usually more pullback trading opportunities than breakouts.

– All stocks go through periods of “channeling” where the stock price bounces between FACs.

Rules for Pullbacks

• Find a stock or index that has hit a good floor or ceiling and wait for it to show it is either going to “breakout” or reverse direction – “pullback.”

– If the security is channeling, make sure there is enough room between the floor and ceiling that your trade can make some profit as it continues to channel.

– When trading pullbacks you should wait at least one trading session to provide confirmation that the floor or ceiling is holding.

RUT – Pullback Opportunities

Our Short Term Trading Check List

Step 1 – Know the fundamentals of the security being traded

Step 2 – Identify the broad market trend – $INDU, SPX or SPY

Step 3 – Identify the underlying security trend

Step 4 – Identify the floors and ceilings

Step 5 – Know the news effecting the security

Step 6 – Determine the entry point for the trade

-- Breakouts

-- Pull-Backs

Step 7 – Have a good trading strategy – credit spreads

Step 8 – Have an exit plan if the trade goes bad

Short Term Trading Review

Our Short Term Trading mindset is different from our Long Term Investing mindset.

Short term trading requires less research but more vigilance.

Staying inside the “box” (following the Rule One rules) is very important for success and peace of mind.

Floors and Ceilings – Breakouts and Pullbacks are key.

Use Credit Spreads with the 90/10/48/FAC guidelines.

Only do trades where you have the odds heavily in your favor by using the fundamental and technical analysis tools we have taught you.

Virtual Trading Homework

Identify a breakout or pullback pattern on a ceiling or a floor of a security.

SPY ---- 5 year weekly chartUse Time Period 2010 thru 2016 Use Fibonacci retracements for Floors and Ceilings

Paper trade it by selling a Credit Spread (BPS or BCS) based on the direction you think the security is going at any date, plus most recent trend trade. ( Two different dates … minimum … Four trades Maximum)

Use the 48% guideline to determine the strike prices used Contract month to use: 20-60 days to expiration (DTE) Open and close the position before the next class. If you want, email me with the following information:

– The underlying security and short thesis for the trade – The strike prices used – The ARORC– The results of the trade earld@ruleoneinvesting.com

Screenshot from Think or SwimSPY - 5 Year Daily w/Fibonacci’s

Screenshot from Think or SwimSPY - 5 Year Daily w/Fibonacci’s