Good Day Rookie Bloggers! This week in the blog I want to talk about the tools in our trading toolbox. When I talk about the tools I am speaking about the concept of strategy selection and all that goes into it. It’s great to find a stellar technical setup but how does one know what to do with it after we have decided this is a pattern or setup that we can profit from? This is the rabbit hole we are going down this week. We will begin by talking about the setups we usually look for and then we will go over the considerations we need to look at before deciding which strategy is going to give us the best edge. Let’s get started!

This week’s topic came to mind because of the volatile movement we have had in the last few days. We have had some precipitous drops and vicious rallies and this has built out some patterns that have the potential to be great technical setups but they also have some challenges to face from those same similar technical catalysts. It is these setups where we start to build trades that can give us a trading edge. Take a look at the chart below, I will describe what I see that makes this technical setup attractive and then we can go over the challenges we face when choosing the best trade to employ.

This chart of XOM shows the increased volatility that we have seen in the last few days and shows the very aggressive pullback in the energy sector. These deeper pullbacks can provide solid opportunities for trades but also can present issues as well. As good as this pullback appears after rebounding nicely in the two trading sessions the challenges that lay ahead are the different levels of resistance and the multiple moving averages that can act as sources of resistance as well. From an overall longer perspective one could say that XOM is bullish even though it is bearish in the short term. It would be hard to ignore the potential of a nice move from the current price back up to the 65 level and this is also attractive from a trade perspective. Now, that we have an attractive setup we need to ask ourselves what is the most profitable way to play this trade?

Obviously, the most attractive part of this trade is the potential directional movement from 58 up to 65. These sticking points that we spoke of above can be a formidable force against that desired movement and so it causes one to rethink the potential trade. So what can we do? This is the point where the toolbox has to be opened up and see what else might work out better? We really only have a few choices when it comes to different types of trades. Those are really limited to delta, theta or vega-type trades. As we have discussed the delta or directional trades can encounter problems and the vega trade or volatility trade has its own issues because of the upcoming earnings announcement. That leaves us a theta trade or time decay trade, this trade has potential but does it give us an edge? This is where we need to look at some other parameters to determine whether this trade is viable or not.

First up is the overall position of the current price action. Are we sitting at a resistance level waiting for a breakout or are we in a retracement pattern and is it ready to reverse or does it need time to get moving in the right way? In the case of XOM, it is already moving in a way that can work for both a directional and time-decay, and it is in the main pattern setup that works for those as well.

The next parameter that becomes important is the personality of the equity itself. Every stock has its own personality, some are good for fast aggressive movements and others tend to be subdued in their movements. There are those equities that tend to hardly move at all and these types of stocks are not going to work well for aggressive directional strategies. In the case of XOM, it has both the potential for decent directional movement but also has periods of subdued movement that can work well for other less directional trades.

Finally, the selection of a strategy can come down to the parameters of the trade itself. If we are using options to build a trade then we need to ensure that those options are going to be liquid enough to make for a decent trade and we must ensure that the prices of the options are not unreasonable. In the case of XOM, the options are suitable for almost any trade but not all stocks are going to play out this way.

It is these parameters that can help us determine what strategy works best in any particular situation. A better way to say this is that if we examine the situation then we will have a better understanding of whether we need the hammer or the wrench from the toolbox to have a chance of a successful trade. So before you jump into a trade be sure you know what tool is going to produce the best results and go with the path of least resistance.

Trade Well,

Coach “Old Money” Holmes