The RSI 3 Strikes and You’re Out Play

Please note the use of the word “Play” in the title.  Note also that it does NOT say “System” or “Method”, nor does it include anywhere the words “you”, “can’t” or “lose.”  So what is the distinction in all of this?

The use of the word “Play” is meant to denote that this should not be considered an “investment strategy”, nor even as a “trading method”.  In all candor it should basically be considered as a potential trigger or alert for traders who are willing to speculate in the market.  A few relevant notes:

1. Contrary to what many will tell you, there is nothing wrong with “speculating” in the financial markets.  There is a lot of money that can be made by doing so.

2. The key is in limiting the amount – and/or percentage – of capital allocated to each such trade.

3. Call and put options offer a great way to engage in this type of trading, because by their nature they allow you to “play” while using only limited sums of money.

Think about it this way.  Let’s say you “get a hankerin” to take a flyer on say a rally in the bond market.  Sure you could go out and buy t-bond futures contracts.  As I write they are presently trading north of 138.  At $1,000 a point, that means that the contract value is roughly $138,000.  You only need to put up margin money of about $3,000 in order to enter the trade.  Of course, if t-bonds decline from 138 to 135 then you have lost $3,000.  Good times, good times.

As an alternative you might have bought a call option on the ETF ticker TLT, which tracks the long-term bond.  As I write TLT is trading at $115.51, so to buy 100 shares would cost $11,551.  However, a trader looking to “play” could buy say a September 115 call option for all of $182.  If TLT rallied to say $118 by September expiration the 115 call would be worth $300, which would represent roughly a 65% gain.  And just as importantly, on the flip side, if TLT falls apart the most the option trader could lose would be $182.  Which reminds me of:

Jay’s Trading Maxim #312: If losing $182 on a trade is too much for you to bear – or will cause you great angst or to lose sleep or to beat yourself up – the “trading thing” might not be for you.

The RSI Three Strikes and You’re Out Play

So we will use the 3-day RSI indicator as a trigger to alert of a potential top.  Note the use of the phrase “potential top.”  Note also that nowhere do the words, “pinpoint”, “market” or “timing” appear.  So here is how it works:

1. (Day x) Price and 3-day RSI make a new high for a given move.

2. (Day y) After at least one intervening down day, price makes a higher close than on Day x BUT 3-day RSI stands below its level on Day x.

3. (Day z) After at least one intervening down day, price makes a higher close than on Day y, BUT 3-day RSI stands below its level on Day y.

4. After Day z the entry trigger occurs the next time price drops below the 3 day low.

To put it another way, after Day x price makes to higher closing peaks (with at least one down day between these peaks), while RSI on Day y is below RSI on Day x and RSI on Day z is below RSI on Day y.  OK, that’s as clear as mud.  So let’s go the “a picture is worth 1,000 words” route.

In Figure 1 you can see two examples of this “play” using ticker IWM, the ETF that tracks the Russell 2000 small cap index.  iwm rsi3Figure 1 – The RSI 3 Strikes and You’re Out Play using IWM (Source: AIQ TradingExpert)

In both cases the same scenario plays out.  Price makes two subsequent higher highs while RSI registers two subsequent lower highs.  The signal to buy put options comes when price takes out the three day low.

In the second example a trader could have bought a September 116 IWM put for $2.96 (or $296).  Eight trading days later that put was trading at $5.43 for a profit of $83%. iwm outFigure 2 – IWM put option using the RSI 3 Strikes and You’re Out play on IWM (Courtesy:


No one should get the idea that this simple “play” is the “be all, end all” of trading.  I specifically have not included any ideas on when to exit this type of trade so that no one gets the idea of trying to use this as a mechanical trading system.  Some traders may use a profit target, some may use an indicator, some may adjust the trade or take partial profits if a certain level of profit is reached, etc.

Like virtually any other trading idea, sometimes things will work out as hoped and sometimes they won’t.  The bigger lesson is that it is OK to speculate in the markets provided you do not expose yourself to large risks.  Which seems like good time to invoke:

Jay’s Trading Maxim #1: Your most important job as a trader is to make sure you are able to come back and be a trader again tomorrow.

Jay Kaeppel

Check the Dow on August 1st

Wow, that sounds pretty ominous and self important doesn’t it? (Hey, I gotta get people to click on the headline somehow!)

I will keep this short.  As I have been saying for some time, in my own mind I am scared to death that the market is getting far too overbought, the investing public is getting far too complacent, and the supposed “professionals” are getting far too bullish.  And for my own reasons I keep expecting something bad to happen between now and the end of September (followed by something good).

But despite all of this, I still haven’t sold a thing, for the simple reason that I am primarily just a dutiful trend-follower and the stock market just keeps moving relentlessly higher.  So who am I to say that the party is over?

But I am keeping a close eye on the weekly MACD for the Dow Jones Industrials Average.  Rather than going into a detailed explanation regarding “why” I will simply encourage you to review the material in this article – A Warning Sign to Watch.  (Hey, I did say I was going to keep it short, remember?).

In any event if and when the Weekly MACD for the Dow drops to negative territory, a more defensive stance may be in order.

djia macd


Figure 1 – Keeping an eye on Dow Weekly MACD (Courtesy: AIQ TradingExpert)

Jay Kaeppel

A Simple, Aggressive Approach to Large-Cap versus Small-Cap

Certain “arguments” just seem to last.  Since I started in this business (As best as I can recall, stock prices were reported on an abacus at the time) there has always been someone willing to pursue the “large cap versus small cap” and/or “growth stocks versus value stocks” argument.  Early in my career “everyone knew” that “in the long run” (usually defined – incorrectly – as the most recent 2-5 years) small cap stocks “outperform” large cap stocks.

Is this actually true?  The answer is “Yes, but only sometimes.”  The same answer holds true or growth versus value.  In short, no matter what you hear (at least in my humble opinion) there is no compelling evidence that large-cap stocks inherently perform better or worse than small-cap stocks nor that growth stocks perform better or worse than value stocks.  That’s the bad news.

The good news is that the interplay between large-cap and small-cap (and growth versus value) fluctuates – or more accurately, trends – over time.  In other words, it is not uncommon for large-cap stocks to outperform for awhile and then for small-cap stocks to outperform for a good long while.  If one can identify a trend then an opportunity exists.

One Simple, Albeit Aggressive Way to Play

The method I am about to describe is really pretty simple, however, it does involve risk as the method uses a leveraged mutual fund.  As a preface, the “safe” news is that this method is in the market only about 44% of the time (and is safely tucked away in cash the other 56% of the time). The “dangerous” news is that when it is in the market it is in a leveraged mutual fund that tracks large-cap stocks.  So, bottom line: it is not necessarily for the faint of heart.  More to the point though, it may be ultimately be useful to traders who are willing to invest a certain percentage of their capital in more “volatile” investments in hopes of an above average longer-term return.

So here are the steps:

A = Closing price for ticker RUI (Russell large-cap)

B = Closing price for ticker RUT (Russell small-cap)

C = 252-day % Rate of change for ticker RUI ((A / A 252 trading days ago)-1)*100

D = 252-day % Rate of change for ticker RUT ((B / B 252 trading days ago)-1)*100

E = (C – D)

If E > 0 this indicates that large-cap stocks have outperformed over the previous 252 days, and vice versa.

Trading Rules

If E > 0 today then buy ticker ULPIX (Profunds UltraBull) tomorrow and hold until E < 0.

If E < 0 today then sell ticker ULPIX and hold cash until E > 0

OK, not exactly “sophisticated”, still as a proud graduate of “The School of Whatever Works” (all hail good old “SWW”), I am far less interested in “process” as I am “results”. Which leads us directly to:

The Results

The test I ran started on 10/15/2001 when ticker ULPIX first began to trade.  The equity curves for the method described above versus buying and holding ticker RUI appear in Figure 1. jotm2014-0724-01Figure 1 – Growth of $1,000 using Jay’s ULPIX Method (blue line) versus buying and holding ticker RUI (red line); 10/15/01 through 7/23/14.

In a nutshell, $1,000 invested using the system grew to $4,257 versus $1,932 using a buy-and-hold approach.  The year-by-year results appear in Figure 2.














































Std Dev






Figure 2 – Annual Results; Jay’s ULPIX System versus Buy-and-Hold

As you can see in Figure 2, since 2002 the system has averaged 13% annually versus just +4.5% for buy and hold.  It should also be noted that the standard deviation of annual returns was lower for the system.

On the downside investors should be sure to note that despite the fact that the “system” showed a gain for 2008, it nevertheless experienced a -42% drawdown during 2008. So just, repeating now, this method cannot be characterized as “low risk” in any way shape or form.

It is also worth noting that the annual system results versus buy and hold is all over the place.  So anyone looking for an endless string of “out performance” year after year, will definitely need to look elsewhere.  The proper perspective is this: when the system is in the market it occasionally makes a lot of money.  When it is out of the market it doesn’t make much at all – even if the stock market overall is rising.

For the record the system has been in ULPIX since the close on 5/7/14 and shows no immediate signs of getting out.  As of 7/23/14, RUI is up 17.8% and RUT is up 10.1% over the latest 252 days.  So “Value E” from above is +7.7%.  The system will continue to hold ULPIX (for better or worse) until Value E once again falls into negative territory.


As always, I am not recommending that anyone rush out today and jump into large-cap stocks just because the method I have described is presently bullish.  Nor am I even suggesting that anyone should adopt this system.  Before anyone engages in any type of trading that involves the use of a leveraged mutual fund, there are a few introspective questions to be asked and answered regarding one’s own tolerance for risk, what type of asset allocation is reasonable, and whether The School of Whatever Works offer classes online? (OK, just kidding about the last one).

The real point of this piece is twofold:

1) To dismiss the notion that large cap stocks are inherently a better investment than small-cap stock, or vice versa and;

2) To illustrate that with a little bit of analysis and effort it may be possible to come up with simple methods that take advantage of trends in the marketplace.

Now if you’ll excuse me, I have to get back to class.

Jay Kaeppel


Everything You Need To Know About the Stock Market in 2 Charts

I have been a little “quiet” lately.  Kind of unusual for me, granted.  But what can I say really that’s new?  The stock market’s moving higher – blah, blah, blah.  The bond market keeps trying to creep higher – sure, interest rates are basically 0%, so why not?  Gold stocks keep trying to grind their way higher after putting in an apparent base.  But who the heck ever knows about something as flighty as gold stocks?

So like I said, not much new to report. 

So for the record – one more time – let me repeat where I am at:

-As a trend-follower there isn’t much choice but to say that the trend of the stock market is still “up”.  So as a result, I have continued to grit my teeth and “ride”.  And let’s give trend-following its due – it’s been a good ride. 

-As a market “veteran” I have to say that this entire multi-year rally has just never felt “right”.  In my “early years” in the market (also known as the “Hair Era” of my life) when the stock market would start to rally in the face of bad economic times I would think, “Ha, stupid market, that can’t be right.”  Eventually I came to learn that the stock market knows way more than I do.  And so for many years I forced myself to accept that if the stock market is moving higher in a meaningful way, then a pickup in the economy is 6 to 12 months off.  As difficult as that was at times to accept, it sure worked. 

Today, things seem “different”.  By my calculation the stock market has now been advancing for roughly 5 years and 4 months.  And the economy?  Well, depending on your political leanings it is somewhere between “awful” and “doing just fine.”  But in no way has the “old calculus” of “high market, booming economy 6-12 months later” applied.

Again depending on your politics leanings the reason for this lies somewhere between “it is entirely Barack Obama’s fault” to “it is entirely George Bush’s fault.” (I warned you there was nothing new to report).

From my perspective, I think that the charts below – the second one of which I first saw presented by Tom McClellan, Editor of “The McClellan Oscillator” (which he presciently labeled at the time, “The only chart that matters right now”) – explains just about everything we need to know about the stock market actions vis a vis any economic numbers.

So take a look at the two charts below and see if anything at all jumps out at you.

spx mnthlyFigure 1 – S&P 500 Monthly (Source: AIQ TradingExpert)


Figure – Fed Pumping (Quantitiatve Easing “to Infinity and Beyond”) propelling the stock market

I am not a fan of using the word “manipulation” when it comes to the stock market.  But I am a strong believer in the phrase “money moves the market.”  The unprecedented printing of – I don’t know, is it billions of trillions of dollars – has clearly (at least in my mind) overwhelmed any “economic realities” and allowed the stock market to march endlessly – if not necessarily happily – to higher ground.

Thus my rhetorical questions for the day are:

“What would the stock market have looked like the past 5 years without this orgy of money?”

“What happens to the stock market when the Fed cannot or will not print money in this fashion?”

Because this is all unprecedented in my lifetime (as far as I can tell) I don’t have any pat answers to these questions.  But I some pretty strong hunches.

My bottom line: Err on the side of caution at this time (

Jay Kaeppel


Crash Insurance

Well it finally happened.  The stock market actually got “spooked” for a couple of days.  It’s been awhile.  And that kind of has me “spooked.”  Before I go any further I should state the following:

1) I am expecting some “trouble” between now and the end of September

2) However, as a dutiful trend follower I have yet to really act on those fears.

So when I write an article titled “Crash Insurance”, I am not necessarily suggesting that everyone rush out and buy some.  I am more or less just “planning ahead.”

I found the following link quite interesting (The 23 Charts Prove That Stocks Are Heading For A Devastating Crash) and suggest you give it a thorough read.  Although I don’t necessarily endorse the headline I do think something very unpleasant is quite possible, and the information contained flashes some clear warning signs.

If nothing else see the following:

Chart #4) QE to Infinity and Beyond qe

Figure 1 – QE to Infinity and Beyond (Chart Source: article “The 23 Charts Prove That Stocks Are Heading For A Devastating Crash” by Jesse Colombo)

This chart explains as plain as day why we have been in an endless bull market for years now (i.e., money moves the market, and when the Fed provides an endless supply, well, you get the drift).  When this chart turns down, be prepared to – all kidding aside – RUN LIKE HELL!

Chart #5) NYSE Margin Debt margin debtFigure 2 – NYSE Margin Debt (Chart Source: article “The 23 Charts Prove That Stocks Are Heading For A Devastating Crash” by Jesse Colombo; Chart generated by Doug Short at

In the 1975 classic “Market Logic”, Norman Fosback first noted that rising margin debt is bullish for the stock market (once again, money moves the market).  He also noted that when margin borrowing gets overdone and then turns down, it’s not such a happy thing for the stock market.  As you can see in the chart, the previous two spikes occurred during the run up to the 2000-2002 and 2008 bear markets.  The current level has recently declined from a new all-time high.  If this downtrend continues it will constitute an important warning sign for investors.

How to Buy “Crash Insurance”

In college I took a class on Insurance (Wow, was I a fun guy or what?  I digress).  What the teacher taught us was to “spend a little to cover alot.” In other words, spend a small sum of money to cover worst case calamity scenarios (granted this is different then what insurance has evolved into today whereby everyone wants everything to be covered and then wonders why the premium is so high…..but again, I digress).

SPY Put Option

One of the simplest way to “insure” against a market crash is to buy a put option on ticker SPY, the ETF that tracks the S&P 500 Index.  As I am looking for a bullish phase to begin on October 1st I need to go out to October options.  In Figure 3 we see the “Probability Calculator” screen from  Highlighted are the potential -1, -2 and -3 standard deviation price levels.

spy prob

Figure 3 – Probability Calculations for 9/30/14 (Source:

The October SPY put option with the lowest “Percent to Double” is the October 198 put option.  As I write the option trades at $5.79 (or $579).  The risk curve for buying one October 198 put appears in Figure 4.  The lower boundary is set to the -3 standard deviation price shown in Figure 3 (166.10).spy put Figure 4 – Risk Curves for October SPY 198 put (Source:

As you can see in Figure 4, if by chance SPY does fall apart between now and October expiration, this option will gain a lot in value.  Of course if the market moves sideways to higher instead this option could expire worthless and the buyer would lose a maximum of $579.


I am not suggesting that now is the exact right moment to consider buying a put option on SPY.   As always I am not “recommending” the trade above.  The example I’ve shown is simply intended to give you the idea of how to use put options as a potential alternative to “selling everything”.  You should also be aware that via the use of options there are other more “sophisticated” strategies available.  Buying a put option to hedge is sort of a “hammer to nail” approach – crude but effective.

In any event, as indicated in the Forbes article in the link above, there are some “clouds beginning to build”.  Which leads directly to:

Jay’s Trading Maxim #102: It is better to know where to find shelter now  in case an actual storm breaks out than to have to “run for cover” somewhere down the road.

Jay Kaeppel

The Tempting Siren Song of Gold Stocks

If you are a “chart” guy or gal you may have taken notice of some interesting developments in gold stocks over recent months.  A strong argument can be made that a “bottom formation” has – well – formed and that price is now in the early stages of a new bullish trend.  Is this an accurate picture?  Let’s take a closer look.

The Chart Picture

The great thing about looking at price charts is that you can see pretty much whatever you want to see in them – er, I mean, there are many different possible interpretations.  In Figure 1 we see a weekly bar chart for ticker GDX – the Market Vectors ETF that tracks a gold stock index.gdx weekly Figure 1 – GDX Weekly Bar Chart with Support, Resistance and Triangle pattern highlighted (Courtesy: ProfitSource by HUBB)

As you can see there is a (OK, somewhat subjectively drawn) support and resistance range between roughly $20 and $32.  There is also a triangle pattern forming as price consolidates into a more narrow range.  Now for the record I got burned by incorrectly guessing the direction of a triangle breakout in ticker GLD recently (link), but I am not much of a “Once bitten, twice shy” kinda guy.  For me it’s more like, “Fool me once, shame on you, fool me twice – damn! I fell for it again.” Cest la vie.

Still, the point is that price action seems to be “coiling” within a larger trading range, so now is the time to start planning what action to take, if any.

In Figure 2 we see a weekly bar chart for ticker GDX with the Weekly Elliott Wave count plotted, as calculated objectively by ProfitSource from HUBB. gdx ew Figure 2 – GDX weekly with Elliott Wave (Courtesy: ProfitSource by HUBB)

As I always I should point out that I do not “blindly trust” Elliott Wave counts.  Sometimes they play out with “uncanny accuracy”, other times, well, not so much.  Still, for what it is worth, the current count is projecting a potential move from $26 to roughly $38 to $42, potentially by the end of this year. 

So this raises two questions:

Question 1: Do you think there is a chance that gold stock prices will advance in a meaningful way between now and the end of the year?

Question 2: Are you willing to risk a couple hundred bucks while waiting to find out?

Option Plays in GDX

As is always the case when dealing with options, the possibilities are limitless.  One possibility is to use the “stock replacement strategy”.  With this approach a trader buys a deep-in-the-money call option that will emulate a stock position at a fraction of the cost.  For example:

*To buy 100 shares of GDX would cost $2,645

*To buy one December 20 GDX call would cost just $675

The Dec 20 call has a “delta” of 93 which means it will act like a position holding 93 shares of GDX, but will cost only 27% as much as buying the shares.  The particulars for the Dc 20 call trade appear in Figure 3. gdx dec 20Figure 3 – Long 1 Dec 20 GDX call @ 6.75 (Source:

An alternative would be:

*Buy 6 Dec GDX 28 calls @ 1.43

*Sell 6 Dec GDX 33 calls @ 0.32

This trade would cost $666 and the particulars appear in Figure 4.gdx dec 28 33 bcs Figure 4 – Long 6 Dec GDX 28-33 bull call spreads (Source:

This trade has a delta of 170, which means it will act like a position holding 170 shares of GDX, i.e., up to a point it can make money much more quickly than the Dec 20 call position for the same investment $.

Comparing the Two Trades

Figure 5 displays the two trades (one Dec 20 GDX call for $675 versus six Dec 28-33 GDX bull call spreads).gdx overlayFigure 5 – GDX Dec 20 call versus GDX Dec 28-33 Bull call spread  (Source:

The Dec 20 call enjoys unlimited profit potential and eventually could make more than the Dec 28-33 bull call spread.  However, based on the earlier Elliott Wave analysis, we are looking at (OK, hoping for)  a move to the $38-$42 range (which would be a huge move).

So if GDX does in fact rise between now and December the Dec 28-33 bull call spread enjoys better profit potential. 


As always, there are many ways to play just about anything in the financial markets, particularly when options are involved.  Also as always, I am not “recommending” either of these trades.  The purpose here is simply to highlight:

*One way to trade options instead of stock shares and get essentially the same position at a fraction of the cost (i.e., the Dec 20 call).

*One way to create greater upside potential for the same cost (i.e., the Dec 28-33 bull call spread)

Finally – and also as always – there are tradeoffs and caveats to keep in mind.  In this case, two that come to mind are:

1) GDX MUST move higher for either of these trades to make any money.

2) YOU MUST be patient and wait for the move to play out (assuming it does) over a multiple month period of time.

Which leads us to close with:

Jay’s Trading Maxim #57: When patience is required in trading – the urge to become impatient suddenly tends to surge.  So prepare yourself mentally to fight the “urge to surge.”  

Jay Kaeppel

September 30th – Mark Your Calendar!

Well the stock market just seems to keep chugging along.  Despite the shaky economy, the national debt, the political discord, the terrorists on the march and the price of – well, just about everything made in China. And as a dutiful trend-follower I continue to “ride the ride” all the while repeating the ever apt phrase, “What, me worry?”

Three things for the record:

1) The stock market is in a clearly established uptrend and who am I to say otherwise?

2) Personally I still expect a serious “something” between now and the end of September

3) Arguably the most important bullish seasonal trend of all kicks in at the close on September 30, 2014.


Yes folks, as of the close on September 30th it will be time for “the Mid Decade Rally”

Defining the Mid-Decade Rally

For the purposes of this article we will break each decade into two periods:

*Period 1 (i.e., the “Bullish 18″) = the 18 months extending from the end of September of Year “4” (2014, 2004, 1994, etc.)

*Period 2 (i.e., the “Other 102″) = the other 102 months of every decade.

So in a nutshell, Period 1 comprises 15% of each decade while Period 2 comprises 85% of each decade.  Given that Period 2 is 5.67 times as long as Period 1 it would seem likely that an investor would make more money being in the stock market during Period 2 than during Period 1.

I mean if you had to choose – particularly given the long-term overall upward bias of the stock market – would you choose to be in the market 85% of the time or only 15% of the time.  Safe to say most investors would answer the former.  But if you are among those who chose this answer, perhaps you should read a little further.

Period 1: The “Bullish 18 Months” of the Decade

In Figure 1 you see the growth of $1,000 invested  in the Dow Jones Industrials Average only during the middle 18 months (Sep. 30, Year 4 through Mar. 31, Year 6) of every decade starting in 1900.  See if anything at all jumps out at you from the chart.jotm20140625-01Figure 1 – Growth of $1,000 invested in Dow only during “Bullish 18” months of each decade; 1900-present

Does the word “consistency” come to mind? For the record, $1,000 invested only during this 18-month period grew to $40,948, or +3,994%.  Now this all looks and sounds pretty good, but surely an investor would have made a lot more money investing in the stock market during the other 102 months of each decade, right? Well, not exactly. In fact, a more accurate statement might be, “not at all.”

Period 2: The “Other 102” Months of the Decade

Figure 2 displays the growth of $1,000 invested in the Dow Jones Industrials Average only during the other 102 months of each decade.  $1,000 invested in the market 85% of the time – but excluding the mid-decade bullish period – would have grown to $6,166, or +517%.jotm20140625-02Figure 2 – Growth of $1,000 invested in the Dow only during the “Other 102” months of each decade; 1900-present

Now for the record, +517% is +517% and no one is saying that you should simply mechanically sit out the 102 “other” months. But the point is simply that the “Bullish 18” made 7.73 times as much money – while invested only 15% of the time – as the “Other 102” – which was invested in stocks 85% of the time.

The difference is even clearer when the two lines are drawn on the same chart as shown in Figure 3.jotm20140625-03 Figure 3 – Growth of $1,000 during “Bullish 18″ month (blue line) versus “Other 102″ months (red line); 1900-present

Mid Decade “Bullish 18” Performance


 Period % +(-) during “Bullish 18”
9/30/1904-3/31/1906 +68.3%
9/30/1914-3/31/1906 +30.6%
9/30/1924-3/31/1906 +36.2%
9/30/1934-3/31/1906 +68.8%
9/30/1944-3/31/1906 +36.1%
9/30/1954-3/31/1906 +42.0%
9/30/1964-3/31/1906 +5.6%
9/30/1974-3/31/1906 +64.4%
9/30/1984-3/31/1906 +50.7%
9/30/1994-3/31/1906 +45.4%
9/30/2004-3/31/1906 +10.2%

Figure 3 – “Bullish 18″ month performance

For the record:

*The average % gain for the Bullish 18 was +41.7%

*The median % gain for the Bullish 18 was +42.5%

On the other hand:

*The average % gain for the Other 102 was +34.3%

*The median % gain for the Bullish 18 was -2.2%

So you see why I am marking September 30, 2014 on my calendar.

By the way, if you like this one, in the immortal words of Jimmy Durante, “I got a million of ‘em.

Jay Kaeppel

(One Last) Garbage in Gold Update

No one likes to waste time so I will give it to you straight.  If you have no interest whatsoever in trading options and/or if either this, this or this cause your eyes to glaze over, I’m going to suggest that you stop reading right here.

But thank you for checking in and have a nice day.

Alright, now that they’re gone… of the things I like to (try) to do is to go beyond teaching people “about trading” (“this is what a risk curve for a butterfly spread looks like”) and get more into “how to trade” (“this looks like a good time to use/adjust a butterfly spread because…”).

In the articles linked above I wrote about a hypothetical bearish on gold trade using put options in GLD.  That trade will expire at the close on 6/20.  Before that happens I am going to add one more update.

The Current State of Gold Affairs

In Figure 1 you see the risk curves for the original (adjusted) trade.

jotm20140618-01 Figure 1 – Risk curves for Out-of-the-money GLD put butterfly spread (Courtesy:

The good news is that:

a) The trade cannot lose money

b) There is still additional upside potential if GLD declines towards 119 between now and the close on 6/20.

The bad news is that most of the open profit can still vanish if GLD advances towards 125 between now and the close on 6/20.

So several choices available to a trader are:

a) Hold on if you think GLD will move sideways to lower in the next 48 hours

b) Exit the position if you think GLD will move higher in the next 48 hours

c) Adjust the current position

No surprise, I choose “C”. Here’s why:

1) First off I don’t have a clue what GLD will do in the next 48 hours.  I do know that after holding this trade since March 6, I don’t want to end up with a meager profit (which would be the case if GLD rallies above 125.  But I don’t necessarily want to exit because there is still a lot of additional profit potential available of GLD does happen to sell off in the next 48 hours.

2) Additionally I think you can make a bullish case for GLD going forward.  As you can see in Figures 2 and 3, the Elliott Wave count on both the daily and weekly charts show a completed 5 wave down pattern (to all of you “non Elliott Heads” this implies that downside momentum is waning and that a new up move may begin).  Now I am not a true Elliott believer but I do pay attention when both the daily and weekly counts point in the same direction.  jotm20140618-02 Figure 2 – Daily GLD with completed Elliot Wave 5 (Courtesy: ProfitSource by HUBB)jotm20140618-03Figure 3 – Weekly GLD with possible completed Elliot Wave 5 (Courtesy: ProfitSource by HUBB)

So let’s survey the situation:

1) I have an open position with an open profit that could get bigger or smaller in the next 48 hours and I have no opinion which way it might go during that time.

2) I have an open profit of $544 “burning a hole in my pocket”.

3) I have some reason to believe that GLD may advance in price moving forward.

What to do, what to do?

Well, in reality the choices are limitless.  But here’s what I’ve come up with:

*Continue to hold the trade but also spend some of the open profit to position myself for a potential up move in gold.  How to accomplish this?  Relatively simple: Buy 1 March 2015 GLD 130 call option for $3.10, or $310.  The risk curves for this newly adjusted trade appear in Figure 4.

gld adjust 6-18Figure 4 – OTM Put Butterfly PLUS long March 2015 130 call option (Courtesy:

A few things to note:

1) If GLD somehow happens to fall below 119 between now and June expiration, the put portion should be exited as this trade would start to lose profit and could even turn into a loss if GLD plummeted.

2) On the upside, the smallest profit we would have at June expiration is $100.  But even in that worst case we still hold a “free” March 2015 130 call option.

The risk curves for this position after June expiration appears in Figure 5. In essence we made $234 on the put butterfly and were able to buy a free long-term call option.

jotm20140618-05Figure 5 – Risk curve for Long GLD 2015 130 call option (after June expiration) (Courtesy:


Is this option trading stuff fun or what?  A couple things to note.  First, figuring out which trade to put on initially is only one part of the equation.  Other considerations are:

*When to exit with a loss?

*When to exit with a profit?

*Can the trade be adjusted to increase potential and/or reduce or eliminate risk of loss?

The trade and adjustments covered in this series of articles serve merely as an example of “how to trade” options.  Another trader may well have come up with a different (and yes, possibly better) initial trade, and an entirely different series of adjustments (or no adjustments at all).

The key thing to take away is the potential to use options to create positions that offer opportunities not available to traders who focus only on individual stocks, indexes and ETFs.

Jay Kaeppel

Trouble in Bond Paradise?

With the Fed “pumpin’” and the economy “thumpin’” (as in “thumping along like a flat tire”) it seems unlikely that interest rates would rise.  Still, sometimes is makes sense to go against the grain if enough evidence presents itself.  So let me show you what I am looking at in the bond market.

EWJ vs. T-Bonds     

As I wrote about in a previous article (T-Bonds and Japanese Stocks, Inversely….), for whatever reason, t-bonds have long exhibited a strong inverse correlation to Japanese stocks (no, seriously).  In Figure 1 we see EWJ (the ETF that tracks Japanese stocks) with a 5 week and 30 week moving average drawn in the top clip.  In the bottom clip we see ticker TLT (the ETF that tracks the 30-year t-bond). You can see that – using highly technical terms that we quantitative analysts types like to use to impress others with how much we know about the markets – when EWJ “zigs”, TLT tends to “zag”, and vice versa.ewj vs tltFigure 1 – EWJ with 5-30 week moving averages versus TLT (Courtesy: AIQ TradingExpert)

This past weekend the 5-week moving average for EWJ once again rose back above the 30-week moving average for EWJ.  If history is an accurate guide then this may be a negative sign for t-bonds.  Although I would be remiss if I did not invoke:

Jay’s Trading Maxim #216: History is not always an accurate guide (but it beats flipping a coin).

Figure 2 displays the raw dollar gain or loss from:

a) Holding a long position in t-bond futures (1 point movement = $1,000) when EWJ 5-week is below EWJ 30-week (red line)

b) Holding a long position in t-bond futures (1 point movement = $1,000) when EWJ 5-week is above EWJ 30-week (blue line)ewj vs tlt equity curveFigure 2 – $(-) from a long position in t-bonds futures when EWJ 5-week MA is BELOW EWJ 30-week MA (red line) and $(-) from a long position in t-bonds futures when EWJ 5-week MA is ABOVE EWJ 30-week MA (blue line) (12/31/1997 to present)

Obviously this indicator is not perfect, but equally obvious is the fact that bonds have typically performed better when the EWJ 5-week MA is below that EWJ 30-week MA. So let’s call this – if nothing else – a potentially negative sign.

TLT vs. Elliott Wave

I am not a true “ElliottHead” but I do tend to pay attention to the Elliott Wave count for a given market when the daily and weekly counts point in the same direction.  Figures 3 and 4 present the latest daily and weekly Elliott Wave counts for TLT as figured by ProfitSource by HUBB.

The daily count just completed a bullish Wave 5 (i.e., implying that the latest rally has run its course) and the weekly count is signaling a potentially Bearish Wave 4 sell signal.  For the record, I do not believe in the “magic” of Elliott Wave.  But I do like when daily and weekly signs for just about any indicator appear to confirm one another.jotm20140616 tlt ew dFigure 3 – Daily Elliott Wave Count for TLT; Completed Wave 5 suggests rally is over (Courtesy: ProfitSource by HUBB)jotm20140616 tlt ew wFigure 4 – Weekly Elliott Wave Count for TLT; signaling potentially Bearish Wave 5 signal (Courtesy: ProfitSource by HUBB)

Ways to Play

So if a trader buys the idea that t-bonds will decline in price in the months ahead, there are lots of way to play.  A trader could:

*Sell short 100 shares of ticker TLT.  This would require roughly $5850 of margin money and would technically entail unlimited risk. 

*Trader could buy 100 shares of ticker TBT, an inverse leveraged ETF that is designed to track t-bonds times minus 2 (In other words, if bonds decline -1%, then ticker TBT should rally roughly +2%).  This would require roughly $6,200.

*Buy a put option on ticker TLT.

*Buy a call option on ticker TBT.

There are pros and cons to each, but the trade that I want to highlight is buying a call on ticker TBT.

Call on TBT

If t-bonds do decline, then TBT would be expected to advance, hence the reason for considering a call option on TBT.  The reason I am looking at this trade is simply because it offers the most “bang for the buck.”  Not only are TBT shares leveraged 2 to 1, but by buying a call option we can obtain even more leverage with limited risk.  As you can see in Figure 5, TBT has support at roughly $56 and resistance at roughly $80. tbt barFigure 5 – TBT; support near $56, resistance near $80 (Courtesy: AIQ TradingExpert)

So let’s look at buying the September 62 call for $281 (NOTE: the bid/ask is fairly wide at $2.62/$2.81.  For illustrative purpose I am simply assuming a market order and a fill at $2.81.  An astute trade might consider a limit order that splits the difference).  Figure 6 displays the risk curves for buying the Sep TBT 62 call at $2.81.TBT risk curve Figure 6 – Risk Curves for TBT Sep 62 call (Courtesy:

As you can see, in the worst case the maximum loss is $281.  In the best case – i.e., TBT rallies all the way back up to $80, the trade can generate a profit in excess of $1,500.  Also there are three months for “something” to happen. 


As always, I am not “recommending” this trade.  I am simply pointing out some potentially bearish evidence that I have found in regards to t-bonds and have highlighted “one way” to play such a situation using the limited risk associated with options.

So will t-bonds take a tumble and in turn, will TBT soar, thus generating an excellent rate of return?    As always, “It beats the heck out of me.”

But from a trader’s perspective, the real question is, “Am I willing to risk $281 to find out?”

Jay Kaeppel

Sell on June 13th?

OK, I will admit I am acting a bit schizophrenic of late.  Yesterday I write an article titled “One Sign That the Bull May Still Have Legs” and today I am writing an article that seemingly suggests that you sell tomorrow.  So what gives?

First off a friendly reminder that everything I write on this blog is for “educational purposes only” and I do not make formal “recommendations.” In other words, “I report (whatever I see – or to be technically correct, whatever I think I see), you decide.”  (This is slightly but importantly different from most of today’s main stream media whose motto more closely resembles “We decide, then we report.”)

So the Bullish Outside Month I detailed in my last piece remains a bullish factor. But today, let’s look at the other side of the coin by combining two indicators.

The Coppock Guide

Because I am hoping to avoid having too many readers suffer “My God This Sure Seems Complicated – Not to Mention Boring” syndrome, I am going to skip the description of the steps involved in calculating the Coppock Guide (may I suggest or better yet here).  Long story short, the Coppock Guide is a momentum indicator which in this case is updated once a month using the closing price each month for the Dow Jones Industrials Average.  Also in this case we are looking at the 2-month rate-of-change in the Coppock Guide Indicator value itself.  Interpretation works as follows:

*Current Coppock Guide value > Coppock Guide value two months ago = GOOD

*Current Coppock Guide value < Coppock Guide value two months ago = BAD

For the record, starting in August of 1900 (and assuming no interest while out of the market):

*$1,000 invested in the Dow only when conditions were GOOD is now worth $379,378.

*$1,000 invested in the Dow only when conditions were BAD is now worth $764

That’s +37,838% versus -23.6% (which is what we “quantitative analyst types” refer to as “statistically significant”).

For the record, the Coppock Guide 2-month rate-of-change is now negative, i.e., bearish.

The 40-Week Cycle

The 40-week cycle can be traced back to April 21, 1967 (no seriously).  Since that date, the first 140 calendar day period (20 weeks times 7 days a week) is deemed the “bullish phase” and the next 20 weeks is deemed the “bearish phase.”

One refinement I’ve added is a 12.5% stop-loss.  If the Dow drops 12.5% or more on a closing basis from its closing price at the start of a bullish phase, then the cycle is deemed bearish until the end of the current 40-week cycle.  Recent cycle phases appear in Figure 1.jotm20140611-40wkFigure 1 – The 40-week cycle (20 weeks bullish; 20 weeks bearish) Courtesy: ProfitSource by HUBB

For the record, starting on 4/21/1967 (and assuming no interest earned while out of the market):

*$1,000 invested in the Dow only when 40-week Cycle is bullish is now worth $28,896.

*$1,000 invested in the Dow only when 40-week Cycle is bearish is now worth $664.

That’s +2,790% versus -34% (again, “statistically significant”).

For the record, the 40-Week Cycle reverts to a bearish phase as of the close on 6/13/14.

One thing to note: As you can see in Figure 1 it is not like the Dow necessarily begins to decline the minute a new 40-week bearish phase  (marked by “-” signs in Figure 1) begins.  So let’s combine the Coppock Guide and the 40-week cycle.

Combining Coppock Guide and 40-Week Cycle

So let’s now take the obvious next step and combine these two indicators.  For our purpose, if either indicator is bullish we will call this a “combined bullish phase.”  On the other hand of BOTH indicators are bearish – which will be the case starting at the close on 6/13/14 – we will call this a “combined bearish phase.”

Figure 2 displays the growth of $1,000 invested in the Dow when either or both of the indicators are bullish, i.e., in a “combined bullish phase.”jotm20140611-0x1Figure  2 – $1,000 invested only during a “combined bullish phase” (blue line) grew to $30,221 versus $19,187 for buy-and-hold (red line); 1967-present

On the flip side, Figure 3 displays the growth of $1,000 invested in the Dow when both indicators are bearish, i.e., in a “combined bearish phase” (again, this will be the case as of the close on 6/13/14).jotm20140611-02Figure 3 – $1,000 invested only during a “bearish phase is now worth just $635; 1967-present


So will the Bullish Outside Month propel stock prices higher still?  Or does the combined bearish phase for the Coppock Guide and the 40-Week Cycle portend that a market decline is finally in the offing?

As usual I have to go with my stock answer of “It beats me.”  But my basic plan remains unchanged.  Unless and until the major market averages start to break down I continue to give the bullish case the benefit of the doubt.

After June 13th I will however, be keeping an ever more vigilant “eye on the exits.”

Jay Kaeppel