From time to time, we here at the Traders Blog will feature a person or product that stands out in the trading world. Today that trader is Alan Knuckman of the Wizard.com. Alan will be sharing part of his Trend Trade and break out trading strategy. Be sure to comment below with your thoughts and questions.
Hello traders I’m Alan Knuckman, Senior Market Strategist. I can be seen every week on financial television networks such as CNBC, Bloomberg, FOX Business and Reuters. I’m blogging today about my favorite trading strategy and my weekly trend breakouts for the week of November 14th. This week I’m also going to discuss how I use options to trade this strategy.
As I mentioned last week, with over 20 years plus experience in the markets, it has been proven to me that the real money is made on trading breakouts candidates that are going in the same direction as established trends. There are two parts to this established trading strategy.
1) Identifying the Trend – As all of us traders know, trading with the trend of the markets significantly increases the chances, or probabilities, for a trade to be successful. The first step in this strategy is to determine the trend of the market and its strength.
2) Trading Breakouts - The price breakout strategy looks for new highs/lows on a monthly, weekly, daily or minute interval basis and the high odds of the future continuation of this momentum strength. The beauty of trading breakouts is IF new highs or lows are NOT achieved you have zero risk because an entry has not been triggered.
The elimination of anticipating what the market is going to do by only trading real breakouts saves money and aggravation from countless frustrating false moves. A new relative high/low for whatever time frame you follow is a proven sign of the
momentum breakout that renews the trend strength once again.
Let’s Look At This Weeks Potential Trend – Breakouts
Step 1. Determine the Market Trend
As I mentioned last week, I like to trade weekly breakouts. This eliminates the need for me sitting in front of the computer all day. With that being said, the trends of the market have been all over the place. One day they’re up huge and the next day they’re down just as big. It’s volatility at its finest. Because of this, I’d usually recommend only trading daily breakout candidates. This allows you to quickly take advantage of these big market swings. But because I’m only writing a weekly blog, I’m going to only look at weekly breakouts. If you trade daily breakouts, you can apply the same trading rules, just do so every day.
Here are the current trends for major indices (L = weekly trend, S = daily trend. Bright Green is Very Bullish, Light Green is Moderately Bullish). As you can see, the Trends are all starting to turn bullish. Because of this, I’m going to run scans that are going long.
Step 2. Find Breakout Candidates
I run a breakout scan on only S&P 100 stocks that have “Very Bullish” trends. Here’s my scan input screen:
Here’s what the scan came back with:
The scan came back with six pre buy candidates for weekly signals for S&P 100 stocks with very bullish long and short term trend.
Note – If I wanted to be conservative, I would also look at each stock’s Sector and Industry trends as well as their recent trading volume. Again a safer play is to also have the Sector and Industries in trend agreement and have volume close to or above their weekly average. You can quickly check volume by click on the “V” next to the stocks Last Price. A red “V” means that volume is below its weekly average, a green “V” means it’s above its weekly volume average.
If I was just trading the stock, the breakout price is the “Entry Price” on my scan results. I will put in a “Buy Stop Limit” orders with my broker on these six trades at the Entry Price. I will also put in the stop loss price (the price in the “Stop” column) for if and when the trade is triggered. But let’s reduce our risk and increase our leverage by placing option trades based on our scan results;
Power of Options
The purchase of an option instead of stock shares has multiple trading advantages. First and foremost is absolutely LIMITED RISK to the premium paid when you purchase a Call or Put option. An option gives the right but not obligation to buy or sell shares.
The benefit is the worst case scenario no matter what happens in the market is that an option can go to zero and expire worthless. Unlike a stop loss on a stock, this risk control is precise. A $500 option has a maximum risk of that cost no matter how far or fast the stock moves.
After risk control another bonus is the LEVERAGE. An option controls 100 shares of stock for a premium price that is much less than it would take to buy them outright. You put up less investment capital and reap the potential benefits of price movement.
The third advantage is STAYING POWER. A specific expiration date gives you time for the markets to fluctuate up and down with a larger long term goal in mind. Options make it possible to ride through short term volatility and be in position for gains week or months after when it may have been nearly impossible to hold onto the shares.
What Option Strike and Month?
Choosing the right option is the problem for most traders. A careful consideration must be taken to select an option that will react properly and has enough time to be right on direction. Too often traders buy Out Of The Money options that have low probability of a major move and too little time for it to happen.
Using an option as a share substitute is a disciplined methodical process. The weekly breakout strategy is looking for longer trends that can possibly continue for multiple months. Buy at least 2 months until expiration with the objective of having too much time as opposed to too little obviously.
To select the strike, the price at which you have the right to buy or sell shares, an In The Money option provides a high payoff compared the stock move. That relationship is called the Delta of an option and 75+ is the play that we want to get close to the movement in the stock. The option will move approximately 75% of the underlying shares.
Two months time and 75 Delta is our formula to attack trend breakout strategy.
Trade Candidate Option Play Conversion
Stock Trigger Distance Option Price Delta Delta X Distance Approx Premium
UTX $80.37 $0.54 Jan [email protected]$9 78 $0.42 $9.45
RTN $45.83 $0.29 Jan [email protected]$4.4 77 $0.22 $4.65
NOV $74.76 $3.71 Jan [email protected]$11.55 75 $2.78 $14.35
LMT $78.88 $1.46 Jan [email protected]$6.10 78 $1.14 $7.25
EMC $25.10 $0.46 Jan [email protected]$2.75 75 $0.35 $3.10
CAT $96.36 $0.23 Jan [email protected]$14 77 $0.18 $14.20
The Approx Premium is the forecasted price of the option if the Stock Trigger price is hit. Again we are trading breakout candidates, so we want to wait to see if these trigger prices are reached. You could also calculate the option’s stop price or what I do is just use the stock stop price from my original scan results. If the stop is hit, then I close the options trade.
I hope I was able to convey why this trading strategy is both conservative to trade with the trend and momentum breakout strength. By adding options to this, you decrease your risk even more and dramatically increase your potential upside returns.
Good luck in all your trading endeavors, Alan Knuckman
Trade platform comments
The trend trade breakout strategy has many challenges from what time frames to follow and how to evaluate all of the thousands of markets choices for opportunities. It can be done on your own but time is such a precious asset to a trader that a trading tool to automate the process is truly valuable.
For many years, I was manually determining the market trend and breakout prices. Then I ran across an article in the Dallas Morning News which reviewed a trading tool called The Wizard that did both.
I subscribed to The Wizard and tested it out for a couple of months. In finding the trends of the market, it is very accurate. Not only does it give market direction, it also breaks down the trends for specific industries, sectors and individual stocks, ETFs, futures and currency pairs.
The value of a trading tool is measured by success and ease of use. The Wizard updates every night for daily breakouts and on Friday night for the weekly information. A quick scan using my filters generates what I need for the week ahead. Just place the entries and stops on the trend trading breakout candidates… it’s just that easy.
Their breakout prices are what I was really impressed with. The great thing about The Wizard is that you can quickly scan the entire market for potential breakout candidates, which saved me many hours every day trying to find the trade opportunities.
The Wizard is currently running a couple of great offers on the tool. They are waiving their initial set-up fee (which can save you up to $400), so all you have to pay is the $99 monthly subscription fee. There’s also a 30-day money back guarantee with the product, allowing you to test the product out for a month. They also are giving away their Market Trend Indicator for free. This tool tracks the trends in the major indices.
To receive either of these deals, just go to The Wizard and in the upper right hand corner is the sign-up for the free Market Trend Indicator and under the “Products” tab is where you can receive the “no set-up fee” offer.
If you’d like more information on The Wizard, send an email to [email protected] and they will answer any questions you might have on the product.