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To understand option strategies, you must first have a clear understanding of call and put options.
A call option is usually purchased if the investor expects the price of the stock to increase within a certain amount of time. This type of options contract gives the buyer of the contract the right to buy the stock at the strike price at any time up to the expiration date of the agreement. The seller or writer of the call option receives the premium paid by the buyer when entering the deal.
A put option is an option contract that gives the owner the right but does not obligate the owner to sell an underlying security at a specified price within a specified time frame. This type of option becomes more valuable as the price of the underlying stock moves below the strike price. Therefore, it loses value as the underlying stock increases. As most options do, put options also decrease in value as the expiration date nears.
The intention with the use of the covered call strategy is to collect money from the options premiums by selling against a stock that the investor already owns. If the stock does not move above the strike price of the contract, the trader can collect the premium and can still keep his or her stock position. This is done by purchasing stocks or using one that is already owned. The investor sells the call options for the same or lower price of the security, then waits for the options contract to be exercised or expire. If the options contract is executed the trader will sell the asset at the strike price but if the deal is not completed and just expires the trader keeps the stock.
Depending on the trader’s plan there are two ways to profit from the selling of covered calls. If the investor wishes to earn an income on the stock, then he or she would want the underlying to remain close to the strike price without going above it. If the trader wishes to sell the stock while making additional profit by selling the call options, he or she would want the security to move above the strike price and stay there until the options contracts expire.
The risk of using a covered call strategy comes mainly with owning the stock as it can lose value.
Used to protect traders from possible short-term losses a married put is often considered a type of insurance for investors. Utilized mainly during bullish outlooks a married put protects the value of the stock in the case of a downward turn in the market.
This type of option strategy position is created by an investor must purchasing the underlying stock and also buying a call put option at a strike price lower than the current stock price. By owning both the put and the underlying security, the investor is protected from any downside price movements below the put’s strike price. This protection comes as the investor now has the right to exercise the put and sell the stock.
The Married Put strategy differs from other bullish options strategies in that it involves actually buying the underlying stock as opposed to only trading the options. Therefore, to earn the same profits as a trader who only bought the stock more upward movement is required to cover the cost of the premium of the option. However, if the stock price falls, your profit will decrease and can become a loss. Once the stock price falls below the put option’s strike price, the loss will be confined. The put option will then become in-the-money, increasing in value the lower the underlying stock price gets, stopping further losses. The most that an investor can lose on a protective put is the difference between what he or she paid for the stock and the strike price of the put, plus the premium paid for the put option.
Often used as replacements for stop orders, married puts give traders more control over when they can exercise their option, and the amount that will be received for the stock is predetermined.
The intent with this strategy is to buy a stock at a lower price than what it is currently trading at in the market. In this case, an investor believes that the security will eventually increase in price but does not want to buy it at its current market price. He or she can sell put options. The hope is for the stock to make a bearish move and fall below the strike price of the options and remain there. When the contract expires, the investor is then assigned the underlying asset at the new lower rate. The premium from the selling of the put option is then used to offset the price of the stock to be purchased. In this scenario, the investor would have already deposited enough funds into his or her account to complete the purchase of the security.
You can think of a collar as running a double play because you are using two strategies, a protective put and a covered call. A protective put operates the same as married put except the investor is not buying a stock at the same time. Investors create collar positions by purchasing an out-of-the-money put option while also selling an out-of-the-money call option. The put option is what protects the trade from a price drop in the market. The call option offsets the price of the put option with the collection of its premium and allows the trader to generate income on the asset until it reaches its strike price. The call you sell caps the upside. If the stock has exceeded strike B by expiration, it will most likely be called away. So, you must be willing to sell it at that price.
One of the first decisions a beginner trader has to make when trading commodities are whether to trade futures or options contracts. Even the most experienced traders go back and forth when deciding which to use. It all depends on understanding their differences, your trading style and trading plan.
Both futures and options contracts have their pros and cons and depending on the situation they are used together by some traders. Other traders prefer to focus on just one of the two, but to make the best choice you must first fully understand each of their attributes.
Options contracts allow investors the right to buy or sell a security at a pre-decided price. The buy or sell action must be executed on or before the expiration day of the contract. Futures contracts are agreements that bind buyers to purchase a specific asset and sellers to sell and deliver an asset at a predetermined price on a set day in the future.
The significant difference between options and futures are in the responsibility they put on their buyers and sellers. An options contract gives the buyer the right but does not obligate the investor, to buy (or sell) a particular asset at a specific price at any time during the viability of the contract. The option seller has to comply with whatever action the option buyer decides to take. While with futures contracts the buyer and seller must satisfy the contract regardless of price moves.
An investor can enter into a futures contract with no upfront cost, this is apart from the commission amount, whereas buying an options position requires the payment of a premium. The premium is the maximum amount the purchaser of the contract can lose. The price of the premium can increase and decrease to allow investors to sell their contracts before the expiration date. As the date of expiration gets closer the value of the options contract devalues. For future contracts, devaluation isn’t an issue because the contract’s execution is definite.
Another critical difference between options and futures is the price of the financial instrument that the contract is based on. Usually, the underlying position is much more significant for futures contracts, that in combination with the obligations to execute the agreement increases the risk of futures contracts. Options contracts, on the other hand, offer limited risk due to their premiums.
When it comes to expiration futures and options contracts, work differently. With the futures contract, the expiration date is fixed, whereas options contracts can be executed before the expiration date or on it. For many traders, the surety that the deal will be completed at a specific time makes futures contracts appealing.
Once you’ve considered the differences of these derivatives the decision on which one to trade comes down to the amount of risk you’re willing to take and your analyses of market movement. No matter which contract you decide to use, ensure that you have a proper trading plan ready for execution.
As day traders say, “The trend is your friend.” Of course, finding that trendy friend requires familiarity with day trading trend analysis and how to find the trend in day trading. Day traders rely on technical analysis, using various indicators to determine the trend of any particular security. One caveat: While these indicators are the lifeblood of day traders, it’s crucial to have a thorough understanding of each indicator before making monetary trades. Without preparation, it’s easy to misinterpret some indicators, causing chaos in your trading operations.
How to Find the Trend in Day Trading
First, let’s define the trend. Basically, it’s a stock or other security price that continues to move in a particular direction. Trends can only go three ways: an uptrend means the price is moving higher, a downtrend means the price is moving lower and a sideways trend indicates sideways movement. While all trends move in one of these directions, prices almost never move in a straight line. That’s where a moving average comes in, as this technical tool allows day traders to see where the trend is heading.
A moving average is a security’s average price during a specific time period. Moving averages are key indicators for trend day trading, as they are an effective and simple way to gauge trends in a fast-paced market. These indicators let you know whether your move is short or long. The type of moving average most valuable for a trader depends on the trader’s time frame. While long-term investors and traders may rely on the 200, 100 or 50-day simple moving average, day traders usually prefer the 10-day moving average. You want to place these moving averages on a five-minute chart, which you can do with shorter moving averages but not those going long-term. Day traders can also use intraday moving averages, showing the price trends for that day.
The simple moving average allows day traders to identify and trade the trend, but also provides direction for exiting a trade. If you are trading breakouts, a trend can only move in one direction. Should the moving average you use go flat, or the security breaches the moving average in late morning trading, that’s a red flag. For best overall results, choose a profit percentage target beforehand and exit when you meet it, even if the trend still looks promising. Odds are your trades will end up more consistently profitable when you “know when to fold them.”
Moving Average Divergence Convergence
The moving average divergence convergence (MACD) is another top indicator for ascertaining trends. This oscillator will also indicate momentum. The MACD calculates the difference between a security’s 26 and 12-day exponential moving average (EMA). The EMA reacts more quickly to price changes than a simple moving average.
As an oscillator, the MACD line fluctuates above and below zero. When the line is above zero the trend is upward, and a trend is downward when the line is below zero. Day traders look for buy signals when the line rises above zero and sell signals when the line falls below. The MACD also has a slow and fast line. Buy when the fast line moves above the slow line, and sell when the fast line moves below the slow line.
Relative Strength Index
The Relative Strength Index (RSI) is an oscillator moving between zero and 100, measuring the changing and speed of price movements. It can help determine a trend, as well as entry and exit points for traders. Traders usually consider the RSI overbought when it is over 70, and oversold when it goes below 30. When overbought, a correction is pending, while when oversold, the security may soon experience a bounce. In either condition, the RSI may remain overbought or oversold for an extended period. In uptrends, the RSI ranges between 40 and 100, while in downtrends it moves between 10 and 60.
On Balance Volume
As its name implies, the On Balance Volume (OBV) indicator considers volume – but it also shows whether that volume is forcing prices upward or downward. Day traders use the OBV as a confirmation indicator for price trends. Rising prices should show a rising OBV, and vice versa. If the OBV rises but the price hasn’t, it is likely the price will start to trend upward. If the OBV and a security’s price are moving in opposite directions – the OBV rising and the price falling – that indicates a possible trend reversal.
Combine Indicators for Trend Trading
There’s no reason to rely on just one indicator for day trading trend analysis. Combine the indicators you prefer for trend confirmation and for entry and exit strategies. Use the RSI, for example, for trend isolation and entry points. Then apply a simple moving average as a chart overlay to identify exit points. For example, when the trend is up, plan to exit as the stock price falls below the line.
While combining indicators can help you make profitable trades, you also don’t want to overdo it. More than three is too many, and can give your conflicting signals. That’s another point – know the strengths and weaknesses of each of the technical tools you use. With that familiarity, you’ll have a better than average chance of identifying trends and earning money on your trades.
As your day trading skills improve, you’ll want to familiarize yourself with and use more sophisticated trading tools. That’s where the Gann square comes in. You’ll need a high comfort level with charting before immersing yourself in the Gann system. Once you’ve educated yourself, you’ll find day trading with the Gann square to be an effective new tool in your trading arsenal.
History of the Gann Square
The Gann square has a long history, as it was developed by trader William Delbert Gann back in the 1930s. Gann, a Texas native, was a widely read, religious man who became a 33rd degree Freemason of the Scottish Rite Order, an interest that may have introduced him to ancient mathematic principles, including Sacred Geometry. He was also well-acquainted with the classical cultures of Egypt and Rome. When using the Gann system, you are delving back into the “technical indicators” of antiquity, now available via computer. Gann’s masterwork, The Basis of My Forecasting Method, was published in 1935. He describes his methods as “allegories,” and it’s safe to say the Gann system is not the most straightforward. It’s also safe to say that the trader will not encounter a stock market theorist quite as mystical as the legendary W.D. Gann.
How the Gann System Works
The Gann system measures important elements, including time, price and pattern. The Gann system has an esoteric quality, in that past, present, and future all exist simultaneously on a Gann angle. Analysis in any type of market requires the day trader to consider the market’s past performance, its current position as to its top and bottom, and forecasting future price movement by using that information.
The Gann system also focuses on geometric elements, especially square, triangles and circles, with the former considered the most compelling aspect. The circle is used to connect the square’s four corners, bringing the angles into sharper focus. In essence, it “squares the circle.”
Gann angles form a straight line on a price chart, providing a fixed point between time and price. In his system, the primary angle is the line representing 1 price unit for 1 time unit. It’s known as the 1×1, or the 45- degree angle.
When following this primary angle, a stock’s value increases by 1 point per day. Other critical Gann angles are the 2×1, which move two points daily, and angles with similar criteria – 3×1, 4×1, 8×1, and 16×1. While the values increase, it’s important to note corresponding value decreasing angles. A Gann fan occurs when various angles are drawn in a group. This is generally drawn from the price’s top or bottom.
Gann Square Types
The essential Gann square is the square of 9, also known as the square root calculator. It involves a spiral, more often referred to as a wheel, of numbers. Gann didn’t invent the square of 9 for day trading purposes. In his wide travels, he found it inscribed on both the Great Pyramid of Egypt and an Indian temple. There’s an astrological foundation to the square of 9, as the ancient inscriptions, he found referred specifically to the summer solstice, on June 22. In Gann trading, this date represents a potential shift in direction or trend. Just as everyone has their own birthday – and the date and time supposedly foretell their future path – so does every stock and/or market has their own “vibration” reacting to the square of 9. In fact, if you’re familiar with astrological charting, you may have an easier time picking up Gann system methodology. Symbols such as the Cardinal Cross and the Ordinal Cross, which correspond to some astrological charting figures, also appear in the Gann system. It is on these crosses that support and resistance levels are determined. The Gann’s square of 9 even takes planetary movements into consideration, so think of it as astrological charting for a particular security. If your only knowledge of astrology is that of the basic sun signs, it’s easy to scoff at this methodology. If you’re more aware of the mathematical calculations involved in this ancient practice, you won’t dismiss it. Gann’s method is a type of forecasting, based on these trends. Not only does Gann forecast support and resistance levels, but also the timing of the breakout.
The Gann square revolves around the square root of numbers. Thus, the numbers to look at in the Gann square are those representing 0 to 360 degrees, or 2, 11, 28, 53 and so on. Also important are those numbers representing 45 degrees, or 3, 13, 31, 57, etc.; the numbers representing 90 degrees, or 4, 15, 31, 61, etc. and numbers representing 180 degrees, or 6,9, 40, 69, etc.
While trading with the Gann square has stood the test of time, it’s not foolproof. You can certainly lose money at times by using the square of 9, but even with that caveat, the system retains remarkable accuracy.
Using the Gann System
There’s no way to simplify the Gann system. It requires serious study on the part of the day trader. Once mastered, the Gann system is most useful for swing trading, a longer-term type of trading that usually requires several days to come to its intended fruition. When day trading with the Gann system, traders don’t have to concentrate on the system’s time alignment but use its support and resistance levels to make their trades. One strategy involves buying at a certain price and making your exit based on an important Gann value. Another advantage of the Gann system is that it’s useful for trading any type of security, from stocks to commodities.
The Sure Trader Advantage
SureTrader’s state-of-the-art platform offers top technical analysis tools, including the Gann system, for clients. While the Gann system is geared toward the more experienced day trader, we have top technical and charting tools for all trading levels. Along with 6:1 leverage, low fees and low minimum balance, these technical tools are just another part of the SureTrader advantage.
Day traders use technical and fundamental analysis when trading securities. While technical analysis is used much more than fundamental analysis, both play a role in successful day trading. As traders hone their trading strategies they will discover which type of stock analysis best suites their purpose. The bottom line is that stock analysis, whether technical or fundamental, seeks to reveal future stock and market activity.
What is Technical Stock Analysis?
Day traders don’t focus on stock price per se with technical analysis. It’s a matter of focusing on the statistical analysis of the stock’s price movements. In essence, technical analysis involves predicting a stock price’s future direction by examining past data. Technical analysis requires a thorough understanding of technical charts. The use of technical charts and the examination of price and volume history reveal long-term patterns. Technical stock analysis looks at the way market factors affect a stock but not necessarily factors affecting the market. The latter is more the purview of fundamental analysis.
What is Fundamental Stock Analysis?
Unlike technical analysis, price is the primary focus with fundamental analysis making it nearly an opposite system. You want to find the fundamental, or intrinsic, value of the security. Anything that affects a company’s value is a component of fundamental analysis, whether that concerns major influences such as the overall economy or specific factors such as company management, revenue, earnings growth and profit margins. Rather than using technical charts, traders look for hard data for security evaluation. A company’s financial statements are the starting point.
Because day traders are interested in very short-term – 24 hours or less – gains and losses, fundamental analysis is not as crucial a tool. However, for longer-term traders, it’s an absolute necessity. Market legend, Warren Buffett relies heavily on fundamental analysis when choosing stocks.
Technical Analysis Tools
There’s no shortage of technical tools for day traders, therefore, the tools used boil down to experience and personal preference. Some technical tools will show basically the same information, so there is no need to use redundant indicators. For best results, rely on one of the indicators in each of these four sectors:
Oscillators – among the common tools, oscillators generally range from 0 to 100 with the former showing oversold conditions and the latter overbought conditions. The most popular oscillators include:
- Commodity Channel Index (CCI) – despite the name, this indicator works with any type of security, not just commodities. It measures a security’s current price level compared to the average price level over a specific period. When prices are above average, the CCI is high. When the prices are below its average, the CCI is low. This allows the trader to clearly ascertain overbought and oversold levels.
- Moving Average Convergence Divergence (MACD) – this tool consists of a fast and slow line, comparing two different moving averages. The exponential moving average (EMA) is compared at 26 days and 12 days with the latter subtracted from the former to calculate the MACD- that’s the bottom line. The top line, called the signal line, consists of an EMA nine-day average functioning as the signal for buying and selling.
- Relative Strength Index (RSI) – this oscillator measures a price’s movement, change, and speed. Generally, an RSI above 70 indicates overbought conditions while below 30 is considered oversold. In an up market, the RSI usually ranges from 40 to 90 with 50 as the support base. In a downward market, the RSI predominately stays between 10 and 60 with 50 serving as the resistance.
- Stochastic – this momentum indicator compares a security’s closing price to its price range over a certain time frame. When the market trends upward, closing prices are near the high and when trending downward, closing prices are near the low.
Volume indicators – volume indicators aren’t absolute necessities but they can help traders make decisions. Such indicators deal not only with volume but with price data to determine trend strength. The best-known volume indicators include:
- Chaikin Money Flow (CMF) – used in conjunction with a moving average, this indicator measures a security’s buying and selling pressure over a specific period. The CMF aids a trader in figuring out future changes.
- Money Flow Index (MFI) – uses price and volume for buying and selling pressure measurement.
- On Balance Volume (OBV) – this momentum indicator predicts stock price changes via volume flow.
Overlays – these indicators are the exception to the “choose one” rule, as different overlays serve different functions. They get their name because these indicators are found on the top of price bars and use the same price scales. The most commonly used overlays include:
- Bollinger bands – this shows higher and lower limits of price movements as per the standard deviation of prices.
- Keltner channels – based on an average true range of prices, this overlay shows a price movement’s highest and lowest limits.
- Moving averages – this overlay uses either simple moving averages or exponential moving averages to provide the average price over a specified timeframe.
- Pivot points – in an uptrend, this overlay reveals reversal points and in a downtrend, shows above points.
Breadth indicators – these indicators show overall market sentiment, whether bullish or bearish. The most used breadth indicators include:
- Arms Index – also known as the Trading Index, or TRIN, this indicator is used by many day traders as its measurement of basic market supply and demand can predict very short-term price movements.
- Tick Index – based on the New York Stock Exchange data, the Tick compares upticking and downticking stocks.
- Tiki Index – basically the same as the Tick but based on the Dow Jones Industrial Average data.
Using Technical Trading Strategies
Once a trader masters technical analysis tools, it’s time to use them and learn technical trading strategies. Familiarity with the top trading strategies allows a trader to find the best-suited method for his or her individual trading style. Here are the major technical trading strategies:
Breakout Stock Trading
With breakout stock trading, traders look for each security’s price resistance and support level. The former is indicative of a price the stock can’t quite reach and the latter, a price at which the stock does not go below. Breaching of that resistance point results in high volume trading. Traders must learn certain patterns in technical charts to seize an upward trend and capitalize on the breakout. Knowing the correct exit point is critical for this strategy.
Simple Moving Averages (SMA)
Sophisticated technical charting isn’t necessary for determining simple moving averages. SMAs are easy enough to figure out on a calculator. You do need to see the SMA on a chart to quickly determine trending and whether to buy or sell based on the SMA trend signal. There are many varieties of SMAs, but most pertain to specific timeframes that may involve weeks, days, hours or minutes.
Trading with trend strategies is relatively simple, but the key is the usage of a variety of indicators and analysis. Depending on a security’s direction, traders assume long position or short positions on a stock. For trend trading, you need SMAs, RSIs and volume measurements.
An easy strategy to master, trading with swing strategies begins with identifying the trend using candlestick charting. However, this is not a day trading strategy but a longer-term strategy. Once you’ve identified the trend, patience becomes a virtue as you wait for gains.
With range strategies, traders find a security’s support and resistance level with the help of oscillators. The stock is purchased at the overbought level and sold when close to the resistance level. Range trading works as either a short or long-term strategy, depending on the trader’s preference.
Using Fundamental Analysis
Whether you day trade or take a long-term approach, understanding and using fundamental analysis is critical. Fundamental analysis is really the foundation of investing and virtually every investment strategy uses it. Much of fundamental analysis involves number crunching and learning the nitty-gritty of a particular company through examination of its assets, liabilities, expenses, and revenues. If you enjoy doing research when investing – and no one should invest without researching a security – you’ll find fundamental analysis compelling. Used correctly, fundamental analysis is the best way to pick stocks – just ask Buffett.
Get started on your fundamental analysis by accessing and dissecting a company’s financial statements, especially the balance sheet, income statement and cash flow statement. Here’s what you’ll learn from perusing these documents:
- Balance sheet – a statement of the company’s assets, liabilities, etc. at a specific time. You’ll learn what the company owns and what it owes, along with shareholder investment amounts.
- Income statement – a company’s financial performance during a particular time period and also known as a profit and loss statement. This document reveals a company’s profitability – or lack of it – over a year or quarter.
- Cash flow statement – the overall incoming and outgoing cash amounts for a certain time period. Compare the cash flow from its operating activities to the company’s net income.
Learn how to perform fundamental analysis by tracking a few stocks over two or three months. Do your homework and decide on the direction of the stock based on its fundamentals. After careful tracking for the three-month period, see how each stock fared compared with your analysis.
The SureTrader Advantage
SureTrader’s state-of-the-art platform offers top technical analysis tools for clients. Whether you’re a novice investor or have decades of experience, you’ll find our technical and charting tools second to none. Along with our low minimum balance and 6:1 leverage, our technical offerings are just another part of the SureTrader advantage.