All posts by T3 Live
What Is the VIX? And How Can I Trade It?
How can I make money trading the VIX? That’s one of the most popular questions we get from aspiring traders. And they usually don’t like the answer — because you can’t trade the VIX. The VIX — better known as the Chicago Board Options Exchange Volatility Index — is not a security, and thus the number you see on your screen is not a price. It’s actually a trading indicator. The VIX uses prices of various S&P 500 options with expirations between 23 and 37 days to measure traders’ expectations of volatility. The VIX helps us measure sentiment by telling us how much traders are willing to pay for these options. Typically, the VIX rises when traders are worried about downside risk. Why? Because when traders are worried about downside risk, they’ll pay higher prices for downside protection through options. Let’s take a look at a 10-year monthly chart of the S&P 500 (bar chart) against the VIX (purple line): The chart shows that the VIX had major spikes during the: A) Financial Crisis B) Flash Crash C) Euro Sovereign Debt Crisis D) August 2015 Minicrash This illustrates how the VIX rises when traders are scared and markets are coming under pressure. Why? Again, because traders were willing to pay up big for downside protection through S&P 500 options. The same dynamic plays out on shorter time frames. As you can see in this 20-day hourly chart, when the S&P 500 (bars) rises, the VIX (purple line) falls: And vice versa. What You Can Trade We told you before that you can’t trade the VIX directly, since it is an indicator. However, there are many derivatives of the VIX that can be traded. But before we proceed further, you must understand that virtually all VIX-related instruments can be tricky to deal with. And we urge you to read the prospectus and understand the pricing mechanics of any VIX-related instrument you trade. VIX Options and Futures The CBOE has created VIX futures and options. VIX futures trade nearly 24 hours, 5 days a week. And VIX options can be traded just as easily as a standard equity option. However, keep in mind that VIX options typically expire on Wednesday, and VIX options contracts are based on the price of VIX futures, not the VIX itself. VIX ETN’s There are many VIX-derived exchange traded products, the most popular of which is the iPath S&P 500 VIX ST Futures ETN (VXX). The VXX aims to deliver the return of the S&P 500 VIX Short-Term Futures Index. Many traders also follow the Credit VelocityShares Daily 2x VIX ST ETN (TVIX), which aims to deliver twice the daily return of the S&P 500 VIX Short-Term Futures Index. VIX ETN’s can be bought and sold like stocks. However, they only appropriate for short-term trading since they don’t track the VIX — they track VIX futures, which tend to naturally fall over time. Here’s a direct excerpt from the VXX prospectus: The index underlying your ETNs is based upon holding a rolling long position in futures on the VIX Index. These futures will not necessarily track the performance of the VIX Index. And for technical reasons related to the VIX futures term structure, they tend to decline over time: On the flip side, shorting these instruments over the long run is not easy because of margin requirements and other issues. Plain Old SPY Options The easiest way to trade changes in the VIX may be to just trade SPY options. They’re very liquid and easy to trade with none of the complex mechanics involved with VIX futures, options, and ETN’s. For example, if you think the VIX is set to increase sharply, rather than messing with VIX products, you could simply buy SPY put options. Why? Because a higher VIX means higher put options prices. Remember, the VIX is a measure of implied volatility on S&P 500 options. And all things being equal, when implied volatility goes up, options prices go up. (click here for a primer on implied volatility) And on the flip side, to speculate on a falling VIX, one could simply buy SPY call options, since a falling VIX is typically associated with rising stock prices. Sure, the VIX products are sexier and more exciting, but for newcomers to trading, simpler is often better.
Continue Reading -->How to Use the VIX Curve to Judge the Market’s Mood
Many traders view the VIX — formally known as the Chicago Board Options Exchange Volatility Index –as a stress gauge for the market. (click here for an introduction to the VIX) But knowing the level VIX alone isn’t very helpful, and it has little value as a predictor of price. One way of getting real value out of the VIX is comparing it to the prices of VIX futures. The VIX uses implied volatility levels on a variety of S&P 500 options expiring in 30 days to estimate traders’ expectations of volatility. So if we compare the VIX with prices of VIX futures expiring later in time, we can get an idea of the market’s mood. We do this by looking at the VIX curve, which is a plot of VIX future prices by expiration. Typically, the VIX curve slants up and to the right because the prices of later-dated futures are higher. Here’s an example from VIXCentral.com: This is called a state of contango. If you think about VIX futures as insurance, this makes perfect sense. Why? Because when there’s more time to expiration, there’s more of a chance that insurance will pay off. If you want to buy VIX futures because you think the VIX will spike 25%, you have a far greater chance of having your bet pay off if you have 6 months to expiration rather than 3. Therefore, the seller of VIX futures will charge higher prices for later-dated futures. On the flip side, occasionally, the VIX curve will invert — or enter what is called backwardation. Here is an extreme example from August 24, 2015, when the market had a mini-crash: As you can see, the near-term VIX futures prices are higher than the later-dated ones. This means that traders expect so much near-term volatility that they’ll pay tremendous amounts of money for VIX futures that are close to expiration. So how can you make sense of all this? One good rule of thumb is to use the 3-month VIX curve as a proxy for fear in the market. This is calculated by taking the VIX future expiring in 90 days, and subtracting the VIX spot price from it. So if the VIX future expiring in 90 days is priced at 15 and the VIX spot price is 11, the 3-month curve is calculated as +4. And if the VIX future expiring in 90 day is priced at 14 and the VIX spot price is 15, then the 3-month curve is priced at -1. Generally speaking, here are some 3-month VIX curve levels you can use to determine how optimistic or fearful traders are. +5: Traders are extremely bullish and in danger of being complacent +4: Traders are very bullish +3: Traders are optimistic +2: Traders are neutral +1: Traders are moderately bearish 0 or below: Traders are very fearful Just keep in mind that as with all sentiment indicators, the VIX curve should not be used a buying or selling indicator on its own. Rather, it should be considered as another potentially helpful tool in your decision making process.
Continue Reading -->Scott Redler Discusses the Market Complexion with CNBC
In yesterday’s Market Insider Column with Patti Domm on CNBC.com, T3 Live Chief Strategic Officer Scott Redler broke down yesterday’s weak market action in the aftermath of the release of the Fed’s March Meeting Minutes: The real test is whether the market will fall below and close below the 50-day moving average, which it hasn’t done since Election Day. That would be a signal the complexion has changed, and that would breed more caution,” said Scott Redler, partner with T3Live.com. Redler, who follows the market’s short-term technicals, said the dramatic reversal in the S&P 500 Wednesday may be a forewarning of more turbulence to come. “When you break key levels and hold them, it’s a constructive signal for the bulls. If you push above levels and it fails, it could give you some clues that there’s more weakness to come. The banks and small caps were giving clues even before the Fed said the market is quite high,” said Redler. Click here to read the full article on CNBC.com, which also includes commentary from market legend Art Cashin, who serves as director of floor operations at UBS.
Continue Reading -->17 Killer Tips Every Momentum Trader Should Know
When people hear the word “momentum,” they think excitement. Volatility. Big wins, and big losses. But the reality is that the most successful momentum traders are highly disciplined. To help you get better momentum trading results, we’ve put together a list of 17 handy rules that will keep you out of trouble: 1. Create a Game Plan and Stick To It You should have a reason for entering each trade and always have a stop-loss price and a level to take profits before you enter a position. In the long-run, discipline is the key to consistent success. 2. Adapt to Changes Quickly If a short-term trade isn’t working, don’t hesitate to switch sides. The market action can change very quickly, and you must be able to change with it. Don’t be stubborn! 3. Don’t get Married to Stocks If you are losing money in a stock, you don’t have to make it back in that particularly stock. Likewise, don’t force a trade in a stock only because it has made you money before. Always trade the best set-ups only. 4. Don’t Try to Pick Tops and Bottoms Trying to identify tops and bottoms will lose you money over the long run. The trend is your friend, so focus on that. And when you find it, follow it. Don’t trade with a bias because you think something should or shouldn’t happen. Let the stock tell you what its next move will be. 5. Accept Losses As Part of the Game Prepare yourself mentally and emotionally, because you will lose money at times. It’s part of the game, so there’s no use in fighting it. Just try to keep your losses small, and don’t be afraid to take a break if they’re getting bigger. 6. Stay Confident and Positive If you’re not feeling confident about your strategies and execution, don’t hesitate to step back from he market until your head is together. 7. Be consistent with Your Game Plan, Size and Execution. Keep your tier and trade sizes consistent and stick to your game-planned trades. You don’t want to end up with $1,000 gains and $5,000 losses! 8. The First Stop Is the Cheapest Stop Do not give into the temptation to let a losing stock run. Most of the time, you will end up getting destroyed because your small loss will turn into a huge loss. 9. When You are Wrong, Admit It and Move On Don’t waste time with a trade that is no longer compelling. Just move on to the next one. 10. Give Your Trade Time If you believe in a trade, but you’re just not getting movement, wait for it to play out. 11. Never Let a Winning Trade Turn Into a Losing One If you see profits in a trade disappearing, don’t be afraid to cash out. You can always get back in later. 12. Try to Capture the Full Move of a Trade While it is important not to let winners turn to losers, you will make your largest profits from capturing larger moves. So you can give a little back if you’re up big — but not too much. 13. Know Your Trade Type Always be aware of the type of trade you are in and act accordingly. Don’t mix up your time frames and don’t mix up your stock types. If you are in a swing trade, don’t get out impulsively on the first tick against you. If you’re in a fast scalping situation, don’t get tempted to hang on too long. And if you’re in a slower-moving stock, be patient. 14. It’s Okay to Take the Money and Run If you have a highly profitable morning session, it’s okay to take the afternoon off and relax, especially if you start giving some back. Don’t turn a great morning into a losing day. And if you have a bad morning and make it back to flat or a little green, call it a day and declare victory! If you push it, you risk suffering the emotional roller coaster of going from red to green back to red. 15. Trade the Same Way Whether You Are Up or Down Traders tend to press hard when they are down, and they get careless when they are up. You should have the same disciplined approach in either situation. 16. Trade Stocks That Are in Play Don’t trade something just to trade it. Make sure the stock you’re eyeing have regular movement, or have catalysts for movement coming. 17. Learn a Proven Method There are many ways to learn to trade, but too many traders take random pieces of information from different sources, and put them together without a plan for success. The best way to learn to make money trading is to study a proven strategy, and then carefully apply it in real-world market conditions.
Continue Reading -->How to Define an Uptrend on a Stock Chart
In technical analysis, one of the biggest mistakes you can make is to not have clear criteria for the patterns you’re looking at. What do we mean by that? Quite often, you’ll hear traders use terms like head & shoulders and support and resistance. But you never hear But you never hear about the criteria they use to actually define these terms. In our T3 Technical Strategies and Trading the Pristine Method Programs, we pride ourselves on giving traders, particularly beginners, clearly defined criteria for the patterns we use. Let’s start with one of the most important — the good old uptrend. What is an uptrend? A trendline that points up… right? Well yes, but that’s not enough. Why? Because without clear criteria to define our uptrend, we’ll never know when the trend breaks! Here are our 5 criteria for an uptrend on a daily chart: 1) Higher Highs: stock is making new highs (see letters on chart below) 2) Higher Lows: stock is not breaking below prior lows (see numbers on chart below) 3) Rising 20 Day Moving Average: indicates an improved short-term trend 4) A Rising 40 Day Moving Average: indicates an improved intermediate-term trend 5) Even Space Between the 20 and 40 DMA (a.k.a. railroad tracks) Here’s a chart showing what an uptrend looks like: Next Steps We recommend that you pick out 10 stocks, and see how each of them fits our uptrend criteria. By completing this exercise, you’ll learn to quickly spot the REAL uptrends.
Continue Reading -->Throwback Thursday: Two of Our Most Popular Articles
Meet the Traders! 8 Questions With Sami Abusaad 5 Reasons Forex Trading Might Be for YOU! Bonus Article: Trading: Trend Following vs. Counter-Trend
Continue Reading -->9 Ways to Destroy Your Account with Options
Options trading is fun. Options trading is sexy. And options trading can destroy your account if you don’t know what you’re doing. Profitable options traders understand the principles of options pricing, order entry, and market mechanics. If you fail to understand these 3 critical elements of options trading, you are not actually investing. You are gambling! So before you hit the buy button on your first options trade, carefully read through this list to make sure you are avoiding these deadly mistakes. There’s a reason I know they’re deadly. I’ve made them all myself. Multiple times. So please, be smarter than I was! Mistake 1: Thinking the Guy on the Other Side of the Trade Is a Guy There is no such thing as easy money in options trading. Let me repeat: there is no such thing as easy money in options trading. As you start exploring options, you’re going to be be tempted by options that are low in price. Well, if the options are so cheap… why is somebody willing to sell them? Remember, the guy on the other side of an options trade isn’t even a guy. Or a woman. It’s a computerized algorithm developed by math and physics PhD’s that are way smarter than you or me. Those algorithms generate millions of dollars a day by selling overpriced options to overeager traders. If you think you see easy money, it’s usually a trap. Mistake 2: Trading Far Out of the Money Options An option is far out of the money when its strike prices is far away from the current stock price. Beginning options traders are often attracted to these options because they look cheap. We’ll Tesla Motors (TSLA) as an example. Let’s assume the stock is trading at $250. An at-the-money call option expiring in 3 months is priced at $19 (or $1900). But the $300 call is trading at just $4. Many beginning traders will be more attracted to the $300 call simply because it has a lower nominal price. However, far out of the money options require huge moves in short time frames to pay off. So you’re paying less money out of pocket, but your trade is much less likely to make money. Mistake 3: Trading Illiquid Options Options on major stocks like Amazon.com (AMZN) and Apple (AAPL) tend to trade with fairly tight bid-ask spreads, and it’s fairly easy to trade in and out of them at reasonable prices. However, you should be very careful with options on small and mid-cap stocks. They tend to have very wide spreads and do not have much trading volume. So odds are you’re going to have to overpay just to get into the trade, and get underpaid on the way out. And in some rare cases — particularly with very far out-of-the-money options, you may have an awful lot of trouble getting trades completed at all. Last year, I bought way, way out of the money put options on Ambarella (AMBA) puts and doubled my money. However, there was no market for the options, and I couldn’t get out at any price. I went from making over 100% on the trade to losing 100%! Mistake 4: Blindly Buying at the Bid and Selling at the Offer As I said earlier, algorithms generate millions of dollars a day by selling overpriced options to overeager beginners. How do they do this? They buy low and sell high. For example, right now I’m looking at April $17.50 calls on UnderArmour (UA). The bid is $1.30 and the offer is $1.65. That means the market maker will buy the option at $1.30 and sell it at $1.65. That gives them a tremendous profit margin. However, you don’t have to accept those prices. Try bidding and offering in the middle. For example, you could bid $1.48 (basically the midpoint) and still get filled. That would save you 17 cents, or $17 a contract. On a 10-contract trade, that’s $170! Mistake 5: Not Double-Checking Your Orders Before you hit send on your options order, double-check it. When dealing with options, you’re often looking at dozens or even hundreds of small numbers on a single computer screen, and it’s easy to make mistakes. Make sure you selected the right the expirations and strike prices. This is especially important if you’re entering an order with multiple legs. You may fool yourself into thinking you’ve found an especially attractive calendar or butterfly spread when in fact, you just got ripped off. Mistake 6: Selling Options While Naked Get your mind out the gutter! Selling naked options entails shorting calls or puts without any kind of hedge. This is what we call “picking up pennies in front of a steamroller.” Let’s talk about naked shorting of call options. This is a bearish trade because you will make money if the stock falls. But if the stock rises substantially, you’ll get destroyed. Let’s say we want to sell nVidia (NVDA) June $100 calls for $6.30. If NVDA is below $100 at expiration in June, I’ll have made a pure profit of $6.30, or $630, per lot sold. But if the stock was at $120 at expiration, the options would be worth $20 each, and I’d be out $13.70, or $1370, per lot. These are the types of trades where 1 bad trade can wipe out your last 10 good trades, so just don’t do them. Mistake 7: Ignoring the Calendar Events like earnings reports, FDA decisions, product announcements, dividend payments, conference appearances, and economic data releases can have a tremendous impact on options prices So before you place a trade, be aware of what’s on the calendar for the stock or ETF in question. For example, if Alphabet (GOOGL) is about to report earnings, its options will tend to be very expensive in the days before the report. Mistake 8: Not Understanding Options Pricing Basics Most options beginners think a $0.01 option is cheap and a $10.00 one is expensive. The reality is not that simple. An option’s
Continue Reading -->Vintage Wall Street: The Paul Tudor Jones Documentary ‘Trader’
Paul Tudor Jones, founder of Tudor Investment Corporation, is one of the greatest traders of all time. Jones has amassed billions of dollars in assets under management and personal net worth trading everything from futures to currencies to commodities. In the 1987 documentary Trader, PBS takes us inside Jones’ world of high-stakes, practically 24/7 trading. In it, you’ll learn: Why like our own Scott Redler, Paul Tudor Jones wakes up so early in the morning Just how quickly Jones can change his mind in the heat of the moment The awesome-at-the-time-but-horrible-now fashion choices of 80’s Wall Street giants. If you’re interested in learning about Jones’ trading style, we suggest you watch the embedded YouTube video — complete with Russian subtitles — above now. When it does surface online, it tends to disappear due to copyright claims. Interestingly, in the 1990’s, Jones requested it be removed from circulation, possible because it revealed too much about his trading style.
Continue Reading -->4 Real-World Investing Lessons You Need to Know
After 13+ years of looking at the market on a daily basis, and flushing a whole bunch of cash down the drain on idiotic trades, I’ve grasped a few realities about how money moves in the real world — far away from the textbooks and theory pushed at your average business school. Here are 4 of them 1. What You Know, Everyone Else Probably Knows, Too. Investors have a tendency to overestimate the uniqueness of their ideas, even though we’re all drinking from the same information cup. Furthermore, the presence of social media outlets like Twitter (TWTR and Facebook (FB) have drastically accelerated the speed at which investable information is distributed. That means that with few exceptions, everything gets priced into the market pronto. So if you’re thinking of buying bank stocks because The Fed’s about to raise rates, or shorting Apple (AAPL) because of slowing revenue growth, slow down and take a deep breath. It’s important to understand the past and present. But to be a successful investor, you’ll have to predict the future — a far bigger challenge than skimming through 10-Ks and listening to earnings calls. In other words, focus on examining not where the fundamentals and newsflow are, but where they may be going. Remember, when a guy on TV tells you a stock is good because it’s trading at X times earnings and has Y in cash on its balance sheet, he’s simply repeating the bare minimum of what the market knows. As men wiser than me have said, “What the market knows is not worth knowing.” 2. Timing Is Everything. When looking at the market,it’s important to understand not only “the what,” but “the why.” But the more I think about it, the more I’d argue that “the when” trumps both those considerations. Let me tell you a story. I once interviewed at a hedge fund that was making a major bet on its prediction that the then-growing housing bubble would implode. Smart money, right? However, that interview took place in early 2003, right before the Housing Index (^HGX) doubled. Likewise, a lot of folks were short FitBit (FIT) year as it crashed and burned from that $51.90 high hit last August. But a lot of bears got smashed on the 73% rally that precded the drop. So when you have an investment thesis in your mind, ask yourself, “What makes now the right time to bet on this?” Furthermore, if the S&P 500 is skyrocketing, it is entirely likely that junky companies rally big-time. Likewise, if the market’s in meltdown mode, even the best of the best can get smashed. Apple (AAPL) closed out 2007 at $198.08. But in 2008, even in the face of enormous earnings beats and the halo of the iPhone’s unprecedented success, Apple finished the year at $85.35 — a drop of 57%! You may be smart, but remember: Sometimes Mr. Market just does not care about what you think. 3. You Are Probably Suffering From Confirmation Bias. The Oxford Dictionaries defines confirmation bias as “the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories.” Translated into financial terms, it means that if you’re bullish on gold (GLD), you interpret everything you see as bullish for gold. I know the power of confirmation bias from a horrible experience with a former tech highflier called Rackable Systems, which changed its name to SGI (SGI) after it acquired Silicon Graphics in 2009. In 2006, Rackable Systems was a momentum King — kind of like newer names like Acacia (ACIA). It was pulling in boatloads of money selling energy-efficient servers to major data-center operators like Microsoft (MSFT), Amazon, and Yahoo (YHOO). And then — let me point out that I had complete knowledge of this — competitors like Hewlett-Packard (HPQ) decided they wanted some of those data-center dollars. Maybe I should have imagined what would happen if Rackable lost Microsoft (34% of revenues) or Yahoo (26% of revenues) as a customer, or at the very least, the margin pressures that could be introduced in a more competitive server environment. However, I viewed the new competition as nothing less but confirmation that Rackable was on the right track. And then Rackable crashed from $56 to under $10 as earnings collapsed. It is impossible to stay perfectly objective when performing research. But you can stay one step ahead of your own bias by regularly asking the question, “Am I just telling myself what I want to hear?” 4. In Isolation, Valuation Ratios Are Useless. Investors often take a simplistic view of valuation ratios, automatically assuming that if something is “cheap,” it’s good, and if it’s “expensive,” it’s bad. But you’ll often see cheap stocks get cheaper and expensive stocks get more expensive. How many times has someone told you that Salesforce.com (CRM) is overpriced? Next, look at the stocks’ chart since it went public: A P/E ratio, like every other valuation ratio, is 100% meaningless in isolation. It is far more important to examine how the “E” part of the equation is changing. (Or sales for EV/S ratios or EBITDA for EV/EBITDA ratios, etc.) A company trading at five times earnings can look awfully expensive following a bad quarter that destroys future earnings expectations. That’s how a stock like GoPro (GPRO) can go from $98 to $50 to $9 in the blink of an eye. It also works the other way around — a high-priced momentum stock can suddenly look cheap if earnings come in ahead of expectations and forward estimates rise.
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