Patience is an Asset – Wait for Your Opportunity

Continuing the theme of sticking to a simple trading plan, there are times where the markets may not want to play ball with us.   Wild price changes do not justify you sacrificing your discipline – in fact, quite the reverse.

 

Last week’s extreme price moves set a record with four consecutive days of 400+ point moves in the Dow Jones Industrial Average.  Such huge fluctuations would set hearts racing among the undisciplined!

 

But it’s at times like this where even making no trade is in fact taking an active position.

 

For example, do you think you can predict what will happen right now, after the turmoil of last week?  (My guess is a few days of relative quiet…but it is just that…a guess!)

 

Failing to plan is planning to fail

 

All investment decisions need to be planned in advance, while selecting only the best of the best opportunities that put odds in our favor.

 

When the markets are super volatile, where even our reliable indicators are not synchronizing, we may need to sit back and wait for our reliable setups to return.  Patience does better than costing nothing.  In fact, you’ll reap the rewards from it--selectively sitting on the sidelines can never result in any dollar losses.

 

At worst, the actual cost of not being in the market is simply missing a couple of potential opportunities.

 

In the last 10 years, trading technology tools have leveled the playing field between professionals and amateurs, giving access of almost everything to almost everyone.  However, the greater user-friendliness of software and indicators often can lead to two problems:

 

• Inertia due to information overload; or
• Overtrading and flawed decision-making based on hunches caused by ease-of-use.

 

Sometimes the ability to invest at the simple click of a mouse is a temptation that is difficult to resist.  The goal is to remain selective and stick to your trading plan.  Occasionally, this will mean deliberate inaction as your best course of action.

 

Invest … Don’t Gamble

 

Blind faith is not a trading strategy.  Investors often get themselves into positions with good intentions, but when the markets turn against them, they have no plan except a misguided hope that things will turn in their favor.  Trading on a hunch is not a disciplined approach to the markets.

 

Successful professional traders steer clear of those gambling attitudes because of the terrible odds against making money.  Good investors can have high success rates with amazing consistency because they wait for the most ideal situations which fit their plan each and every time like clockwork.

 

In this way, we exercise control over ourselves and stay true to our philosophy of only trading when our chosen planets line up.  Waiting for that most desirable trade setup pays big dividends and is much less stressful emotionally.

 

A time to trade and a time not to trade

 

For example, let’s take GS in April (when I recommended a short) and GS today.

 

Goldman Sachs stock was in a downtrend since January.  Back in April, a Bear Flag was in place with negative OVI for a short play on a break below $149.55.

 

 

 

The OVI Indicator Revisited

My proprietary indicator (called the OVI) measures options transaction data and plots it as a simple line that oscillates between 1 and -1.  It is a key part of my trading plan each and every time.

When the line is positive, we’d be more inclined to focus on bullish chart patterns; and when it’s negative we’d focus the more bearish chart patterns.

We only use the OVI in combination with a chart pattern such as a consolidation or flag.  We never use it in isolation.

Although the OVI has nothing to do with the stock price, the correlation is often astounding as you will see over and over again.

In many cases, the OVI will actually precede a breakout, and this is the key to our strategy.  We’re not looking to pick out highs and lows, just breakouts from clear areas of support and resistance.

In this way the OVI performs as a LEADING indicator because it so often precedes a breakout.

Used correctly together with our preferred chart patterns, the OVI demonstrates that the options markets can often be ahead of the stock market and is an invaluable tool.

In the GS trade, the combination of the Bear Flag breakout and OVI in alignment produced the fantastic result of a massive breakout to the downside.

Now see below for a look at Goldman Sachs this week.  Another consolidation pattern has formed between $120 and $110.  The negative OVI indicator supports another short play, but only when the bear flag support is broken.

The problem here is that the Bear Flag is so deep because of last week’s wild fluctuations.  With GS, the consolidation part of the flag is $10 wide, which means our initial stop loss could be $10 away.  This would force us to absorb too much risk unless we adjust our trading plan.

On this basis, we may be best off sitting out this trade until the market forms a pattern where we absorb far less initial risk.

Remember, our approach is to combine a breakout pattern with the OVI indicator.

The ultimate benefit of this is that it forces us to have a simple trading plan that works.

 

Doing nothing can be one of the outcomes of the trading plan, if the stock doesn’t actually break out from its support or resistance.

Another benefit of our approach is that it helps us filter for the most compelling setups.

This consistency throughout all market conditions eliminates any guesswork on our part.  Our approach may be repetitive…but by golly it’s good!

 

 

 

 

Related posts:

1. Extraordinary Price Movement Means Opportunity
2. Options Transactions Data: The “Dark Side” of the Stock Market
3. My Favorite Stock Market System
4. If Disaster is Near, You Have a Decision to Make.
5. The 60/30/10 Ratio Means Cash for You

Other posts by Guy Cohen