Profit on Discipline, Not News Noise

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What an amazing world we now live in.  Technology and globalization have brought us great financial opportunities to profit nearly every day.

The downside of the new interconnectedness is the contagion potential from faraway places.   When someone sneezes it starts the worry about catching a cold.

Investors now watch the Greek (now Italy), default crisis, catastrophic Japanese earthquakes, and U.S. debt ceiling political bickering.  That leaves everybody trying to analyze potential market fallout.

The truth is thinking about these macro issues often takes away from solid trading setups.

Last week I mentioned a few stocks including this one:

PEIX

Now here’s a non-optionable stock where the pattern doesn’t get much better than this.  We have a long shallow bowl (cup) with a handle forming.  This is the pattern that dreams are made from.  If the market (and this stock) were to trend up from here, this stock could be your home-run.

However, we don’t have the benefit of hindsight, so what you’d have to do is:

(a)    Only trade on a breakout past $0.80.

(b)   Keep a tight stop on this one and be prepared to re-enter if it breaks out, comes back and breaks out again.  There’s a feeling that this wouldn’t be a straightforward breakout, but it is a delicious pattern and the stock has a lot of potential.

Alas we were wrong about one thing … it was a completely clean breakout - and look at it go!  Here's PEIX today - almost double the price of the breakout.

Where Is Your Financial Focus?

Caterpillar (CAT) has led the DOW index higher with a jump from $70 to above $95 in the last six weeks.  The small bull flag at $85 mid-October was an ideal consolidation breakout regardless of the fury of news uncertainty.

An even larger opportunity has developed here with the rally above $98 this week.  The price pattern breakout combined with the OVI indicator signals the market internals are strong and trending higher.  The OVI has been positive for over a month.

The OVI Indicator

The OVI readings for the main indices (particularly the S&P and the Nasdaq ETFs) have been very powerful over the last couple of years.  It is also very powerful with leading stocks that have liquid options.

Remember from previous articles, the OVI measures options transaction data and plots it as a simple line that ranges between a high of +1 and a low of -1.

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

Remember the key part of how we use the OVI:  It’s always with a chart pattern such as a channel, consolidation, or flag pattern.

Changing Times

In the old days, only a few short years ago, attention was on more on fundamentals.

Government reports, quarterly earnings releases, broker upgrades, and everyday news information are CONSTANTLY being released in the marketplace.  The data overload can lead to emotional trading for those who react to a flood of micro price movements.  Disciplined traders know most events are already discounted and priced into the market.

It is important to understand that financial markets are forward looking and current information is often already reflected in current prices.  The release of government financial data and corporate earnings announcements is anticipated by the investment banks and professional traders. Unless the actual numbers are dramatically different than EXPECTATIONS, the reaction is often muted.

That is not to say that there are not opportunities to profit and lose when this new data is released.  Even if someone had the information prior, it would still be very challenging to make profitable trades from it.  Even having that potentially illegal inside information doesn’t mean guaranteed profit.

The million dollar question is how the market is going to react, not the actual data numbers.  Analysts and investors have executed their trades based upon what was expected.  Buying and selling has already occurred and unless the information is dramatically different the trend moves on.

Price Gusher

Conoco Phillips (COP) shares have confirmed a reversal bottom on the price breakout above the September highs near $70.  Third quarter earnings released October 31 actually beat expectations but drove the stock down.

Go figure; the initial reaction was negative.  That shows how noisy the news can be.

The current price pattern in COP has set up a potential buy above Oct 27^th highs at $73.70.  This stock has a strong OVI in conjunction with the technical trigger.  This is only a candidate WHEN the breakout occurs; never anticipate.

Filter Facts

The OVI “Inside Information” measures the action from the most knowledgeable and leveraged traders.    The OVI is an oscillator derived from options volume, open interest and implied volatility.  It has nothing to do with the stock price, and yet the correlation is often astounding.

News can be Noisy, the overall trends are often more important in identifying high probability trading candidates on a consistent basis.  We may see some short term increase in price volatility immediately from events, but rarely does that change the overall trend.  Often times, the trend is actually accelerated.

In the instances where events differ from expectations it is vitally important to have a disciplined trading plan in place.  Getting stopped out is a desired outcome if and when the markets reverse.

The momentum behind trending markets is a powerful force.   The force that moves markets can be news or more often a lack of contrary information to let trends remain intact.

The most important reality of trading is NOT what cause markets to move, but rather, having a plan to deal with it.  The number one goal for professional traders is to control risk.  Proper money management and having a trading plan will ensure discipline in order to have long term success.

The nearly 24 hour world of trading efficiently digests all of the known information and reflects the buying and selling in the PRICE.  Good discipline and money management prevails.  Let the news stir up others’ emotions.

Remember, Plan your Trade and Trade your Plan.

Guy Cohen

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