Indicate that there was quite a bit of selling coming into the market, as the market declined. There was a lot of selling coming into the market as the market declined, increasing the odds that there is a wave of selling coming into the market that isn’t quite complete yet.
Again, we have this little bit of a rally. Again, we see volume stabilizing. It’s not really going down, but it’s not terribly heavy to the upside, either. Then, we have quite a bit of selling, and a huge move down in the market. At the same time, we get a very large spike in volume here.
Then, what do we look at? We look at a period after this large down-turn in the market with high volatility, lots of volume going on. The things that stand out are the large red day bars, in which the ease of movement is quite frequent. Then we get another rally, with yet declining volume again. We get a couple of days in which there’s a pretty big spike there, but for the most part, volume is declining as the market is advancing.
Those are the clues that we look for. We do get this little downturn here. The volume was fairly light. Then we get this up-turn, where the volume was fairly light. Now, all of a sudden, we’re starting to get a turn down again, in the market. Let’s say we’ve noticed this pattern, that as the market was going up, the volume was relatively flat. We get this one-day high sell-off and high-volume day, and then we start to see this pattern where the volume increases on the declines, and it decreases on the advances.
That is the clue that you’re looking for. You’re looking for those days in which volume is advancing when the market declines, and when the market advances, volume declines. That is a key tool to determining future market direction.
We’re going to play this very simply. We zoom in. We take a look at this particular period right here. We see the market starting to go up. It seems to be falling back. We have one high volume day, in which the market advances. Then, all of a sudden, volume starts to tail off, and we start to get some clusters of red bars here. We have a couple of bars here that are red. We have a red bar here that surpassed the previous day, giving us an idea that the market is ready to resume a decline.
On this particular day, the volume wasn’t spectacular. Then we get a little bit of a reversal here. Importantly, the volume increased on this day, compared to the previous day. We’re looking at this rounded top here as well, and we’re looking for a time in which we can go short.
We picked December 7. If we go over to our Analyze tab, let’s go back to December 7. Remember, when buying a put, we want a Delta between 86 or 95. That’s what I look for. I’m going to pick this put right here, the $1.37s, and I’m going to go ahead and buy that.
Now, I’m going to advance to our current day, to see how we did. Obviously, we need to put a stop loss in there. We have about a $458 profit after a few days, and that’s per contract. The more contracts we have, the higher our profit would be. In this case, if we had a 10-contract position, we would have a $4600 profit in just a few days, from that sell-off.
What happens if we’re wrong? Let’s say that the market does not go as anticipated. Of course, I like to buy the Deltas between 85 and 95. However, what happens if the Deltas go against us?
The nice thing about puts, and buying a single put – number one is the commission rate. If you’re buying a complex spread position, and I know a lot of traders like to do spreads and things like that, you have multiple commissions that you’re going to be paying. I’ve heard from a number of different investor friends, people that I coach, and traders – in my particular case, I’m very good friends with a retired CBOE floor trader. He says that commissions end up eating into a lot of people’s trading accounts. Even when they’re right or when they’re wrong, they end up putting on these complex spread positions. It’s very hard for them to understand the complexities of the positions they put on.
Number two is that they’re paying so much in commissions, both to get into and get out of the positions. It wouldn’t be so bad if they were on the winning side most of the time, but unfortunately, they’re on the losing side most of the time. They end up not only losing equity in their account, but they also lose from the commissions they have to pay to exit those positions.
It’s very important to think not only in terms of being right on the direction of the market, but also being right as far as the positions that you take, and trying to keep them as simple as possible. With a single put position, remember that you are controlling 100 shares of the SPY. At the current price of the SPY, at $121.73, controlling 100 shares is equal to a $12,173 short position on the SPY.