If you hang around this business long enough, one thing you will come to find is that there are a lot of different ways to succeed (and unfortunately, even more ways to fail, but that's a topic for another day).

Some methods sound perfectly logical and intuitively make a lot of sense.  Others just don’t mesh with your personality and make you too uncomfortable to use.  Others just make you go “Seriously?”  

But interestingly, the other thing that you come to realize if you hang around long enough is that sometimes methods that don’t seem logical or that make you uncomfortable can actually turn out to work pretty well.  And you also come to realize that it might be in your own best interest to test your own personal boundaries once in awhile, because while you must be comfortable with your approach to the markets, you never really know where the next good idea is going to come from.  Ultimately this can all be boiled down to….

Jay Trading Maxim #9: The fact of the matter is that there are lots of trading methods that work well.  The trick is finding one that works well for you.

So for the sake of “expanding our horizons” I will discuss an idea today that you probably have not considered.

Going With Momentum – And When I Say “Going With Momentum…..”

….I really mean it, as you will see in a moment.  For now, the thing to note is this:

Very often when a market or a stock or an index starts to “go” - to put it into the type of highly technical jargon that us "professionals market analysts" like to use - it “really goes.”  And sometimes this move goes way beyond rational levels and accelerates into a blow off top. For traders who can latch onto - and who remember to let go of - these opportunities, the potential for large, quick profits (and let's be honest, isn't that what we all really want?) exists.

There are three steps to making money from this type of situation:

1) Spotting a market that is exploding to the upside.

2) Mustering up the, um, "kahoonees" to climb on board (if you stay in this business long enough you find yourself using words like “kahoonees” - don't ask me why - as well as many other fun words that I am not at liberty to use in this particular forum).

3) Getting out before things crash and burn.

Step #3 tends to make alot of investors a bit uneasy.  Like I said in the title, “Attention Thrill Seekers”.

Jay’s “Shooting Star Alert”

For the record:

-The Shooting Star Alert does not constitute a trading “system”, per se, but rather just triggers an alert of an extraordinary situation (hence the use of the word "Alert" in the title).  As such I am not going to offer any formal exit rules, only a general idea of when to enter.  So you’re pretty much own your own once you get in.  Sorry.

-This method is basically like jumping onto a speeding roller coaster as it accelerates towards the next inevitable peak, all the while planning to exit the ride before it reaches the peak, or in the worst case only shortly thereafter (hence the earlier use of the word "kahoonees").

-This method is best suited for trading physical commodities – as they are susceptible to the occasional “shortage”, “blight”, “limited supply” etc.  However, any type of volatile security will do.

The entry rule is ridiculously simple:

-Buy when the 3-month (yes, 3-month) RSI exceeds 90.

Well, at least it’s simple, huh?  Of course the obvious question is “how well does it work?”  And as I have sort of alluded to, it all depends on how you define “work.”  More on this topic in a moment.

The general uses for this method are:

-As a method to highlight a market that is trending in an exceedingly strong manner

-As an actual entry signal

For anyone who chooses to treat it as an entry signal, the basic guidelines would be:

-Buy a futures contract

-Buy a call option

-Buy a futures contract and hedge it by buying a put option

-Buy a futures contract, sell a call option and buy a put option to create a “collar”

In terms of managing a position, the possibilities are many.  Chief among them would seem to be:

-Sell half at “the first good opportunity” (your definition of “first good opportunity” here) and let the rest “ride” (until what exactly is another question to be asked and answered)

Let’s look at a couple of examples.  Figure 1 displays a chart of Spot Soybean prices since 1991 with several Shooting Star Alerts highlighted. 

Figure 1 – Soybeans with Shooting Star Alerts highlighted

As you can see there have been 8 occasions when bean prices rallied long enough and strong enough to push the 3-month RSI above 90.

What happens from there?  Well as the disclaimer goes, “results may vary.”  Sometimes beans kept charging to sharply higher levels, sometimes they advanced a little bit for only a short while, and every once in awhile it all went south in a pretty big hurry.

So like I said, the strategy that you choose to use and the methods you use to exit the position ultimately will have a huge influence on overall results.

But the real purpose of all of this is simply to add another method for “spotting opportunity” to the repertoire.  To fully appreciate the potential please see Figure 2, which is the same chart but zoomed into the most recent years.

Figure 2 – Soybeans with Shooting Start Alerts

The three dollar figures displayed in Figure 2 indicate the dollar value of the move from the opening price the day after the 3-month RSI pierced 90 and the ultimate peak in beans for that move.  Now it should be pointed out that no one would have realized these gains since that would involve selling at the top on each occasion.  Good luck with that.  Still, if you could manage to pull out a half or even just a third of the values shown, that’s not doing too badly.

Summary

No one should use a method such as the one I’ve detailed here without giving some serious consideration to:

-Their own tolerance for risk

-The type of strategy or strategies they would consider using

-Some pretty rock solid risk management techniques

-Understanding that every once in awhile something that they buy is going to go south in a hurry.

If you ever find yourself using a method that buys into sharply upward trending markets, remember:

Jay’s Trading Maxim #77: When it comes to momentum plays, enjoy the ride but never forget that the ride can end abruptly (so always keep an eye on the exits).

And if you find yourself entering a momentum play all the while saying, "I'll figure out when to get out when the time comes", let me repeat from last week:

Jay’ Trading Maxim #202: There is an exceedingly fine line between courage and stupidity.

NOTE: I will out the week of 7/21-7/28.

Jay Kaeppel

Staff Writer and Trading Strategist

Optionetics.com ~ Your Options Education Site

NOTES:

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