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Daily Newsletter, Wednesday, 05/11/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Where Does One Begin\?

Where Does One Begin?

The term "wild" would best describe today's session with the Dow Industrials (INDU) 10,300.25 +0.19% squeaking out a 19-point gain after having traded a 126-point intra-day range as traders were inundated with news that drew knee-jerk reactions.

Breadth at the big board finished positive with 9 advancers for every 7 decliners, but after an impressive reversal toward bullish leadership, the shorter-term 5-day NH/NL ratio of the NYSE, which reversed from a 12.7% reading on 04/20 to a 72.6% reading by Tuesday's close, may suggest a restful pause, with all eyes focused on PRICE for the NYSE at its recent bounce high of 7,150.

Four and five-lettered stocks at the NASDAQ, which have been showing the "you (NYSE) lead and I'll follow on strength," ended with negative breadth. Despite a mid-session decline to 1,944 for the very broad NASDAQ Composite (COMPX), today's 95 new lows were fewer than yesterday's 104.


Stocks erased marginal gains from the open in what looked to be a pre-expiration volatility move, where options expiration volatility seems to start taking place about midweek in the week ahead of monthly expiration.

One bit of economic data that may have drawn an initial "knee jerk" reaction of negativity, and you'll love this, was that the U.S. trade gap narrowed 9.2% to $55 billion in March from a revised $60.57 billion in February as imports fell despite a big jump in oil prices. Meanwhile, exports climbed to a record level. The $55 billion reading in March was not as wide as economists' forecast of $61.5 billion. Investors have been worried that the widening gap would be a doom and gloom scenario for the U.S. economy. When the gap narrows, there's the camp that fears it signals global slowing.

While the trade gap narrowed in March, the Treasury said it saw a $57.71 billion budget surplus in April, which was up sharply from the 17.58 billion when tax receipts were collected last year.

The dollar found strength with the U.S. Dollar Index (dx00y) 84.94 +0.58% back to test its still trending lower 200-day SMA (85.01) intra-day.

But things got exciting when a sell program premium was generated just after 12:00 PM EDT, which sent the major indices to their lows of the session on reports that the White House had been evacuated, as well as other government buildings in the vicinity. Early reports had U.S. fighter jets in the sky above the nation's capitol, but it was soon learned that a Cesna had "wandered" into the no fly zone.

Cisco Systems (NASDAQ:CSCO) $18.55 +1.86% topped today's most active list with just over 132 million shares traded. A positive reaction to Cisco's quarter did help the Networking Index (NWX.X) 202.42 +1.29% reclaim the 200.00 level by the close, but it was a struggle early.

Apple Computer (NASDAQ:AAPL) $35.61 -2.22% was red all session and number 2 most active among stocks after Yahoo! Inc. (NASDAQ:YHOO) $34.88 +2.40% announced it was launching a music download service. Yahoo traded in the red for the better part of the session, but launched from the $34.00 level as the clock struck 01:00 PM EDT.

Homebuilders as depicted by the Dow Jones Home Construction Index (DJUSHB) 845.52 +0.96% have been struggling to reclaim their trending lower 50-day SMA (840.16) after the Mortgage Bankers Association said that mortgage applications increased 9.4% in the week ended May 6th.

Closing U.S. Market Watch - 05/11/05


I'm showing the 5-day percentage gains/losses for the various indices tracked in the U.S. Market Watch, as this would represent the close-to-close change since our visit last week. If you're a day trader that questions a 2% intra-day gain in a stock trade (long or short), then some realization of how you're doing versus what the MARKETs are giving you sets in.

Oil prices gave back recent gains, putting to an end a 5-day winning streak that had seen June Crude Oil futures (cl05m) rise $2.57 since their May 3rd settlement. Weekly inventory figures showed mixed builds and draws. Gasoline supplies rose by 84,000 barrels, while distillate supplies jumped by 2.2 million barrels. Crude oil supplies fell by 6.1 million barrels. June Crude Oil futures (cl05m) settled down $1.62, or -3.11% at $50.45 today and look to have extended losses to $50.33 as Thursday's trade gets underway. My (Jeff Bailey's) "key level" settlement that may lift some broader equity market sentiment is a June Crude Oil settlement below $49.42. This was a "key level" of resistance until a strong gap move higher took place on February 22, where oil then went on to trade contract highs of $59.20 by April 4th.

June Crude Oil Futures (cl05m) - Daily Intervals


I believe crude oil has as much "psychological" impact on broader market equity traders as it may economic/fundamental. I also believe that COMMODITY traders trade levels as they know better than anyone, what being on the wrong side of a highly leveraged security can do to their financial status and they assess their risk one level at a time. I feel GREAT PRESSURE in the oil markets, where important near-term support is marked with my "fitted 38.2%" (PINK) retracement, which I've been following in various monthly expirations, and is tied to that sharp rebound high inflection point settlement from 01/25/05 at $49.42. My thoughts were that every short that thought they got the highs back in October, turned into a stampeding bull when oil went "boom." We can see how this level has been defended buy bulls, and perhaps many a short that saw $59.00 in April.

Now, I'll share a "not so good trade" I made on May 5th, when toward the end of that session, I ANTICIPATED that June Crude was going to settle BELOW the $49.42 level. I profiled a 1/2 bearish (short) position in ExxonMobil (XOM) $57.29 +0.61% that day at $57.21. I was stopped out the following day at $58.25 as the Crude Oil break at $49.42 never came to fruition. The pressure I feel comes from how Crude begins to find a range from $49.42-$52.11. Which way will buyers vs. sellers win out? I'd try and answer, but with an unsuccessful anticipatory short in XOM under my belt, you shouldn't be asking me. I'm "neutral" here.

DDow Diamonds (AMEX:DIA) - 30-minute intervals


Two quick intra-day observations I would want traders to be aware of. One is that today's "knee-jerk" low on the DIA did find buyers at its 03/07/05-04/12/05 downward trend that was broken to the upside on Wednesday of last week. In a "crisis" mode, we want to take some notes. Also... I did NOT see any "bad ticks" in the QQQQ, or the SPY today, but did note today's "back tick" in the DIA on the White House evacuation news. We can never say conclusively that a computerized program was set to sell TO THAT LEVEL of the "bad tick" of $101.50, but I like to observe that "bad tick" level nonetheless. Certainly the $101.50 could be a typographical error as the DIA was struggling to hold its MONTHLY Pivot of $102.46, but with the DIA near this type of MONTHLY level where institutional computers would be expected to be making some buy/sell decisions, an observation to $101.50 may be a "downside risk" assessment that computers are willing to sell to. Today's fact will show that cooler heads, and most likely some old bears that had seen their downward trend broken to the upside, become eager buyers regardless of what the news at that hour was.

In last Wednesday's Market Wrap, I reviewed "field position" with the S&P 500 Bullish % ($BPSPX) from Stockcharts.com.

Tonight, I wanted to share a sector bell curve from Dorsey/Wright and Associates (www.dorseywright.com) where I captured Tuesday's closing sector bell curve readings. Due to Market Wrap deadlines, I can't wait until tonight's readings are updated, but these are rather slow moving indicators. However, once they get moving (up to the right, or down to the left) the various sectors can move as bullishness and bearishness builds.

The comparisons shown below are from a week-to-week period. As you digest last week's Market Wrap, think of all these various sectors as being tributaries to the S&P 500 Index (SPX.X).

Sector Bell Curve - (courtesy Dorsey/Wright & Assoc.)


Since our visit last week, fore= forest/paper products and biom= biomedical actually saw a net loss of stocks to point and figure sell signals. Hmmm.... but the Biotechnology Index (BTK.X) 544.77 -0.07% is up 4.37% over the past 5-days and THE STRONGEST price performing sector. What this may tell us is that there are probably just a few stocks doing the bulk of the work, or we're seeing some rebounds from more oversold conditions. META= non ferrous metals reversed up to bear correction status after having been as high as 92% in March, and having falling to as low as 38% in early May! Remember, the playing field of RISK is 0%-100%. This rebound in the non ferrous metals would most likely be considered a short covering rally after the group has seen a strong round of distribution. The building products = buil is perhaps the strongest sector (internally) where bulls will play with stops just below the recent lows.

Now... last Wednesday, the broader S&P 500 Bullish % ($BPSPX) read 52.4% bullish (262 of the 500 point and figure charts of its components still had a point and figure buy signal intact with the chart). Today, this broader bullish % was unchanged at 53.20%. So, we've witness a net increase of 0.8% on a Wednesday-Wednesday basis, or a net gain of 4 stocks to a point and figure buy signal.

Federal Express (NYSE:FDX) $87.60 +1.33% recently gave a reversing higher double-top buy signal at $88 on Monday after a successful test of support at its longer-term bullish support trend at $83 in late April. Dorsey/Wright places FDX in the Aerospace/Airline = aero sector, but I could also see it as being a tran = transport. The sector is still "bear alert" status at 48%, and most likely, some very profitable bears are locking in some gains and demand begins to outstrip supply (selling). Bulls can play with 1/2 positions, but stop just under the $84 support.

I mention FDX and "verbalize" the supply/demand, to try and give traders/investors a depiction of what MARKET participants may be thinking. It's one stock out of 500 in the S&P.

Hmmm... United Parcel Service (NYSE:UPS) $73.85 +3.09% traded strong today after "Brown" reiterated its profit guidance for the year and said volume was "growing faster than expected."

Dow Transports (TRAN) - 10-point box


The TRAN looks to be mirroring some of the technicals discussed in FDX, and UPS got a lift today. The TRAN gave a reversing higher point and figure buy signal on 05/02/05 at 3,450 and there may well be some room for a rally to 3,650-3,660. Further strength to my "BIG Resistance would equate to a 3% gain. If the TRAN were to make that type of move, we might think the SPX.X itself could do at least another 1.5%?

It may well have been UPS that warned in early January from the $83 level that shipping volumes had tapered off that brought some bearish notions to the transports and economy itself.

How about you bar chartists out there? Does any of this make sense?

Dow Transports (TRAN) - Daily Intervals


A bar chart gives a little different look, but traders can begin to see what is going on, and use their retracement tool. Some of the VERY same levels shown in the point and figure chart are represented in the conventional retracement.

Now check this out. Do you believe "market theory" that says the transports are a good indicator for broader market direction?

S&P 500 Index (SPX.X) Chart - Daily Intervals


I've quickly slapped a conventional retracement on the SPX as I showed for the TRAN. Looks like the SPX needs further TRAN strength if it is to breach the 50-day SMA. If you've been short/put below SPX 1,183, then you're probably going to stay put for now. But keep an eye on the Transports, maybe mix in a partial long with FDX to easy any near-term heat.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
CAT None

New Calls

Caterpillar - CAT - close: 90.90 chg: +1.25 stop: 89.00

Company Description:
For 80 years, Caterpillar has been building the world's infrastructure and, in partnership with our independent dealers, is driving positive and sustainable change on every continent. Caterpillar is a technology leader and the world's largest maker of construction and mining equipment, diesel and natural gas engines and industrial gas turbines. (source: company press release)

Why We Like It:
We like CAT as a bullish candidate because it looks like the stock has put in a short-term bottom. Actually if you look closely at the daily (or better the hourly) chart you can see an inverse or bullish head-and-shoulders pattern. Yet traders need to keep in mind that as a Dow component the success of any bullish play in CAT will depend heavily on the Dow Industrial average breaking out over resistance near the 10,400 level. The company reported earnings on April 20th and blew past the estimates. Plus the company guided higher. If shares can trade above the $92.00 level it will reverse its P&F chart into a new buy signal. A move above $92.00 will also break the neckline of its H&S pattern. We are suggesting that readers waiting for CAT to trade above its 100-dma currently at $92.30. We'll use a trigger at $92.35. Our six-week target will be the $99.25-100.00 range.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 90.00 CAT-FR OI=3198 current ask $3.30
BUY CALL JUN 95.00 CAT-FS OI=2094 current ask $1.15

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.8 million
 

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

Avalonbay - AVB - close: 74.40 change: +0.18 stop: 71.99

AVB continues to inch closer to our target in the $75-76 range. Prepare to exit. More conservative traders can seriously consider exiting now.

Picked on April 24 at $ 70.05
Change since picked: + 4.35
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 345 thousand

---

Chubb Corp - CB - close: 82.87 chg: +0.22 stop: 79.99*new*

Hmm... CB gapped lower this morning after announcing that it had received a subpoena from a U.S. attorney for an investigation into finite risk insurance. The stock did rally back to close positive but traders should be cautious here. We are raising our stop loss to $79.99.

Picked on May 01 at $ 81.78
Change since picked: + 1.09
Earnings Date 04/25/05 (confirmed)
Average Daily Volume = 1.2 million

---

Coventry Hlth Care - CVH - close: 68.20 chg: -0.53 stop: 66.99

No change. CVH drifted lower toward technical support at its 50-dma on Wednesday. We remain on the sidelines waiting for shares to breakout over the $70.00 level and hit our trigger at $70.51.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/03/05 (confirmed)
Average Daily Volume = 973 thousand

---

Golden West Fincl - GDW - close: 63.06 chg: -0.10 stop: 60.95

We remain concerned over the short-term direction for the financial stocks. Yes, most of them managed a rebound from Wednesday's earlier losses but the very short-term trend is discouraging. We're not suggesting new bullish plays in GDW even through the stock did bounce from the $62 level.

Picked on April 26 at $ 62.55
Change since picked: + 0.57
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 1.3 million

---

Hovnanian - HOV - close: 53.98 chg: +0.56 stop: 49.99

The housing sector was one of the better performing sectors today and HOV paced the intraday rebound as well. We see no change from our previous update on 05/10/05 and 05/08/05.

Picked on May 06 at $ 54.26
Change since picked: - 0.28
Earnings Date 03/02/05 (confirmed)
Average Daily Volume = 1.2 million

---

Invitrogen - IVGN - close: 76.97 change: +0.45 stop: 71.49

No change in strategy for IVGN. The stock notched another new relative high today. Our target is the $80.00 level.

Picked on May 03 at $ 75.51
Change since picked: + 1.46
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 888 thousand

---

Eli Lilly - LLY - close: 58.75 change: -0.38 stop: 57.49

No surprises yet. We've been expecting a pull back toward the $59-58 levels and LLY traded to $58.23 this morning before bouncing. Today's low was very close to the exponential 200-dma. Its simple 200-dma is closer to the $57.50 level. More aggressive types might want to consider new bullish positions on a move over $59.00. We would suggest waiting for a new move above the $60.00 mark before initiating new positions.

Picked on May 04 at $ 60.15
Change since picked: - 1.40
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 4.7 million

---

Reynolds American - RAI - cls: 78.82 chg: -0.30 stop: 77.95

We're still in limbo here. RAI is oscillating around the $79 level. We are waiting for shares to trade at $81.31 before going long.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 866 thousand

---

Research In Motion - RIMM - cls: 71.14 chg: +0.42 stop: 66.85

RIMM continues to show relative strength. We see no change from our previous update on 05/10/05.

Picked on May 10 at $ 70.51
Change since picked: + 0.63
Earnings Date 04/05/05 (confirmed)
Average Daily Volume = 1.7 million
 

Put Updates

L-3 Comm. - LLL - close: 67.84 chg: -0.17 stop: 70.55

LLL produced a small oversold bounce this morning but it quickly failed under the 200-dma. This continues to look like a bearish entry point. We see no changes from our previous update on 05/10/05.

Picked on May 10 at $ 68.01
Change since picked: - 0.17
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 855 thousand

---

Lehman Brothers - LEH - close: 89.00 chg: +0.17 stop: 92.80

No change from our previous update on 05/10/05. Our target remains the $86-85 range.

Picked on April 29 at $ 89.45
Change since picked: - 0.45
Earnings Date 03/15/05 (confirmed)
Average Daily Volume = 2.3 million

---

Marriot - MAR - close: 61.96 chg: +0.31 stop: 64.21

MAR bounced back toward its simple 10-dma but did not break it. There is no change from our previous update. Our target is the $60.00-58.00 range.

Picked on April 28 at $ 63.37
Change since picked: - 1.41
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 1.2 million

---

Parker Hannifin - PH - close: 59.53 change: +0.47 stop: 62.01

No change from previous update on 05/08/05.

Picked on April 28 at $ 59.08
Change since picked: + 0.45
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 1.2 million
 

Dropped Calls

None
 

Dropped Puts

None


Trader's Corner

Getting More Winning Trades

OIN SUBSCRIBER QUESTION:
I've followed you for several years now and believe you are the best techniician as I have seen for swing trading short term times frames on options. You also have been generous enough to share your entry and exit philosophies as well. Mostly I just observe and no longer trade options directionally, having been burned badly in the past.

I'm wondering what your success ratio is for every directional short term (one to several weeks) option play you make. I'm sure you track this. What's a realistic number for a lesser expert than yourself?

RESPONSE:
You're kind or too kind in your assessment of my work. I don't try to create and keep a "track record" because:

1.) the suggestions I make in my weekly OIN columns are usually not specific enough for me to track them like a money manger could who is in control of an account. Moreover, I could suggest getting into a trade, but don't have the means (like with an ongoing intraday commentary), to indicate a suggestion to exit.

2.) I am not allowed to publish such a track record anyway by the regulations that we are governed by in the Market Advisory space.

Personally, I have done well but don't trade as actively these days. I find that I don't want to spend the days glued to my trading screen here along the California coastline. This is another reason that I like trading the bigger price swings; e.g., week over week, such as we saw in the recent 7-week decline. And, for me anyway, it tends to be the case that if I am in the market as a usual circumstance, my advice to our Subscribers gets skewed by my position; for example, if long OEX calls, tending to see the market more through a bullish lens.

I would say the following regarding a realistic assessment of what you could or "should" make in trading in terms of a success ratio: I stress all the time that the way I trade, which began when I only traded index futures, is to ONLY enter trades where I make an evaluation that my profit potential is 2-3 or more times greater than what I have to risk.

The foregoing reasons are why I mostly like to buy pullbacks to a recognizable technical support area or adopt bearish strategies after a rally to a resistance area that I can identify on the charts. These are the entry points where I can also set exiting stops at just above or below my entry. For example, at the recent S&P 100 (OEX)low made in the 545 area ...

When successful in executing trades where profit potential could be reasonably projected at 2-3 (or more) times what I have to risk, and I always set stops; I only need to be right or make a profit half of the time or LESS.

Now, what's WRONG! with this picture !!??
Well, for one thing, most traders would consider it an impossible goal to make money on one-half, or perhaps even one out of three of their trades.

The answer to this question or dilemma is to trade LESS; and, WAIT for the few opportunities that come along where a trade set up looks something like the above; in terms of, for example, aspects related to why we might find buying OEX calls at 545 to be compelling: reasons included, a 2/3rds (66%) pullback of the October to early-March decline that took place over a relatively short 7 weeks (they always 'slide' faster than they 'glide'); an oversold condition; very bearish "sentiment"; a bullish hourly price/RSI divergence..

A second part of "what's WRONG with this picture !!??" is that most of us lack the patience and DISCIPLINE to WAIT for the few high-potential trades. I'm not preaching to the "undisciplined" masses or anything. It's the recognition of how hard it is. After all, it's quite likely that one of our attractions to options trading, at least index options (and taking positional trades), is that we like the leverage involved and the ACTION too!

And, saying we should wait for "ideal" trade setups, is like saying that in the heat of battle, we should wait until we see the whites of their eyes.

For all of the psychological reasons that I've referred to, there has been a significant movement toward "systems trading" or trade entry using a set of objective guidelines. This approach attempts to raise the winning track record in trading and take out the emotional factors (fear, greed, etc.) that leads to being, as you say, being "burned" in trading.

I end this rather long discussion or answer here that is a, more or less, a direct response to your question.

NEXT, I want to discuss trading systems as a matter of possible interest, to the few who use or might take up, systems trading.

TRADING SYSTEMS; Part 1 -

You may well know that, as a trader, you are pitted against some quick reacting fellow traders that seem to place orders in a heartbeat. Ever wonder why the order flow at market turning points is so fast? besides the fact that there are a number of sharp professional traders that do this for a living on or off the exchange floor, there is also an order flow from trading system "signals" that are generated in an instant.

Suppose you sense that market momentum MAY be starting to shift no sooner than you sense it, let alone react to it, buy or sell orders are streaming in. Ever wonder why? Well, one reason is the number of computerized trading systems that are being used.

Technical trading systems are a product of the computer age, in that computer power is what has allowed System Testing And Development which I may refer to my its acronym "STAD".

Trading systems are typically composed of a set of entry and exit conditions that are set up in specialized software. The most widely used such software is TradeStation. This company has been and is still, in the forefront of this activity and the company provides seminars on the System Trading And Development approach moreover, there are a substantial number of TradeStation user groups out there that meet and swap ideas.

When was the last time you met to share trading ideas with a like-minded group of fellow option traders? Probably never, but these groups are out there and are very dedicated to constantly improving their trading systems. There are also books on devising and using trading systems, such as by Martin Pring. TradeStation (the company) has developed some of their own resource materials; for example, basic booklets on designing trading systems, which I found to be excellent in the past.

If I mention TradeStation a lot here its because they are one that has a business model based on selling and promoting this type of trading software. No one has been able to catch up to them in this regard, as far as I know. Others may disagree.

The basics of what "systems trading" is, is the first part of this discussion. While learning how to set up trading systems takes the right software and some dedication, the basics are not all that difficult, particularly such tools as optimization. I think its something that well-informed option traders should at least know is out there as this type of trading is part of the "competition" so to speak.

A trading systems entry and exit conditions must be "back-tested" on historical market data to see how profitable its "trigger" conditions for entry and exit would have been in the past. Back-testing, in turn, allows refinement of the technical rules and is another key part of trading systems -- without computer applications to handle this, trading systems could have not have evolved as a popular means for systematic investing and trading.

Finally, use of the method going forward must be monitored to prevent a serious drawback of the systems approach that of "curve-fitting"; this is finding a set of rules that worked perfectly with the benefit of hindsight and past events but will not necessarily be effective going forward in new types of market conditions and cycles.

I will concentrate on demonstrating some basics of trading systems and not so much on the pitfalls and shortcomings of developing and using trading systems. There are strengths and weaknesses in the "systems approach", but this discussion can be left to a specialized study of trading systems, should you become interested in applying technical analysis in this manner.

I would just note that the obvious appeal and a strength of trading systems very much relates to the common investing and trading pitfalls lack of a plan and discipline in carrying out a plan that includes rigid risk management principles and the difficulties in taming negative emotions like fear, greed and even 'fantasy'; seeing market conditions in a way that reflects our bullish or bearish bias rather than objectively.

As I said, specialized computer applications are required to develop and use trading systems. The one I am familiar with is TradeStation. The TradeStation application product is also probably the best known for trading systems development in use by individuals although many institutional traders also use this or similar software.

The software that allows trading system development and testing doesnt look that different from ordinary charting applications there is a real time (or end-of-day) data feed (e.g., signal), which charts and applies chart markings (e.g., trendlines), indicators and other studies such as fibonacci retracements. The similarity stops here as there is a vast amount more involved and which makes the software a relative memory hog a fast computer is essential and substantial memory (e.g., 512 RAM) is desirable.

Trading systems can be broadly broken down into ones that use
1. technical indicators
or, ones that use
2. chart patterns
or, a combination of both methods.

The validity of each approach stems from a basic principle of technical analysis the knowledge that market cycles repeat and are identifiable. The sample systems I employ might be "applied to" tested on daily or weekly charts, but systems that employ intraday data are not any different in construction. The concept is that systems calculate a certain number of "bars" or trading periods whether this is 5, 10 or 60 minutes, a day or a week.

INDICATOR-BASED TRADING SYSTEMS
A popular technical indicator, of the "oscillator" type study, is the relative strength index or RSI. In the past it has been hard to identify how well the RSI worked in terms of its use as a buy or sell "signal". A rule-based trading system using the RSI is demonstrated here as written in the TradeStation programming language (i.e., EasyLanguage):

This forgoing language will likely look "greek" to you! However, its not that complex. First you define some terms or "inputs". Then you define a condition involving those inputs. Lastly, the trading rules are defined; e.g., above its the "BUY RULE" and "SELL SHORT" rule. The sell short rule in options will typically be to buy puts. It doesnt much matter the system is generating a "sell signal" and you decide how you will attempt to profit from a decline.

A common use of the RSI is to buy a market or individual item (a financial instrument) when the RSI is registering an oversold or overbought condition for example, buying below 30 and selling above 70. However, because markets can stay at overbought or oversold readings for some time, the system shown above takes a position only when the RSI crosses ABOVE 30 or BELOW 70 that is only when the RSI is retreating from an extreme. Early exit may be desirable if the RSI moves back into those extreme readings. Such a move is an alternative exit "signal" as shown in the way the system is written.

PATTERN RECOGNITION SYSTEMS
This next part of systems trading, as well as more on back-testing trading systems and a Conclusion, is "TO BE CONTINUED" in my next week's (Wed, 5/18) Trader's Corner; assuming that I don't fall into the ocean on my next fishing trip between now and then (salmon season has begun).

Good Trading Success!

NOTE -
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.
 

Today's Newsletter Notes: Market Wrap by Jeff Bailey, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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Option Investor Inc
PO Box 630350
Littleton, CO 80163

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