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Option 101 Classic:
Sometimes nuances of option strategies need to be revisited and both veteran and novice traders can use a little reminder when it comes to perfecting their game plan. Enjoy this Options 101 classic.

Article originally written 03.27.2003

Support, resistance, oscillators. When we boil it all down, isn't that what the mechanics of trading is all about (aside from the primary directive of "preserve capital, make money")?

These concepts are so simple and yet so overlooked as the single best trigger to get us in or out of a trade, whether it be stocks, options, or futures. They all rely, for the most part, on swings of human emotion, which can be neatly condensed into one little visual presentation. So it has been throughout history.

Question: When we hear the phrase, "This time it's different", how different is it, really than previous swings of human emotion at a different and perhaps even recent time in history?

Fundamentals Guy's answer: Not so different that it will cause oscillators to exceed 0% on the downside or 100% on the upside. Markets do not go from 0 to 10,000, nor from 10,000 to 0 overnight. They get there gradually over a long period of time. In the grand scheme of things ranging in millenniums of time, it really isn't different. Business people do business, politicians squabble, people fight, economies ebb and flow, central bankers issue lots of paper currency, and unseasonable weather happens everywhere. One day at a time, that progress is reflected on a chart in the form of price action according to the information available at the time.

But while I will always remain true to fundamentals - guess I was raised that way, I would never trade a thing without first focusing on the basics, which can all be neatly summarized in a simple chart. Charts provide recognizable patterns for us to follow if we would only choose to do so. That involves cutting out distractions that milk our trading account, or in short, separating useful information from useless information.

What leads me here is the incessant rattle of the media offering commentary on every SNAFU or success in the field of battle, every packaged up economic report representing only a best guesstimate on the part of the guesstimator, and a parade of so-called experts that have been mostly wrong about productive ways in which to invest capital over the last three years. This is the useless information, which while interesting, especially to me, Fundamentals Guy, won't make me dime if I attempt to trade it.

Why won't it make me money? Because if I got the information over the net or on the airwaves, I can be pretty sure everyone else did too, including the floor traders who got it 15 minutes earlier than me and Jonathon Livingston Public. . .and gamed us in anticipation. News, unless we are the ones making it, is stale upon arrival. Using it is like trading with delayed quotes. We'll be killed every time.

Charts on the other hand - as long as they are real time - tell the whole story no matter what time frame or series of time frames we use. The candles from a printed trade will reflect the news more quickly than we'll receive it over the airwaves. Thus when it comes to trading, just like flying an airplane, I trust my instruments. Everything else is useless information at worst, or a distraction at best.

Useless distraction can often take the form of "misdirection" or "disinformation". Such is the case, I believe, with investors who have been thrown off the scent of making money by believing that the market rises and falls based on inclement weather, fudged economic statistics, interest rates, or perceptions on how the war effort is coming along. While that stuff will mess with our emotions on a momentary basis if we let it, the real issue will ultimately be related to the strength or weakness of our currency.

That is especially true with the price of gold. It has nothing to do with the war effort, weather, statistics, or interest rates, and everything to do with value of the Dollar compared to other currencies, and what basket of goods gold will purchase.

As an aside, I find it interesting that an ounce of gold, if converted at its exchange price during any point in history, will buy approximately the same amount and quality of goods or services that it did 100 or even 1000 years ago - a nice suit of clothing, food for two weeks of survival, three to five days of basic labor. Gold is the only money that ignores inflation and holds its value. All un-backed paper currency floats around IT, not the other way around.

Simplified into current day bumper sticker language, when it comes to gold, "It's the Dollar, Silly" (although I don't think "Silly" is the personal pronoun the phrase-coiners had in mind ).

"Wait a minute, F.G. I thought you said we ought to only be interested in instruments, aka charts, candles, and oscillators - technical stuff." True. However, for the oscillators to give us maximum bang for the buck, they ought to be in alignment with the fundamental picture. In similar vein, we should also make sure we are looking west and not east if we are in search of a sunset! For gold, the fundamentals are there for a bullish play. Now we watch the oscillators for a bullish entry. Let's go back two weeks and see the gold chart that I thought was setting up a nice buying opportunity.

Gold - April Contract chart - GC03J (weekly/daily)
From March 13, 2003:

The following was the technical picture then:

"First off, "coming bullish" does not equal "buy it now" if we try to time the purchase in any way, shape or form. While I personally think the price is right, I also think timing is a little early for a trade. Those wanting an insurance policy though may consider it anytime."

"But here is what the charts are saying. Starting with weekly candle support at roughly $330-$332, note that dovetails nicely with support of the 200-dma - also $330 - on the daily chart. I would consider $330 significant support based on those two indicators."

"But the reason I would not, as a trader, be tempted in to buy it here is two-fold."

"First, the stochastics on both the weekly and daily charts are still falling - in both the 5 and 10 period lookbacks - and there hasn't been a reversal yet. Oversold, yes, but still room to fall."

"Second, there is a large disparity that is just now beginning to close with relation to the 200-dma and the 50-dma. This will likely take some time. As this gap begins to close, I believe the entry opportunity becomes better. Hovering around the 200-dma for a week or more until that gap closes seems appropriate, but again the market can do anything. So make your buying decision carefully."

"Remember that the 200-dma at $330, while not perfect, should provide heavy price gravity on a technical basis to that level."

"Conclusion: The fundamental case for gold still stands. The technical picture shows us nearing a buying opportunity for the market timer. The price drop to $334 on a rumor just made it more attractive."

OK, back to current day. I believe this is a great time for even a "timer" to begin accumulating a position. Take a peek over my shoulder at today's chart.

Gold - April Contract chart - GC03J (weekly/daily)

Notice that even the 10-period stochastic (bottom one) has entered oversold, and the 5-period stochastic (top one) is in the single digits. Yes, it could stay oversold a while longer, but I note with bullish enthusiasm that this bottoming happens to coincide with a dead stop on the weekly ascending trend line, a point of apparent good support.

Dovetailing this with the daily chart, we can see a stochastic bottom on the 10-period oscillator and actual signs of life on the 5-period oscillator, as the latter arises from oversold. Careful on that part though. While it appears to have emerged from oversold, the most recent 30 days of candles have been erratic and unpredictable - nice to see to rise, but not a sign of a sure-fire winner when each of the other oscillators are still oversold, at least not yet.

The other things I like about the daily chart are that the price has stabilized and is hovering around the 200-dma (good support) with the 50-dma finally beginning to close the gap with the 200-dma. The gap ought to narrow fairly quickly since the last 50 days of candles, some of which include the rapid gains through February 5th, will soon no longer be calculated in the 50-dma.

Chart summary - weekly and daily stochastics buried with the first sign of bullish life coming from the daily 5-period stochastic; strong support and consolidation near the 200-dma; support at the weekly ascending trend line.

Fundamental summary - It's the Dollar, Silly! For more on this, see March 13th, 2003, Options 101.

http://www.optioninvestor.com/page/oin/education/opt101/2003/03-13.html

Support, resistance, oscillators. That's the basics of what it takes to successfully enter or exit a trade. The rest is noise. My take - Gold has been sold hard in the last few weeks, and now appears to be a good time to begin an accumulation of the stuff based on technical indicators.

Like any good pilot, trust your instruments! Until next time, make a great week for yourselves!

Buzz



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