Sometime in the next few weeks, I'll include a review of a book on rogue traders that I think has some relevance for us retail traders, too. Some of the behaviors and circumstances that encourage rogue trading can be present in our lives as retail traders.

Some retail traders already recognize in themselves the ability to go rogue, to take on far more risk than they're capable of managing. Maybe they've blown through a trading account or have scared themselves. Other traders may feel confident of their abilities to pull the plug on losses rather than compound them, but they're tired of fighting this crazy market environment we've had lately.

Some traders I know are experimenting with small directional debit-spread trades where potential rewards are fairly equally balanced with potential risks, and just letting them run. As long as they're keeping the size of the trades small in comparison to their account sizes, they don't have to trust themselves. They just have to be right about direction a little more often than they're wrong about direction.

I'll show an example of what I mean. When I'm trading an equity, I like to use non-correlative studies to determine what direction I think the equity might like to go. I like to use volume with price studies. A move up can occur on high or low volume, as can a move down or a move sideways. If you're looking only at oscillators such as MACD, stochs or RSI, you're using a study of price action to study price action, and the two are strongly correlated. You're not getting completely independent information, as useful as that information can be.

Long ago, I studied what Tom Williams had to say about volume in his book, Master the Markets, a book that at the time was terribly expensive. It also had terrible production values, and a good portion of the book was devoted to hyping a subscription trade service that I did not want. However, Williams taught a method of studying volume that I found invaluable. I don't pretend to have mastered (deliberate pun) all he had to say, but I use one precept to sometimes go looking for trades. I scan for instances when optionable and liquid equities have had unusual volume and have either bounced on a day that was part of a decline, with unusually high volume, or fallen back on a day that was part of a rally period, also on unusually high volume.

Williams teaches that unusually high volume means that institutions have been involved in that market. What have those institutions been doing? The shape of the candle and particularly the candle shadow tell us what institutions have been doing. Imagine markets have been dropping and there's a day of unusually high volume, but a day in which the equity bounces off the low of the day, leaving a shadow or wick below the body of the candle. Institutions have obviously been buying, Masters says in his book. If they weren't buying and were instead selling, their volume would have overwhelmed retail volume and the bounce wouldn't have occurred. Williams warns that institutions can afford to buy early and in fact often start buying while prices are still dropping, which we retail investors can't afford to do. Signs of institutional buying don't promise that a bottom has been reached. However, if there's a day like that, and then prices bounce but come back down to the same area on lower volume this time, that could mean that sellers are exhausted. Since institutions have already bought and the retest shows they aren't changing their minds (the lower volume shows this), maybe it's a good buy. Or maybe not.

However, when scanning on November 20, I found a setup that I liked, if I could set up a trade where I wouldn't lose too much if I were wrong.

Daily Chart of JEF:

Remember that these charts were snapped on December 7, when this article was first roughed out, and are not current.

At the area of the pink oval, JEF had dropped down on huge volume (blue oval), and then sprung up by the end of the day. If I understood Williams correctly, he would have suggested that institutions might have been buying. On November 20, when I was scanning, I noticed that JEF had come back into that area, and was again producing candles that bounced from the low, but this time on lower volume than previously. The volume was still higher than it had been the immediate few days leading into the retest, but I felt okay about giving this a try if I could structure the right trade. News was terrible about the financials, and I didn't intend to buy JEF or add it to my long-term portfolio. I just wanted a speculative trade in which I might be able to make about as much as I was risking. By the way, Williams specifically mentions that news will be "terrible" when institutions are buying.

On November 21, one of the candles in the yellow oval, I chose a JEF DEC11 10/11 call vertical. I bought a JEF DEC11 10 call and sold a JEF DEC11 11 call. I paid a $0.51 debit. If JEF ended up at DEC expiration at or above $11.00, I could make $0.49 for my risk of $0.51, minus my costs. In reality, I had no intention of letting it run into expiration, especially if JEF was over $11.00. As extrinsic value leaked out of an ITM sold call, there would be too much opportunity for the holder of that call to decide to exercise it and buy JEF at $11.00, so I didn't want to carry this too close to expiration. I also checked to make sure JEF didn't have earnings or an ex-dividend day during the time the trade would be in force.

Since I was testing this trade again after not trading it for several years, I actually closed it out as soon as I had a 10 percent profit, which goes against the grain of the equal risk and reward parameters. However, as of December 7, 2011, when I last checked it before expiration, that spread was bid $0.80 by ask $1.05. Since I had already closed it, I can't guarantee whether I would have been able to close it at the mid, which would have made for a nice trade.

On November 23, I found another example that I decided to test. Although the volume pattern wasn't as stellar as the other, I had noted that F was dipping into an area that had seen past evidence of institutional buying, and retesting that area with bullish price/RSI divergence and with an extremely low volume bar.

F Price Chart:

Based on this evidence, on 11/23, I bought a JAN12 10/11 call spread for $0.39. Again, my intention was just to test this method I hadn't used in years, so I took a quick profit as soon as it was offered. As this article was roughed out on the afternoon of December 7, that spread was bid $0.64 and ask $0.74, so again a nice profit is offered.

I'm not suggesting either of these trades as a long-term trade. I never intended either to be, and the opportunities I saw then are not the same now. Traders don't have to use Williams' precepts to find such trades, either. The point I was trying to make is that I found trades that I could, if I'd been willing to do so, just let run. The JEF debit spread had the possibility of profiting $0.49/contract minus commissions, and the possibility of losing $0.51/contract plus commissions. The F debit spread had the possibility of profiting $0.61 minus commissions and losing $0.39 plus commissions. I closed the F trade for a small profit, again because I was testing the procedure. As of early afternoon on December 22, F was 10.93, and the spread was bid $0.68 and ask $0.71.

It's my intention after a period of testing to use this small account to set these speculative trades up and let them run, untended other than a quick check now and then. The account is small, so it's self-limiting in the amount of money I can spend in these speculative trades. Moreover, because this particular account is under $25,000, I am limited to three day trades a week, which means I can't be trading in and out of these but need to let them work. If I'm halfway decent at technical analysis, I can set these and not watch them other than to watch for options that have gone deep into the money and have little extrinsic value and so are in danger of being assigned. I also have to watch for ex-dividend days and that sort of thing.

I like keeping these trades small as I feel is appropriate for what is a directional trade after all. I am good at watching losses and can generally trust myself to pull the plug on a losing trade, but I don't trust the markets these days. That's my reasoning for putting on some of these. If you're the kind of person who can't pull the plug on a losing trade, this more-or-less equal risk/reward trades might be an alternative for you, as long as you keep the trades small.

I also thought I saw a bearish price/volume setup in EMC when it was trading at about $23.20, pulling back sharply from an attempt to push higher. A few days previously, EMC's volume had spiked sharply higher as it attempted to move higher and then fell back. A climb the next few days was met with decreasing volume, which I interpreted as a sign that institutions were not participating in the buying. I had bought a JAN12 24/22.50 put vertical, buying the 24 and selling the 22.50. I paid $0.73. That meant that I had the opportunity to profit $0.77 minus commissions on a potential loss of $0.73 plus commissions.

By December 7, the position showed a loss. It was bid $0.58 and ask $0.64. For a while after I entered this trade, it looked as if I might have been off in my interpretation. A total loss of the debit I paid wouldn't have hurt even the teensy test account I was using. Nor would it have hurt my confidence. However, as it turned out, I was able to take a small profit in the position. If I had left it open, I would have made more of a profit. As this article was again edited on the early afternoon of December 22, 2011, that spread was bid 1.24 and ask 1.31.

Not all such trades have been profitable. I also opened and closed at a small loss another small trade with a similar setup. This had been a bullish NOK JAN12 5.00/5.50 call debit spread. I lost $11.00 plus commissions on the trade. I had the opportunity to make $29 minus commissions on the trade. I elected not to let the trade run because the reasons for setting it up disappeared from the chart. In addition, NOK wasn't performing well when other stocks were bullish.

So, my suppositions were wrong on that one. They'll be wrong on others, too. The point is that I found a small trade that I could let run. I didn't have to worry about adjusting now that I've run my initial trial-balloon trades to confirm that my setups are valid and have a chance of succeeding. As long as I made sure no ex-dividend day or other surprises awaited and kept the position small and was fairly confident that I had at least some technical analysis skills, I didn't even have to trust myself to take it off when there was a loss.

Whatever your reasoning, trades such as these, as long as they're kept small in proportion to the size of your trading account, might have a place in your active trading portfolio. Educate yourself about ex-dividend days and option exercise before you engage in such trades.