Investing Articles

Directory for all blog posts

TradeStops … and True Love

Last Valentine’s Day a panicked lover, and TradeStops subscriber, wrote in to say:

Getting tested today as my NAK stock that was up 300% has fallen by 30%. Hoping it’s a flash crash, so I’m not going to panic. But OUCH!

NAK is Northern Dynasty Minerals – a widely held junior gold mining stock with a compelling mining opportunity in Alaska.

It’s easy to fall in love with a stock like NAK. It’s been recommended by at least two highly respected investment advisory services. It controls the world’s largest undeveloped gold deposit … and that deposit is in Alaska, a place where there’s a reasonable hope of actually extracting the gold. There is also some hope that regulatory burdens may be lightened under the Trump administration.

It’s also been up over 500% in the past six months.

Believe me, I’m all for love. Investing should stir the heart. But as in all romantic relationships, we need to be clear about the rules of engagement.

That’s where TradeStops enters the picture. TradeStops establishes the boundaries within which investing romances can flourish … and the terms on which the engaged parties can agree to go their separate ways. TradeStops is like an investor’s prenup.

Let’s take a look at how TradeStops helped thousands of subscribers keep their relationships with NAK alive when a shock event threatened to derail the budding romance.

Just to get us visually oriented here, let’s take a look at the current SSI chart on NAK.

Editorial_Feb21_01.png
It first triggered an SSI Entry signal on May 23, 2016 at $0.38 per share. Ten months later, on January 24, 2017, it made a new high of $3.32 per share … a gain of 773%.

NAK has been recommended by a couple of prominent investment advisory services with large readerships. One service recommended it at $0.74 per share and another at $2.05 per share.

Thousands of TradeStops subscribers have positions in NAK … many of them up hundreds of percent.

RECOMMENDED LINKS
DottyHooper_150px.jpg How Dotty the widow made $180,000 per year with options
When Dotty’s husband died, she sold some real estate and turned to an options trading
master to learn how to make income for her retirement. With his research Dotty ended up making $180,000 – $200,000 per year. Here’s what he did, and how you can do it too…

NAK is one of the highest volatility stocks I’ve ever seen recommended in a widely read investment advisory service. Its TradeStops Volatility Quotient (VQ) is currently 72.2%.

That means that investors in NAK should be prepared for a correction of up to 72.2% if they intend to hold the stock for a year or more. Like I said, it is a very volatile stock.

Last week, on Valentine’s Day, a New York-based hedge fund came out with a scathing critique of NAK … and announced that they were shorting the stock (i.e., hoping to profit by the stock falling in price).

NAK fell as much 40% on Valentine’s Day, February 14. It had closed at $3.18 the day before and it hit an intraday low of $1.92 on February 14, before finally closing at $2.50.

So … what was the TradeStops response to the wayward behavior of NAK this past Valentine’s Day?

“Ho hum … That’s to be expected.”

Let’s take another look at that SSI chart on NAK …

Editorial_Feb21_01.png
Again, NAK has a VQ of 72%! As of the most recent close of $2.26, it’s down 32% from its recent high. Yes, that’s a dramatic drop, but it’s not even half of what investors in NAK should be prepared to accept in NAK.

NAK hasn’t even dipped into the SSI Yellow Zone yet.

I’m sure that many investors in NAK sold in a panic this past Valentine’s Day. Many of them probably got out near the bottom range of the day around $2.00 per share and then had to watch NAK rise into the close to $2.50 per share.

I’ve said it before, watching the prices of stocks intra-day is bad for your health … and bad for your portfolio.

True love requires trust. Given that we’re not all saints, trust between partners requires boundaries. TradeStops provides investors with the boundaries required to let love … and profits … flourish.

Investors in NAK with a plan to sell and the right position sizes for their portfolios had nothing to worry about this past Valentine’s Day. It was all part of the normal expected course of business.

To romance!

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Wrong…and Long

Being right … or making money. That’s the choice we investors often face. I’ve been warning of bearish signs in the US Stock Market for weeks now. I’ve been wrong … but I’m still long.

There are a lot of reasons to be concerned about this market. Last week, I showed you that the CBOE Volatility Index (VIX) recently traded below 11 and was heading down towards 10. This is a condition we haven’t seen since before the market crash in 2008.

Editorial_Feb17_01.png

Even my time-cycle forecasts have been showing that the market should be topping. This was what I showed you last week. It looked like the S&P 500 was ready to move lower.

Editorial_Feb17_02.png

It hasn’t happened the way I thought it would.

Instead, the markets have continued to make new highs for the past three months since the elections. The S&P 500 is solidly in the SSI Green zone and hasn’t even touched the Yellow zone since giving us a new SSI Entry signal in April, 2016 (I didn’t want to believe that signal
either).

Editorial_Feb17_03.png

And it’s not just the S&P 500. The other major averages are all hitting new highs including the Dow Jones Industrials, the Nasdaq Composite, and the Russell 2000.

This uptrend could continue for a while.

In the past 40 years, the S&P 500 has had strong moves to the upside when the Volatility Quotient (VQ) started to rise from the 10% area. The only time this didn’t happen was during the bear market of 2007-2009.

Editorial_Feb17_04.png

If history repeats itself, we could see another year or even more of this strong upward trend. This has been a historically powerful rally.

It’s all over the news this week how a major mutual fund lost $600 million in the past week as the S&P 500 continued to defy gravity and undo their bearish bets.

I’m thrilled to say that I’ve learned to be wrong and still be long. It’s been one of the most impactful changes for the better in my personal investing. I no longer confuse my ideas about what might happen with what is still actually happening.

I’m still bearish overall on the S&P 500 in the short-term, but I’m happy to wait for the market to confirm my thesis … and I’m happy to be wrong if it doesn’t … and to still make money.

To incredulous profits,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Optimizing Covered Calls with VQ

I’m often asked the question, “Can the TradeStops Volatility Quotient (VQ) help with covered calls?” Today, I’ve got the beginnings of an answer to that important question.

Covered calls are a popular strategy for generating income from your existing portfolio and doing so with limited risk. If you own 100 shares of Walmart, for example, you can sell a covered call option against your Walmart shares. Here’s how it works.

Walmart is currently trading around $68 per share. There are options buyers out there right now who are willing to pay you $1 per share today ($100 total for your 100 shares) if you will give them the right to buy Walmart stock from you at $70 per share any time before April 21, 2017.

This options “contract” is known as the “April 21, 2017 $70 call” on Walmart. The “strike price” is $70 and the expiration date on the contract is April 21, 2017. The $1 per share that you receive equals 1.47% extra income that you’ve generated from your Walmart stock on top of any dividends you will receive.

As an owner of 100 shares of Walmart, you can sell one of these contracts and your contract is covered in the sense that if the the buyer of the contract exercises the right to buy the shares from you, then you’re covered because you already own the shares.

If Walmart trades above $70 per share before April 21, 2017 then you will likely have to give up your 100 Walmart shares for $70 per share.

That’s the very basics on covered calls. If you want more details, you can learn more here.

So … hopefully you can now see that if you’re an investor looking to sell covered calls, it would be great to be able to find just the right covered call to sell that would maximize your income or profit while minimizing the likelihood that you will end up having to sell your existing shares.

That’s the challenge we set out to investigate.

To do so we decided to use the S&P 500 going back over 50 years to 1965. The first question that we asked ourselves was how many days, on average, did it take for the S&P 500 to move one VQ?

Just looking back over the bull market of the past 8 years, you can get an idea of what I’m talking about. The chart below shows how many calendar days it has taken the S&P 500 to move up one VQ for each leg of this bull market.

Editorial_Feb14_01.png
Going back to 1965, we found that on average, it took 210 days for the S&P 500 to move, up or down, by one VQ.

We also asked how long it took, on average, for the S&P 500 to move ½ VQ as well as ¼ VQ. The answers were 115 days and 65 days respectively.

The following chart shows the three data points that we found. ¼ VQ = 65 days. ½ VQ = 115 days and 1 VQ = 210 days … and then we drew a line in between these three points.

Editorial_Feb14_02.png
So, what exactly are we looking at here? We’re looking at a chart that answers the question, “Over the past 50 years, how many days has it taken on average for the S&P 500 to move x VQ’s?” (Sorry for introducing a little algebra here but it was unavoidable if I wanted to share this with you.)

Our goal is to find a way to capture as much income as we can and still have a better than 50% likelihood that the call options we sell will expire worthless (and we’ll get to keep our shares).

Many investors like to sell options that expire 30-60 days in the future. This allows them to easily manage their option trades. Using this criteria, we could sell a call on SPY with a strike price that is ¼ VQ out-of-the-money, 65 days in the future, and there is a slightly greater than 50% chance that the call will expire worthless.

Here are a few details if we wanted to execute this strategy.

SPY is trading at about $232.50. With a current VQ of 10.4%, that means ¼ VQ = 2.6%. When we multiply the current price of SPY by 2.6% we get $6.05. So we’d be looking to sell a call that expires about 65 days in the future and for which the strike price is $6.05 “out of the money.”

To find a call option with that strike price we take the current price of SPY ($232.50) and add $6.05 to it to get a strike price of about $239. Looking 65 days into the future puts us right at about the April 21, 2017 monthly options expiration date.

Thus, our optimum covered call to sell would be the $239 strike price with an April expiration. Currently, that call is selling for around $1.04 which is additional income of 0.45%. That’s a 2.6% annualized return.

SPY currently has a 2.29% dividend yield so it’s possible to effectively double the income generated from SPY by using this strategy.

We could also go out about 115 days, or 4 months, in the future and sell a call with a strike price that is ½ VQ, or about $12 out of the money. And if we wanted to try to maximize the capital gain in our trade, we could sell a call on an option that is a full 1 VQ, or $24, out of the money and expires in 8-12 months.

I think that this is pretty exciting research and I know that many of you will find it very exciting as well. It’s not yet available as a service in TradeStops but I did want to let you know the direction in which we’re thinking.

If you have feedback on this research, we’d love to hear it.

Always balancing risk and reward,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

A troubling signal from the VIX

It’s often said that bull markets climb a wall of worry. That’s certainly been true of this eight-year long bull market. Investors have been nervous and incredulous about this bull market ever since the bottom in early 2009.

What we’re seeing today, however, suggests that all the worry that’s fueled this bull market may have finally been used up.

The CBOE Volatility Index (VIX) measures the short-term volatility of S&P 500 options. In the media, it’s called the fear index. Usually, as the S&P 500 is moving higher, the VIX is moving lower. Institutional traders trade VIX futures all the time and use the VIX as a way to hedge against possible downward moves in the stock market.

Going back over 20 years, the VIX has traded with a strong area of support between 13–17 as can be seen in the volume-at-price (VAP) chart below.

Editorial_Feb10_01.png

The VIX has been creeping closer and closer to the 10 level. It recently moved under 11 during the last week of January.

Why is this level important? Because, the last time the VIX traded at this level was in 2007 before the market crash of 2007-2009.

You can see the critical 10 level in the bottom area of the chart below. You can also see what happened to the S&P 500 the last time we saw the VIX dip below 10 in early 2007.

Editorial_Feb10_02.png

There is also a very stable one-year time cycle on the VIX that has been very accurate over the past decade. This cycle is showing that we’re currently close to the low on the VIX and likely moving higher from here.

Editorial_Feb10_03.png

Each time that this cycle bottomed, the VIX moved higher going forward. And that usually means the S&P 500 is going to move lower.

The time-cycle forecast for the S&P 500 also shows that the market is close to hitting its top and could well move lower over the next few months.

Editorial_Feb10_04.png

I’ve shared my concerns about the current state of the US stock market several times recently. I’m still favoring a move lower in US stocks in the first half of 2017. The fact that the VIX may very well be forming a significant bottom here close to 10 only adds to those concerns.

Of course, the TradeStops Stock State Indicator (SSI) is still solidly green for the S&P 500.

Editorial_Feb10_05.png

Letting our winners run is part of our core philosophy. I’m not hitting the panic button on US stocks by any means, but I do believe that it’s a time for caution and definitely not a time for irrational exuberance.

Have a great weekend,

Regards,

Richard Smith, PhD
Founder & Creator, TradeStops

SSI vs. 200-Day Moving Average

A reader once again challenged us to test our Stock State Indicator (SSI) strategy against a widely followed Wall Street strategy – the 200-day simple moving average (SMA) strategy.

We’re up to the challenge. Let’s get started.

For the past few weeks we’ve been putting our SSI system to the test against buy and hold strategies on the Dow Jones Industrial Average (DJIA) over the past 50 years. We’ve shown that:

  • Even following our most basic SSI strategy nearly doubles the percentage gain and more than doubles the reward-to-risk ratio;
  • Adding our “add-to-your-winners every 2VQ’s” strategy makes the outperformance nearly absurd.

Here’s the chart to remind you where our current research results stand.

Editorial_Feb07_01.png

So … what exactly is a 200-day SMA strategy? It’s simple. You buy the DJIA when the price of the DJIA is above the 200-day simple moving average (SMA) of the DJIA. When the DJIA is below the 200-day SMA, you are out of the market.

Our SSI system is similar in that it is a trend-based strategy – which is why your fellow reader wanted to know if our SSI strategy outperformed the 200-day SMA strategy.

By the way, the 200-day moving average is calculated using 200 trading days, not 200 calendar days. Since there are approximately 250 trading days in a year, the 200-day moving average works out to just under 10 calendar months.

So let’s see how the DJIA has performed over time using both the 200-day moving average strategy and the two strategies that use the TradeStops SSI signals on a reward to risk basis:

Editorial_Feb07_02.png

I think you’d agree the chart speaks for itself.

How about if we look at it just in terms of simple percentage gains? Here you go.

Editorial_Feb07_03.png

From 1966 until recently, both of the SSI strategies substantially outperformed the 200-day SMA strategy. While the 200-day SMA strategy returned almost 1300% during the period, the SSI strategy returned almost 2000% and the 2 VQ strategy returned around 2800%!

And … there were far fewer trades using the SSI strategies. The simple SSI strategy had only 19 trades over this 50+ year period, while the 2 VQ strategy had only 31 trades. The 200-day SMA strategy had 194 trades during the same timeframe.

Wow. I’m not usually one to toot my own horn (though I am getting better at it) … but I have to say, I’m impressed.

I hope you are too,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Gold is Following Our Script…

In December and again in January I outlined a script for gold to form a bottom and start a sustained rally through 2017. That script continues to play out nicely … with gold really starting to shine in the past month.

In just the past six weeks, gold has gained over 8% or nearly $90 per ounce. Most critically, it has recently climbed above critical volume-at-price (VAP) resistance at $1,200 an ounce.

Editorial_Feb03_01.png

The big boys also continue to stake their claim to potential gold profits. The chart below shows how each time the commercial players in the gold futures markets have reached a local extreme (bottom section of chart below where black volume line touches top of red bands) the price of gold has rallied shortly thereafter.

Editorial_Feb03_02.png

My time cycles also continue to be bullish for gold … both in the short-term:

Editorial_Feb03_03.png

… and in the long term:

Editorial_Feb03_04.png

I highlighted the above chart back in December too and mentioned how the real kicker for me would be when the commercial hedgers (bottom section of chart above) add to their position and get back near the zero line.

That would mean that their gold would be officially unhedged and a very strong indication that they’re expecting higher prices ahead. Nice progress has been made in this area in the past month.

Before we get too far ahead of ourselves, however, gold is still in the SSI Red Zone after getting stopped out back in November of 2016.

Editorial_Feb03_05.png

Yes, we took a small loss on the 2016 SSI entry and exit signals, but I’m fine with being wrong once or twice … and then being right big time after that. (I just never want to be big time wrong.)

I think that the next SSI entry signal for gold could be the biggie. I’m watching the US dollar, which is falling nicely … and I’m watching the commercial hedgers in the futures markets to see when they’re signaling “all in.”

For those looking to dip their toes in the water ahead of a new SSI entry signal, call options or a stop loss around $1,100 both look like good bets to me.

I’m patiently waiting for the fat pitch,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Doubling Up On the DJIA

For the past couple of Tuesdays (here and here), we’ve been exploring how our Stock State Indicator (SSI) system has performed against a buy and hold strategy on the Dow Jones Industrial Average (DJIA) during various types of market conditions.

Today I’m going to show you how what I call our “2VQ” strategy of adding to our winners boosts the outperformance even more.

When we left off last week, we were looking at this chart:

https://tradestops.com/wp-content/uploads/2017/01/Editorial_Feb01_01.png

This is a chart of the risk-adjusted returns for the DJIA SSI strategy and the DJIA buy and hold strategy. The SSI strategy greatly outperformed the buy and hold strategy on a risk-adjusted basis.

We’ve talked about risk-adjusted returns before. If you want a more in-depth review you can find it here. The simple idea, however, is how many units of reward did you get for every unit risked. If you can get higher reward for lower risk, you should do it.

Our 2VQ strategy is also known as doubling up on your winners. If you want, you can review the full strategy here. Bottom line … by investing more money as a stock is moving higher, we have the opportunity to increase our profits as the momentum continues to climb.

Here is how our SSI + 2VQ strategy performed against the buy and hold and SSI only strategies:

https://tradestops.com/wp-content/uploads/2017/01/Editorial_Feb01_02.png

The “adding to winners” strategy even further increased the rewards gained for the risks taken beyond the gains that the SSI strategy achieved alone. What I particularly love to see is that the outperformance was consistent and enduring. Once the 2VQ strategy pulled ahead, it never relinquished its lead.

It’s great confirmation that our core risk management strategies outperform buy and hold in different market conditions over an extended period of time.

It’s hard to believe that adding to your winners can actually lower your risk but when you look at it the right way, it clearly does.

Make more … risk less. That’s the TradeStops way,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Profiting from Unpopularity

Two months ago, I told you about an investment that the pundits hated. Since then, it has climbed 17% higher. I’ve spotted another opportunity … and the pundits hate it as well.

Back in mid-December, we looked at EWZ, the ETF for Brazil, and the potential for the Brazilian stock market to continue climbing even after already having booked a 100% gain in 2016.

Since that time, EWZ is 17% higher in only 7 weeks.

ishares s&p 500

Before I reveal today’s subject, let’s see what the pundits have been saying about this particular opportunity.

“Adds yet another wave of uncertainty to sales and profits at the high end”
~ CNBC 24 Jun 2016

“If they vote to leave, the markets will probably never recover”
~ Former BP CEO, John Browne 23 June 2016
“Brexit could be really bad for the final two seasons of ‘Game of Thrones’”
~ CNBC 24 Jun 2016

Yes, we’re talking about the United Kingdom.

EWU is the ETF for the UK market. It was stopped out on the second day of the Brexit crash. It started moving back up and triggered a new SSI Entry signal in September. (Yes, whipsaws happen sometimes … but we err on the side of caution)

Editorial2017_Jan27_02

The price moved lower after the most recent SSI Entry signal and even dipped into the Yellow zone before the US elections. Since then, it has moved higher by almost 9%.

EWU is trading at the top of a very important resistance level. My volume-at-price chart shows that EWU is close to breaking above this level.

ishares s&p 500

A break above the $32 level could send it up another 10% before running into resistance at the $35 level.

So far, it has touched this upper resistance level four times and has not broken through yet. Why do I think it could break through now?

This ETF covers 85% of the UK market. The top 10 holdings account for almost half of the ETF and eight of these are either in the SSI Green zone or Yellow zone. Having 80% of the largest companies in the UK with active SSI signals is bullish. We would expect these stocks to lead the UK market higher.

Editorial2017_Jan27_04

Finally, the time-cycle forecast is very positive for EWU. The forecast bottom is just a few weeks away, and a move higher is projected all the way through the end of October of this year.

ishares s&p 500

Bottom line, EWU is solidly in the TradeStops’ Green zone and my other indicators are telling me that the UK market looks ready for more upside.

As always, I’ll continue to listen to the pundits, but with only one ear.

Sometimes it’s good to be a little hard of hearing,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Bull, Bear, or Sideways, you win!

We’ve shown time and again now that the TradeStops Stock State Indicator system (SSI) can make you more money and can do so under different market conditions. That’s impressive. What’s even more impressive, however, is that it can do so with less risk.

When you factor both reward and risk into the equation you see how truly powerful the SSI system is. Let me show you what I mean.

Last week we responded to a reader’s challenge asking us how the SSI works during periods where a market goes nowhere for a long period of time. To answer that question, we applied our system to the Dow Jones Industrial Average (DJIA) between the years of 1966 and 1984.

In 1966 the DJIA was at 1,000 and 17 years later in 1983 it was also at 1,000. It was nearly two decades of a whole lot of nothing.

We’ve shown numerous time how the SSI system can improve performance during bull markets. What we showed last week is that even during the 17 year long sideways market in the DJIA, the time the SSI system still outperformed a buy and hold strategy.

Editorial_Jan24_01
Just like we can measure a Volatility Quotient (VQ) on the price history of an individual stock, we can also measure it on the performance history of a portfolio or strategy. If we look at the two lines in the chart above, we can ask what the VQ is for each of these two strategies.

For buy and hold, the VQ is 12.2%. That’s how much random movement, up or down, occurred in the buy and hold strategy. The VQ for the SSI strategy, on the other hand, was only 7.5%. That’s a LOT less volatility!

It’s obvious when you look at the chart that the SSI strategy had less risk. It avoided the big dips of 1970 and 1974. Not only did the SSI system outperform buy and hold, it preserved capital during market downturns.

To capture both the impact of reward gain and risk taken, savvy investors look at what’s known as reward to risk ratios or risk-adjusted returns. I’ve written about risk-adjusted returns before. It’s critical for investors to understand the concept. At the simplest level it’s the reward gained divided by the risk taken.
Let’s look at the same chart that we looked at above but this time we’ll divide the gains (rewards) by the VQ (risk).

Editorial_Jan24_01
Factoring in risk here together with reward shows how the SSI strategy outperformed buy and hold even more than we originally thought. If we look just at gains (rewards) the buy and hold strategy ended at a 35% gain whereas the SSI strategy ended at a 60% gain (see first chart above). The SSI did about 70% better than the original 35% gain for buy and hold.

If, on the other hand, we look at the risk-adjusted performance, buy and hold managed 2.9 times the rewards per risk taken while the SSI strategy achieved 7.9 times the rewards gained per risk taken. That’s an improvement of over 170%.

For the record, that risk-adjusted outperformance has been sustained for not just the past 20 years … but for the past 50 years as well:

Editorial_Jan24_01
Pretty cool, huh?

Make more. Risk less,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops

Why the S&P 500 Could Surge Higher this Year

A new chart unexpectedly grabbed my attention this week because it has such big implications for the future of the US stock market. Let’s get right to it.

For the most part the USD and the S&P 500 move in broadly opposite directions. Stocks in the S&P 500, just like gold and oil, are priced in USD. When the USD is increasing in value, it takes fewer US dollars to buy assets priced in US dollars … so the prices of those assets tend to fall.

Below is a comparison chart of the S&P 500 and the USD for the past 30+ years. The gray highlighted areas show the times when these two important assets were moving in opposite directions from one another.

correlation between usd and s&p 500

There are also times when the S&P 500 and the US dollar both move up together. These are usually times of economic recovery … when everything is going right. The chart below highlights such times over the past 30 years.

Editorial2017_Jan20_02.png

What’s extremely uncommon, however, is to see both the S&P 500 and the US dollar moving down together. That has only happened a handful of times over the last 30 years … as seen in the gray highlighted areas of the chart below.

Editorial2017_Jan20_03.png

What’s striking about the times when both the S&P 500 and the USD are moving down together is that they haven’t lasted long … and the stock market has been significantly higher shortly thereafter.

Why does that matter? Because I’ve been telling you for the past month that I expect both the US dollar and the S&P 500 to start downward corrections by late January or early February.

If we do see both the USD and the S&P 500 correct over the next few months, I’ll be eagerly awaiting the start of a new rally in the S&P 500 because I think it could be a very powerful one.

My time cycles analysis on the S&P 500 suggest we could see that rally start to unfold by the middle of this year.

Editorial2017_Jan20_04.png

Waiting patiently,

Richard_Signature
Richard Smith, PhD
CEO & Founder, TradeStops