When I’m looking for good setups I mostly rely on the 8 SMA bands (the upper band is the moving average of the prior candle highs and the lower band is the moving average of the prior candle lows) but often price is too far distanced from the 8 SMA bands to be useful. At those times I’ll view the 20 and 50 SMA bands to see what they may indicate. When price approaches a declining upper band that’s generally a good location for a short (buying Puts or Put Spreads) and when price approaches a rising lower band that’s generally a good location for a long (buying Calls or Call spreads). Below is the 20-day SMA bands of FB.
The daily chart below shows the FB 50 SMA bands. At the current day’s high price was near the declining upper band of both moving averages. When I first noticed the potential good trade location for a short trade price had already backed off of the high and the daily candle was starting to look like a bearish reversal (long upper wick).
I then tweeted about the setup and in the tweet I pointed out the good potential short setup and indicated that if the still-developing daily candle was indeed a bearish reversal then the high of the day, and potentially an even longer period of time, was likely set.
While viewing the FB charts I also looked to see how well the price action was behaving in relation to the monthly pivots. The pivots that I use as support and resistance consist of the yearly, monthly, weekly and daily high, low, and HB (Half-Back or the midpoint of the range). Since FB appeared to be making a bearish reversal on the daily chart I was considering a trade that, if I wasn’t stopped out, I’d be in for at least a week or two and possibly longer. For a trade of that length of time I usually utilize the month pivots for targeting price levels. See a detailed explanation of the monthly pivots on the chart below.
When I see a potential setup on the daily or weekly charts I use the 60-minute chart for the actual trade entry location. Price is seldom away from the 8-hour SMA bands for more than one or two trading day’s so using the 60-minute chart gives me the opportunity to refine my trade entry location. On the chart below you should notice that the current and previous 60-minute candles were at the rising lower band. That’s good location for a long but I was considering a short entry based on the daily chart. What I needed to see was a failure of price to reach a new high for the day as it should have after finding support at the rising lower band. If that happened then the 60-minute chart would align with the daily chart in indicating a short trade.
My tweet from that time indicated that I was expecting a failure of price to rally to a new high for the day and that the current high of the day at 212.48 was the stop on a short trade. I also indicated that I needed to see some downside follow-thru in order to hold a short position over the weekend. After all, if the bears were truly in control, then price should start moving lower.
2 hours later you can see how price was unable to take out the high of the day as it should have if the FB bulls were still in control of the price action. Of course, failure by the bulls is bearish and supports a short position.
Below is a 15 minute chart showing the current price action at the time in relation to the monthly pivots.
During that time frame I was filled on two separate orders of Puts which I tweeted about a couple of hours later. In that 2 hour period from when I bought the Puts I explained that it was already possible to lock-in a minimum profit on the position if I had wanted to.
Here were my fills on the Puts.
Below is what the risk profile would’ve looked like if I wanted to make that adjustment to my long Put position. The adjustment trade would consist of rolling down the Puts that I had bought just two hours earlier by selling them, buying lower strike Puts and then selling further OTM (Out of the Money) Puts to create a Put Vertical spread for a net Credit. That adjustment would’ve created a position with a minimum $45 profit and a maximum $5,045 profit at July 15 expiry.
I didn’t make that adjustment as shown above because the daily and 60-minute charts were now in alignment that the FB bears were in control so there was no need yet to make an adjustment to reduce the position’s short Deltas. Below you can see how waiting until later in the day, as the price of FB declined, would’ve offered an even better ‘adjustment’.
If you are unfamiliar with this style of trading I encourage you to study this post as well as the other posts on this blog and to follow me on twitter. If you have questions or comment let me know.
Thanks for this post. was there any reason you put on two different 5 lot trades to buy FB puts…As compared to placing a single 10 lot FB put order? Thanks
Risk management is the **most important** component in option trading. To reduce the initial capital risk of getting stopped out of a trade I’ll sometimes (not always) initiate a trade with a 1/2 or 1/3 size position and add to it if price behaves as I’ve expected it to. That is cost averaging *up* on a trade (adding to it as the price of the position increases). I typically do that on longer time frame positions. I never, never, never, cost average *down* on a trade!!!! That would mean that the position is moving against me which would mean my price action analysis is not following through as expected. In that case I stop out! Multiple small losses are a part of trading and can easily be eclipsed by *one* large profitable trade.