In the past I’ve highlighted many times the importance of the 8 and 20 SMA bands for analyzing price action. I’ve just recently introduced you to the 1.5 standard deviation 20 SMA Bollinger Bands. The Bollinger Bands can add another dimension to your analysis because many of the strongest directional moves occur well away from the 8 or 20 SMA bands and the Bollinger Bands can provide a reference point during those times. In this post I’ll be referring to a bullish move but, of course, the analysis also applies (in reverse) to bearish moves.
In the chart below you can clearly see that the current move in AAPL is a continuation of a strong bullish trend that began more than a month ago. Using the Bollinger Bands as a measure of the strength of the move, price has closed above the rising Bollinger Bands 14 of the past 15 days!
And what does the AAPL daily chart look like with our longtime favorite Heikin Ashi candles? A string of bullish trending candles (blue) with only a single indecisive candle. Price has remained above the rising 8-day SMA bands since June 8th.
So AAPL is in a strong uptrend. We need to analyze the price action from week’s ago to understand the point where we could’ve identified this potential trend and initiated a bullish trade. First, it’s very important to understand that the 3rd wave of a move is almost always the strongest. You don’t know that price is in a 3rd wave until it’s established waves 1 and 2. On the AAPL chart below the low at 122.25 isn’t important until price rallied up the declining 20-day SMA and then began falling again as it should have. At that point I’m watching to see how price reacts as it approaches the 122.25 pivot low. A breakdown below 122.25 would of course be bearish. The two bullish possibilities would be for price to drop below 122.25 and then quickly recover back above that level (failed breakdown) or to find buyers above that pivot low, failure to make a new low and then beginning to rally. That gets me prepared to buy the next breakout.
Now look at the chart below. When price took out the high at #1 that confirmed that the low at #2 was a wave 2 low and that price was in a 3rd wave higher. The candle that confirmed the 3rd wave breakout was an unconvincing bullish candle and so I could’ve waited to see if price continued the breakout. After price consolidated for a few days it had a strong bullish candle (#3) breakout. I could’ve initiated a bullish trade on that close or waited for a potential retracement to the HB zone of that bullish candle. In fact 2 days later price retraced to within $.06 of the 61.8% retracement before establishing a pivot low there and beginning a strong rally.
Using the Thinkback feature in ThinkorSwim we can do a ‘what if‘ analysis. I could’ve initiated a bullish position by buying an out of the money (OTM) Call Vertical debit spread after the breakout into wave 3 was confirmed. Then, as price continued to advance I could’ve Delta Hedged (DH) the position by ‘rolling up’ the long Call by 1 strike for a credit to reduce the position’s cost by about 40%. Then, as price continued to rally even more I could’ve turned the position into a 136/140/143 Broken Wing Butterfly (BWB) and reduced the original cost by almost 90%! The net cost of the position would be just $.14 and the maximum potential profit would’ve been $4.00.
Each trader can decide for themselves if and when they would DH a trade. It’s easy to make a case to say why DH that position at all if price remained in a bullish trend? My response to that is that it’s easier said then done when you’re actually in a trade as opposed to looking at it in the past, but again, each trader must find their own comfort level in holding profitable trades. The point of this conversation is to understand that there are ways to hold positions and reduce cost/risk along the way! Questions or comments? Let me know on the twitter feed.