My first assignment working undercover was straightforward enough…
“Make friends with criminals.”
I was young, just 22. The training was brief, to say the least. I was told to stay out of danger and gather evidence.
My supervisor said I needed to figure out the details on my own. If I used her approach, it wouldn’t seem natural. And if it didn’t seem natural, I would get caught.
Working undercover is not a glamorous job. It’s stressful. One mistake could blow the operation and let the bad guys go free — and put me at risk.
So, I focused on the task at hand. I developed my own techniques. I learned to be comfortable in uncomfortable situations. And we made the arrests.
What does this have to do with trading?
As traders, we need to figure out what tools work for us.
It can be tempting to use other people’s techniques — especially successful ones who seem to have it all figured out.
I should know. I worked with a pretty good trader who taught me everything he knew…
You may not know this, but my first job in the industry was as a trader at his firm. He showed me the ropes, and the strategies he used to find trades — which centered on momentum.
They’re great strategies, and I was happy to learn them. But they were still Mike’s strategies. I would never be as comfortable using them as I would with my own.
I knew that to really succeed as a trader, I needed to find my own way.
Here’s how I did it, and how you can do the same…
How I Created My Volatility Indicator
If you want an edge in the market, you can’t look at the same price charts and indicators as everyone else. You need to create your own tools.
And the process isn’t as complicated as you’d think…
To create my own indicator, I first had to decide what I wanted to trade.
As a new trader with limited capital, I found options appealing — particularly selling options, which is a great way to generate income.
So I studied options pricing, and quickly realized the importance of volatility.
When volatility is high, premiums (the price one pays for an option) are high. And when volatility shifts from high to low, premiums drop.
That’s the perfect time to sell an option. You can sell short an option for a high premium, with the expectation that it will drop. When the price goes down, you can buy the option back lower and pocket the difference, or just wait until it expires worthless and walk away with the entire premium.
To sell options effectively, I developed an indicator that signals when volatility shifts from high to low. This maximizes income while reducing risk. (You can read my full paper here.)
But after testing, I realized I’d also unintentionally created a momentum indicator.
After all, high volatility marks fast price moves. Momentum leads prices — so my indicator also signals when momentum is high, but slowing down. This keeps us ahead of major price moves.
Let’s see it in action…
Below is a chart of the SPDR S&P 500 ETF (SPY) with my indicator at the bottom. The orange-shaded areas are bearish. Green is bullish.
After being bearish since December, we got a quick buy signal earlier this month.
An extended bearish signal followed by a short-lived buy signal is a rare pattern. The last time we saw this was in 2012… And it resulted in a five-month, 21% rally.
For that reason, I expect a bullish summer. It’s still early spring, so we could see some more selling. Though, that means any further decline is a buying opportunity.
And if stocks keep falling and volatility keeps rising, that just means even higher option premiums to sell short and collect income.
I’ll continue to follow my indicator, and trade what it tells me. I’ll share my ideas here, too, and you can feel free to follow along.
But to be the best trader you can be, you need to find your own techniques.
That’s why, next week, I’ll touch on some beginner-friendly software and tools to get started with, so you can create your own indicators and start beating the market.
Senior Analyst, True Options Masters
Chart of the Day:
5-Year Euro Lows
By Mike Merson, Managing Editor, True Options Masters
Regards,This chart doesn’t look pretty for the eurozone…
The Euro, charted against the U.S. dollar, is breaking through multiyear support levels in today’s trading. This comes as Russia cuts off gas supplies to Poland and Bulgaria for not paying in rubles, with threats to continue this campaign not stated, but effortlessly implied.
European natural gas prices also rose almost 20% intraday in yesterday’s trading.
For now, the situation is somewhat contained to relatively small economies. But if Russia cuts off fuel to a larger country like Germany, things could quickly spiral out of control.
The trade to make from this chart isn’t especially clear. Shorting the EURUSD pair here is risky from a technical perspective. More likely, you want to bet on still-higher energy prices across the board, as Russia continues to disrupt the world energy markets.
Managing Editor, True Options Masters