Monday, July 6, 2009

Buy the Dips, Sell the Rips

I don't tend to comment on TA on this blog much but wanted to shed some insight on my approach to charting.

Technical Analysis can be as complex or as simple as you make it. My opinion of TA is less is more. On my initial venture into charting I naively thought as I progressed as a trader I would continually consult more and more indicators in an effort to receive maximum confirmation in forecasting the future price direction of the stock. Funny thing is I've come full circle in my approach. At first I kept it simple by using a candlestick chart and volume. As I learned the intricacies of indicators, the Stochastic and MACD become my bread and butter with the occasional glance at the Chaikin Money Flow and RSI. However, as my understanding of the importance of price action (trend, support/resistance) and volume grew I began shedding the indicators one by one until I was back to using candles and volume (with the occasional glance at moving averages)

Now I actually get somewhat perturbed when I see someone's screen chalk full of indicators-

Can you say OVERKILL??

For directional trades, all I really worry about are the current trend, momentum, and key support or resistance levels. I believe many traders would benefit from using less, not more.

In my opinion, the following mantra is over quoted, and under utilized.
Buy the Dips and Sell the Rips

The gist of the statement is to trade with the trend: buy dips in up trending stocks and sell rips in down trending stocks.

Now the tricky part is knowing when the dip or rip is done. Sometimes stocks dip or rip too much and put the existing trend in peril. That's the beauty of selling OTM credit spreads - you have a wide margin of error, so that if the stock rips say 2,3, or more additional days after you sold an OTM spread, you still have quite a bit of room before you're crying for your mama.

Using the SPY as our underlying, let's analyze a simple way to utilize credit spreads in "buying the dips and selling the rips".
1. When the SPY is in an uptrend, I will use dips as opportunities to sell OTM put spreads
2. When the SPY is in a downtrend, I will use the rips as an opportunity to sell OTM call spreads
3. When the SPY is trendless, I will sell iron condors (OTM bear call + OTM bull puts)

Now as with any trading system or approach, the devil is in the details. Obviously there will be times when you will be wrong, and that's where proper trade and money management come into play. However, I see way too many people overcomplicating charting and trading by either using way too many indicators and trying to get the stars to align in the sky before pulling the trigger OR spending way too much time searching for trade find perfect individual chart setups. It can really be as simple as using the same underlying (like the SPY) month to month and simply using strategies such as credit spreads to place bullish/bearish/ or neutral trades.

My most successful 6 month spurt came around October 2007 to March 2008, when I used each and every rally in the RUT to sell call spreads. Because the RUT and the entire market were in the midst of a downtrend, I was in "sell the rip" mode. And continued to do so until it didn't work anymore.
I showed a trade journal of a recent RUT bear call spread (view it here). I've subsequently entered other July bear call spreads that have all worked great. Using ""if it ain't broke, don't fix it!" as my current investing thesis, what do you think I'm going to continue to do until it doesn't work anymore?

4 comments:

Tim Justice said...

Love the post TY!!!!

Tyler Craig said...

Thanks Tim

Anonymous said...

Great post. I recently read a great article on the same topic. It was about streamlining your analysis of a stock. The author had a comparison between hiking and trading. I'd have to say that since adopting this strategy, I've been able to get in and out of positions much quicker when I kept my strategy "Streamlined". Thanks for the constant feed of good info!

Mike said...

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