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Larry’s note: Welcome to Trading with Larry Benedict, my free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us. My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’m featured in the book Market Wizards, alongside investors like Paul Tudor Jones. But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it… |
Up until the end of 2021, investors did well from “buying the dip” and hanging on for the ride…
However, it’s a strategy that no longer works today.
Rapidly rising interest rates as a result of chasing rampant inflation is putting a deadweight around the neck of the market.
That’s why I’ve been telling readers that they need to be nimble by sitting on the sidelines… and to jump on a trade only when they see a strong setup.
You need to be ready to take any profits off the table and prepare for the next trade.
While that might sound good in theory, today I’m going to show you exactly what that means…
To do that, I’m going to use a trade that I recently did on ARK Innovation ETF (ARKK) with my trading service, The Opportunistic Trader.
You can see in the chart below that when we did the trade, ARKK was in a strong downtrend (left red arrow). From trading at around $125 in early November, ARKK had fallen over 50%…
ARK Innovation ETF (ARKK)
Source: eSignal
The 10-day moving average (MA – red line) had crossed down below the 50-day MA (blue line) back in November, with both in a downtrend.
However, the 10-day MA line had retraced several times toward the long-term 50-day MA.
It’s these nuances in the markets where the real opportunities lie…
I was also watching the Relative Strength Index (RSI) in the lower part of the chart. If you look at ‘A,’ ‘B,’ and ‘C,’ you’ll see a pattern…
When the RSI went into oversold territory (below the lower grey line) and formed a ‘V,’ ARKK subsequently rallied.
With the RSI again forming a ‘V’ at ‘1’ – and at a higher high than ‘C’ – we took out a long position by buying a call option (which increases in value when a stock goes higher) on ARKK.
Remember, when there’s divergence between the share price and the RSI (as there was here), that often leads to a change in direction.
We saw this as the RSI rose, sending ARKK higher, and our call option increased in value.
Then, just a week later when the RSI closed right in on resistance (green line) at ‘2’ – we closed out our option position for a 94% gain.
To clarify, we generated this return using options. So, this represents a far bigger gain than if we had directly bought the shares.
Another reason we buy options is because we know the maximum amount we can lose (the premium) before we place our trade. That’s important during these volatile times in the market.
Now, we don’t always get it right. When we placed a similar trade on ARKK around a week later, we closed it out for a 22% loss.
However, by using a consistent winning strategy, the volatility we’ve seen this year has seen our overall returns go through the roof.
When most folks look at the ARKK chart, they only look for the most obvious moves.
However, professional traders look for all the smaller (and profitable) counter moves that the rest of the market misses. And in doing so, give themselves the edge.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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