Markets Take the Stairs Going Up, and the Elevator Going Down

 

When markets rally, it's usually a slow and deliberate climb on the way up. Just like taking the stairs walking up in a high-rise building. When markets sell off, the drop is usually fast and steep, just like taking the elevator on the way down.

Let's look at a daily chart of the US 500 Index.

Look at the difference between the length of each green daily candlestick on the way up. You will quickly notice that they are much smaller than the red candlesticks on the way down.

It's also important to note the relationship of the markets in relationship to  the "T-Line" (8 EMA), which is plotted in purple. On an uptrend, the market travels above the T-Line. On a downtrend, the market travels below the T-Line.

Finally, Stochastics (set at 12,3,3) can help you identify when markets are overbought or oversold, signaling a potential reversal. When it's above the 80 line, a move to the downside is imminent. If it's below the 20 line, a rally back to the upside is also imminent.

Election Week - What's happening?

The US Equity Indices (Dow, Nasdaq, S&P 500, Russell 2000) all broke sharply below the T-Line which suggested that strong selling pressure was in progress.

You can argue all day long as to why that is happening. Covid-19 surge, Stimulus deal delayed, Election-Day jitters prompting a wave of profit taking, or maybe a combination of all. To me, none of that matters. The charts graphically depict investor reaction to the events of the day.

How to trade this?

For my part, I have been extremely cautious over the past 2 weeks. While I trust the market's relationship with the T-Line, I'm also aware that markets can reverse sharply on a tweet.

So, I have consciously made the decision to reduce my exposure to risk through the General Election.

With Nadex, there are a few ways to do that:

1. I can reduce the number of contracts I trade, thus limiting the amount of capital exposed to risk.
2. I can adjust my risk per trade, risking less per contract for a greater reward.
3. I can do both of the above

Stocks take the elevator going down, and this week has been a classic illustration of that adage.

On Tuesday evening at 6pm ET, Nadex opened with fresh new strikes for the following day. The markets closed bearish that day for the 2nd consecutive day, so the decision was made to follow the prevailing down trade, but also to choose a strike price that would reduce my exposure for risk, while maximizing potential gain.

I placed Limit Orders for the following US Equity Indices:

US 500 (Dec) >3363.0  Max Risk $40, Max Reward $60 per contract x 5 contracts

US SmallCap 2000 (Dec) >1570.0  Max Risk $30, Max Reward $70 per contract x 5 contracts

US Tech 100 (Dec) >11460  Max Risk $30, Max Reward $70 per contract x 5 contracts

Wall St. 30 (Dec) >27120  Max Risk $20, Max Reward $80 per contract x 5 contracts

I also placed 2 trades on Forex pairs. One trade one, the other was losing. They cancelled each other out.

In total, I had $600 tied up in risk on the US Equity Trades.  By 8:30am ET, I closed those trades out for $965, representing a 160 percent return on capital risked overnight.

Not a bad trade to wake up to. I decided to cash out with a handsome profit simply because there was no way of telling what the markets would do after the Opening Bell.

This was a low risk, high reward approach to trading uncertainty in the week prior to the General Election.

Using Knockouts to Trade the "Rubber Band" T-Line Trade

 

In my last blog post, I talked about the "Rubber Band" T-Line Trade.

While I'm not crazy about the name of this strategy, it does depict the relationship betwen the 3 Exponential Moving Average (EMA)against the T-Line (8 EMA).

These 2 moving averages track along with each other, but the 3EMA occasionally gaps away from the T-Line. When that happens, just like a stretched rubber band, it always snaps back.

You can catch some very nice price moves with Nadex, risking very little for a potentially nice gain. All you need to do is spot the gap away, and then look for the snap-back to happen.

Today the  US 500 was on a down trend, and the 3 EMA was Gapping away from the T-Line on the 4-Hour charts.

Notice how the Green 3 EMA gapped down away from the purple T-Line. Just like it has done in the past, the market was trying to make its way back to the T-Line.

That's when I decided to try doing a Nadex "Knock-Out" Trade.

Knockouts resemble traditional futures trades, with the exception that they have a hard floor and a hard ceiling. 

In today's case I decided to go long at 11:41am from 3459.9. I chose the 3440-3490 Knockout spread. My maximum risk was approximately $200 for a maximum $300 reward. Each tick the market moves is equalized at $1.

If price travels through the floor of the Knockout bracket, then I'm knocked out for the maximum $200 loss. If price travels through the ceiling of the knockout bracket then the trade closes, and I collect the maximum $300 profit.

You are not married to the trade. You can exit any time you want to lock in profits or to pare losses.

In this case, my profit target was a touch of the T-Line, about 70 or so ticks away.

Sure enough, the market ground its way back up to the T-Line and I exited for a 65 Tick profit, or $65 on one contract traded.

There are lots of ways to trade with Nadex, and Knockouts can be a nice way to capture sudden price moves.

The "Rubber Band" T-Line Trade

 

What happens when you pull back on a rubber band? It snaps back, right?

The same happens with price in the markets when you plot the 3 Exponential Moving Average (EMA) and 8 EMA on your charts. 

The 8 EMA, also known as the T-Line, is an excellent indicator for determining whether a market is on an uptrend or on a down trend. Simply put, if price is traveling above the T-Line, then you are in an uptrend. If price is traveling below the T-Line, you are in a downtrend.

The 3 EMA tracks along with the 8 EMA, but every time it gaps away too far, it snaps right back to the T- Line, as seen on the chart below.

Notice what happens every time the 3 EMA (plotted in green) gaps away from the purple T-Line. It snaps back like a rubber band. In fact, the further it gaps away, the harder it is more likely to snap back.

This can provide some excellent trading opportunities if you spot the 3 EMA gapping away from the T-Line.

In the daily chart above you can see that the US 500 futures are bullish, but also gapping above the T-Line. Looking at the intraday 15-minute charts, the US 500 started to plunge. 

Knowing where the market had the potential to drop to, I chose to SELL the US 500 with Nadex Binary Options as soon as price started to plummet at a price level nearer to the T-Line.

This was a low-risk, high reward trade. I sold 5 contracts, risking $14 to make $86 per contract with a daily expiry of 4:15pm ET. My maximum risk was $70 for a maximum reward of $430.

Within 90 minutes, the market dove through my strike price and kept diving, like the rubber band snapping back. This trade was flashing a profit of $398.75 and I opted to close the trade for a 560% return on capital risked with in 90 minutes.

When you plot the 3 EMA and the 8 EMA on your charts, it will expose some prime opportunities to capture fast intraday price movements.