If you’ve been paying attention to the crisis in Greece, you’re probably curious like I am what’s going to happen there. I’m not sure however that you need a strong opinion in order to make money on it.

The Crisis

Ultimately the crisis in Greece boils down to two things:

• The Greeks spent too much and lied about it.
• The other Euro states don’t want them to default, but don’t really want to bail them out.

Germany, the Euro country in the best position to bail them out wants to see serious improvements in their fiscal policy and serious cuts before they extend help.  In fact they’re hoping that just hinting around about giving aid will be enough to calm the bond market down.  It’s not clear however that their populace will put up with the idea of bailing out Greece so that Greeks can retire 10 years before them.  This of course highlights some of the conundrums the EU faces.

The Likely Outcome

Most people think some kind of bail-out will be worked out.  Greece will agree to spending cuts and other criteria and the most fiscally fit EU countries will help them out.  Order will be restored and faith in the EU will be revived.  In fact this is almost assured, because if they don’t bail out Greece, Portugal will probably default right behind them and several countries after that.  The EU can’t afford that kind of crisis so they will help, even though they won’t like it.

If you’re confident in this outcome, you could simply buy calls on the FXE.  Once order is restored in the European Union, the currency rebound and you’ll rake in the easy money.  Of course that’s assuming a lot of things.

The Black Swan

In his book The Black Swan, the author argues (I’m poorly summarizing here), that people by their nature underestimate the likelihood of the improbable.  Because of this you should always bet on the improbable because you’re getting better value for your money.  This is of course a painful strategy to accept, since most of your bets will be losers.  Of course your winners will be magnificent.

In the case of Greece, there is an interesting opportunity to just assume something interesting is going to happen.  Simply buy slightly out of the money calls and slightly out of the money puts.  If order is restored and the FXE rises, the gains should offset your losses on the puts.  If something unforeseen happens, then you will make a fortune on your puts, more than offsetting your losses in the long position.  The only situation in which you lose heavily is if the EU manages to punt the issue down the line and keep the FXE where it is.  So if you think this is a possibility then you probably wouldn’t want to make this trade.

Photo Credit: alaskapine

Sadly I was on the same boat with him then and I’m on the same boat with him again. While I generally wouldn’t want to touch financials, if I had to take a position in the “premium” issues, I would be short. Goldman Sachs has had a huge run. It’s priced for a “V” recovery that isn’t going to happen. This isn’t a technical view, but I wouldn’t trust an indicator that told me otherwise.

The most commonly used indicator by far is the moving average. Its value is easy to understand intuitively and one of the least controversial indicators. Almost any trader will agree to the value of moving averages.

Moving Average Basics

A moving average represents the average value of an issue over a trailing window.  All moving averages are designated in terms of a time span for how many days of trailing data should be included in the average.  For example, 10 day, 50 day and 200 day moving averages are commonly used.  There are however several ways to calculate this average.  The two most common are the simple moving average and the exponential moving average.

Simple Moving Average

The simple moving average is the most obvious type of moving average.  For an X day moving average you simply total the values of the previous X days and divide by X.  However, in addition to being simple, this method of calculation is somewhat volatile.  The fact that all days are given an equal impact on the average leads to a high sensitivity to the value that has just dropped out of the window.

Exponential Moving Average

In an exponential moving average, or EMA the weight of each piece of data decays as it gets farther from the present.  While much harder to calculate, these tend to give results that are less subject noise.  The impact of each day decays exponentially as it gets farther from the present and thus the most recent data is the most influential.

Trading with Moving Averages

Using these moving averages is fairly straightforward.  In general you want to be trading in the direction of the moving average, however there are some caveats:

When price has deviated particularly far from its moving average, there is a good chance it will return and “touch” the MA again.  This deviation can be a good opportunity to take profits and re-enter the position when it returns to the moving average.

When a price crosses a moving average, this can indicate a change in trend direction.  Many traders will use this as an indicator for a trend change.

Moving averages are integral to trading and are also pivotal in calculating other indicators.  They are the basis of most numeric analysis of stocks and understanding them is very important.

Everyone liked the candlestick video so much I thought I’d point out another cool video that makes a good point about how to look at things simply. Those who’ve been reading my technical analysis basics series can tell that I’m a fan of simple chart analysis. This video gives a great example of looking at trends with an eye for a solid trendline, and using other tools for confirming data.

Given several other indicators of broader economic welfare, most potently the money supply, I’ve got a bit of a bearish feel already. The NASDAQ in particular has been a bit overzealous in it’s climb and seems a possibility for an appealing short. Looking at the trendlines in this video you can see some compelling indications that it may be time to start closing out longs at a bare minimum. Of course the evidence has mounted since this video was made and it was a good opportunity to make some money, or at least save some.

It’s also pretty striking to look at the kind of climb we’ve had without any significant retracement. Even if it’s only a short-term dip, there could very well be some money making opportunities here. I never rush in when fighting the trend long-term, but if you’ve been long you’ve made quite a bit of money and you should at least take a look and see if there’s evidence that the tide might be turning.

Click Here to Watch The Video

Am I saying that candlesticks are better than bar charts?  We’ll get to that as well as a great resource to help you make money using candlesticks, but first let me tell you why you should familiarize yourself with candlestick charts.

As you read more and more charts your brain starts to make subconscious snap interpretations.  You learn a particular type of chart the way you might learn a language.  Before you buy or sell you’ll sit down and do rigorous analysis, but having familiarity helps you parse information quickly.  Learning to read candlesticks gives you another dimension from which to analyze a chart and there’s no reason not to know how to use them.

The Difference of Candlestick Charts

So given that they represent the same data, why do you need candlesticks?  Well if you look at a typical bar chart, a lot of the data is deduced.  You have the same information on a bar chart that you do on a candlestick chart, but some information is not immediately obvious.  Did the stock close higher or lower than it opened?  I can tell this at a glance with a candlestick chart, while I need to read the little nubs on a bar chart to know this.

As I mentioned, the same information is there, but on a candlestick chart some of it has already been processed for me.  Thus my powers of induction are freed to look a little deeper.  From years of experience, my mind can intuit from a bar chart whether a stock went up or down, but that information was obvious to anyone at first glance on a candlestick chart.

The distinct shading of the open and close regions also yields other benefits for helping your mind read a chart quickly.  The candlestick has a tendency to make your mind more aware of the area between the open and close by representing it so visually.  It highlights that difference, where a bar chart does not.  Thus the candlestick chart helps my mind prioritize things that a bar chart doesn’t.

So, are Candlesticks Better?

Candlestick and Bar charts focus on different things and provide different benefits.  Neither is “better,” but this answer to me is clear:  Being able to read both is better than being comfortable with only one.  Why limit your analysis to only one area of emphasis.  Why not be able to get the benefits of both methods?

Learning More about Candlesticks

So now you want to learn more about candlestick charts?  INO’s Trend TV currently has a free video about candlestick charts for its users.  It’s free to sign up, and you’ll have access to the video before you need to decide if you’re interested in the product they offer. They’re also offering three other free videos at this time.

TrendTV's Free Video on Candlestick Charts

In this complimentary video, “Advanced Applications of Candlestick Charting,” authors, software programmers, and co-founders of the International Pacific Trading Company, Gary Wagner & Brad Matheny will walk you through:

• History of candlestick charting
• How to interpret candlesticks
• How to merge techniques of Eastern & Western technical analysis together
• How to merge candlestick techniques with your current trading plan
• And more…

This 100 minute complimentary video can be found on Trend TV. You don’t have to worry about watching the whole video at once. After you have a password, you can revisit anytime to watch the rest of a video, review a video, or watch other videos on Trend TV.

Go sign up and put another tool in your toolbox.  How can you regret getting more money making weapons for free?  Speaking of which if you haven’t already, be sure to read our technical analysis basics series for more free information.

The final component of a classical charting education is the study patterns.  Chartists can name a bewildering array of patterns and it would be ridiculous to try to cover them all.  Moreover it’s not clear that they provide as much value as their proponents might argue.  That being said, there are several basic patterns that are routinely discussed and are worth noting.  If nothing else the fact that people believe in these patterns means they will likely have some merit.

Gaps

Gaps occur when the low of a day is higher than the high of the previous day, or the high of a given day is lower than the low of the previous day.  They are quite easy to see on charts and they tend to stand out.  Gaps often occur on the heels of news or other outside influences, however they can be mysterious.

Typically gaps indicate a burst of momentum in a given direction.  However they can also indicate an aberration that will be corrected.  The conventional wisdom in telling the difference is that gaps that are followed by new extremes in the same direction are indicators in that direction, while those that do not make new extremes will usually “close the gap.”  So if a stock gaps up and subsequently makes new relative highs, then the gap is considered to be “confirmed.”  If on the other hand the stock fails to make new relative highs, it’s likely that the stock price will return to pre-gap levels.

Other Patterns

There are a myriad of other patterns.  We may cover them in more detail in individual articles, but they are of less use than basic support, resistance and trend analysis in the author’s opinion.  Some of the more common ones like the head and shoulders or double top/bottom can be useful tools, but others can be nearly a Rorschach test, where the investor can see what he or she wants to see.  Here is a brief list of some of the more common patterns:

• Head and Shoulders
• Lines
• Flags
• Triangles
• Rectangles

Each of these may have some merit, but I recommend using more clear cut indicators in addition to these in your analysis.

Once we understand the concepts of support and resistance we can talk about the two basic states a trend can be in: A trading range and a trend.

A Downtrend -- Note the lower highs as well as the lower lows.

A trend exists when prices are moving in a direction.  When prices are consistently becoming higher, you are in an uptrend and when prices are consistantly lower you are in a downtrend.  This distinction may sound arbitrary but the basic definition is that when prices are reaching higher highs and higher lows then the price is moving upwards and vice versa for downwards.  When prices are not trending they are considered to be in a trading range. In this state, most prices hit roughly the same highs and the same lows.

Obviously these defintions only make sense in terms of a timespan.  A particular issue can be in a long-term uptrend, but a short term downtrend.  This is usually defined by what time period a bar represents on a graph and what kind of timespan in which you are planning on executing your trade.  Moreover traders oftentimes tend to avoid issues when they are in a trading range, however this can be a great opportunity to profit using options.

Trading Trends and Trading Ranges

The rules of trading trends are fairly obvious.  You very rarely want to trade against the trend for the timespan in which you are investing.  While you might trade against a long-term trend if you plan on holding for only a short period of time, or against a short-term trend if you’re planning on holding for a long period of time, typically you want to trade with the trend.  Additionally, profit taking can be very difficult in trading ranges.

You’ll find that most techniques for trading are not rocket science. In fact most of the difference between traders who make money and traders who lose money is about discipline, not about technique. That being said, there are some approaches that I feel can help broaden your toolbox and could be a missing component for some traders. Today I’m going to talk about what I call the “Triple Call Technique.”

I utilize this approach in several situations:

• One is in a market like now, where I lack conviction and I feel that overall the issue I’m looking at might be trading in a line.  In cases where I’d like to go long something, but I’m feeling very risk averse this method can be great.  It works particularly well going long on issues that pay a high dividend.
• Another is when I’m looking to hedge a position.  Typically when I’m hedging I’m trying to pick the issue most likely to benefit if I’m wrong and give myself a small upside on that position.  This can also be useful in markets like today’s where I tend to lack conviction in any fundamental sense.
• Finally I can use this in auto-trading systems where I’m trying to build up a position in something over time.  I have a tendency to employ this with ETFs to gain exposure to a certain position over time.

Ultimately the crux of the system is pretty simple.  Let’s assume I’m going long but it can be used in exactly the same way to go short.  This only works with stocks and ETFs in which you can sell options, so they typically can’t be thinly traded.  Typically I set up some type of automated system that will notify when certain criteria are met.  One great approach is to use Market Club’s Trade Traingle system and get notifed whenever a particular score is hit.  You could also consider using any indicator or combination of indicators, even something as simple as Moving Average crossovers.  Once my signal is hit, I take my position and then immediately sell calls as follows:

• 1/3 I sell a deep in the money call.
• 1/3 I sell a slightly out of the money call.
• 1/3 I leave uncovered.

If I’m hedging or otherwise particularly skeptical of the position, I will sometimes not take the uncovered position at all.  What you’ve essentially done by doing this is get your cost basis down but severely limit your upside.  If the intent of the position is to hedge another position this can be perfect.  Additionally if this is a position where you’re likely to get out if it runs very far anyway, then a limited upside isn’t really a liability, since it should be offsetting the limited risk as set by your stop.  Meanwhile you’re risk is significantly curtailed.   Let’s take an example from today’s prices:

Suppose I want to gain exposure to international sales to offset a bias in my other trading positions.  To do this I set a series of watches on Market Club to let me know when any of a series of stocks hits a score of 90.  If you’d like to get a FREE score for a stock just sign up here.  As of today PM is has a score of 90, which is a strong uptrend so let’s use that as my buy signal.  Phillip Morris International closed today at $48.18.  Now let’s start with my in the money call.  Assuming we’re using Dec calls, here are my possible selection:

With these options available, you might be surprised to learn I would take the $43 strike price option. By taking that on 1/3 of my position, I would make 0.88% in 2 months as long as the price stays above 43. If it plummets and goes to $41 then it has brought my price for that block down to $42.67. This makes my hedge less painful if I’m right.

On the second third of my position I would sell a $50 strike price call for $1.20.  Then I would leave the final third uncovered.  The net result of all this is that my average price is $45.94.  Let’s look at what I gain or lose at various prices:

As you can see, the net effect is that if the stock goes down a lot we lose less than we would have otherwise. If the stock stays about flat you make more than you would have and if the stock goes up you make less than you would have otherwise. Ultimately it dampens your effects in either direction. If I did this over a significant period of time with automatic trading signals and a selection of appropriate stocks, I could build up significant exposure without nearly as much risk.  When trying to build up a position, or in unconvincing market the key components are:

1.) Using an Automatic Trade Indicator
2.) Selling staggered options on portions of your position.

When hedging you should simply take the position to offset your other positions.  You can see the many applications, especially in environments where you are risk averse.

Photo Credit: Corey Leopold

Probably the first type of chart analysis to come into play is the analysis of area areas of support and resistance.  Support is a price level at which buying increases to either pause or reverse a downtrend.  Similarly resistance is a price level at which selling increase to either pause or reverse an uptrend.  This sounds complex, but is really quite intuitive in practice.

For the purposes of this conversation we’ll assume we’re talking about a stock, although this applies to any traded issue.  Intuitively you can imagine that various members of the market see the stock as atractive at a certain level.  As the price gets lower and lower more members start to see the stock as underpriced.  This effects becomes manifest at a certain price at which there doesn’t remain enough selling power to push it down and the price  ”bounces off” the support level.  In this chart that price is roughly 87.

Support and Resistance (Blue and Red)

The same effect happens in the positive direction as well.  As the price raises participants  increasingly lose their conviction in the stock.  Eventually it reaches a price at which equilibrium is reached, at least temporarily and the price “bounces off” downward.  This is a resistance level.

Interestingly, like many technical indicators, this effect is more pronounced because other traders believe in it.  As the price approaches a support level, more players will go long to see if the price will reverse.  This additional buying tends to create a self-fulfilling prophecy.

Strength of Support and Resistance

These effects are easy to see in a chart.  Over time there are obvious price levels at which price movements either slow down or stop their directional movement.  The more times a price fails to penetrate a line of support or resistance, the stronger the effect is pereceived to be.  Each time the bears or bulls fail to penetrate a given line, the less optimistic they will be about breaching it.

Addtionally support or resistance in longer term charts tends to be perceived as more meaningful than in short term charts.  There are typically levels of support and resistance in each time period and they should be approach holistically.  Don’t ignore the long term support and resistance just because you’re making a short-term trade.

Trading Support and Resistance

Prices Can Only Stretch So Far

Trading using support and resistance lines is very basic and should be considered in just about any strategy.  Even the most complex strategy will usually pay heed to support and resistance lines.  Support and resistance lines can provide great index lines for where to enter or exit trades.  Additionally they can provide “stops” that indicate when your trade has moved against you.

In a simple example, when a stock “boucned” off it’s support, you might buy and then place a stop just on the other side of its support.   Thus if you’re right, the price will continue away from the support and you will make money.  If the stock moves the other way and pierces the support level, there is evidence you picked the wrong time to get in.  Support and resistance levels also provide good places to tighten your stops in positions you’ve already taken.

Ultimatley noting areas of support and resistance will become second nature.  They are both one of the most obvious and one of the most important components of chart analysis.  It pays to pay attention to them.

Photo Credit: fazen

No one factor is likely to drive broad trading decisions than inflation. As with so many other factors right now, there are fundamental indicators swinging in both directions when trying to make a call on inflation. The conventional wisdom has been that a recovery will mean inflation due to a policy of quantitative easing, and that if the green shoots aren’t really green, that we’ll have deflation. There are problems with both of these suggestions however.

The Problem with the Deflation Hypothesis

If you look at the CPI numbers you will be impressed with the year over year (yoy) deflation.  The recession has been biting us hard and we’ve been tightening our belts driving prices down.  That all sounds good except the data don’t seem to support that at all.  If you look at the 12 month CPI numbers for June 2009, you’ll see that other

than Transportation and Energy there has been no other sector that has experienced deflation.  Let’s be clear about what that means.  Despite all the panic going on, overall prices haven’t come in at all except for the collapse of oil prices and the disinterest in cars.  This would seem to suggest that once the economy gets moving again we’re going to have rampant inflation once all the money the government has printed gets moving.

The Problem with the Inflation Hypothesis

But of course things can’t be that simple.  On the flip side of all this is an important fact:  A tremendous amount of wealth was destroyed in the financial crisis.  While the numbers vary, there are suggestions that somewhere around 40% of the world’s wealth was destroyed by the financial crisis.   Imagine the impact of that destruction of wealth on the buying power of the world.  If people are not exercising the same purchasing power they did before, then all that money that the government is printing may never gain enough velocity to cause any real inflation.  Unless governments printed a lot of money, they’re going to have a hard time counteracting all that destruction of wealth.

Another Case for Technical Analysis

This leads me to the same old drum I’ve been beating all along.  In cases like this you have to resort to the technicals (e.g. this free video from INO.com, simply join their mailing list and you’ll get a fantastic resource for free).  Buy (or sell) and hold can be disasterous when applied at times of chaos like this.  You can be right in the long term and still go broke in the short term.  Thus I strongly suggest arming yourself with the tools to make decisions based on market psychology as well as other factors.  In addition, in times like this you can hedge your bets with what I call the the “Triple Call Technique.”

Photo Credit: Erik Charlton