Bullish MACD Divergence -Trade Analysis IWM
The Options Hunter Approach is based on four distinct aspects
Step 1: Divergences in technical indicators warn that the current trend is losing momentum in the short term. The stock or index is making new highs or lows, and the MACD indicator does not confirm new highs or lows, which is known as a divergence.
Macd Divergences can be Bearish or Bullish and signals to option traders a potential opportunity for extraordinary gains. Divergences can occur in any timeframes and with many indicators, but we’ll address multiple timeframes in-depth shortly.
The Options Hunter approach focuses on divergences between the MACD and the price action. We don’t employ other indicators such as RSI, Stochastics or Bollinger bands as we keep our approach simple, straightforward, and repeatable
In this example, we’ve identified a Bullish Divergence on the MACD indicator in a striking contradiction to the Double Bottom in the Price Action.
Step 2: The second criteria is the Price Pattern. The Options Hunter MACD Divergence must coincide with at least a Double Bottom or Double Top.
IWM had a double bottom, which satisfied the Price Pattern component, coinciding with the Bullish divergence on the MACD Indicator on the 15-minute Chart. This is a promising trading candidate. The Next step is the application of multiple Time frames is critical for Options traders.
Step 3: Multiple Time Frames is the exercise of reviewing a potential trade setup under differing time frames. The granularity of the time frames defines your trading style. A good rule of thumb is using a ratio of 1:4 or 1:6. Determining your time frames will clarify the type of trader you are. We consider ourselves medium-term traders as defined by Trading Style.
Longer time frames establish the overall trend. IWM has a bullish MACD divergence along with a double bottom. Now we examine the lower times for an entry. We are not looking for any additional divergences, but they sometimes appear.
Here are some examples of timeframes that are often grouped.
|Short||10 Minutes||15 Minutes||60 Minutes||Less Than a day|
|Medium||30 Minutes||4 Hours||Daily||Hours to Days|
|Long||60 Minutes||Daily||Weekly||Days to Weeks|
In this example of IWM, we identified a Bullish Divergence on the 15-minute chart.
The 5-minute chart MACD turns up in the direction of the 15-minute MACD divergence and gives us our entry point to determine optimum trade execution.
Price Target, Trade Duration and Exit Plan
The divergence pinpoints the change in trend and provides an estimate of the magnitude and the duration of the move.
Price Target can be estimated by simply comparing the slopes of the divergences to gauge a potential target price.
In the IWM example, we’re simply comparing the slope of the trendline on the MACD divergence and overlaying it on the price to calculate a potential target price for the move.
Trade duration can be estimated by counting the number of bars required to establish the divergence and use that number to estimate the number of bars (periods) the trade could last.
Step 4: Trade execution is the most critical aspect of the Options Hunter approach and, in some ways, the easiest. The options we trade have two characteristics
In IWM, the slope, and duration of the MACD divergence give us a target of around 230 for IWM over 40 or so 15-minute bars.
The pattern would complete within a day, and the closest out of the money weekly option to expiration was the June 30 230 calls. Entry would have been toward the end of the first 30-minutes of trading around 10c a contract. The options range for the day was from 1c to 60c. An exit on the MACD losing momentum would have exited the position in 2 1/2 hours at 30c to 40c for over a 300% gain.
Let’s examine this theoretical example.
Assume we fund our trading account with $1000, and the plan is to take options positions of $200 per trade. The Options Hunter only uses Weekly Out-of-the-Money Options (or the monthly when that week is the expiration) which explode with movement in the underlying security.
In our example, the first two trades were flat-out losers, and the remaining three trades showed modest gains.
|Trade Size||Purchase Price||Contracts||Selling Price||% Loss/Gain||Net Dollar Gain||% Return|
Over the five trades, we showed a return of over 100%. We’ve posted more detailed information on the weekly options below to highlight the benefits of using weekly options
What are Weekly Options and Why Do I use them.
Trading Weekly Options can result in extreme profits, and those profits can also be incredibly volatile.
How do Weekly Options Differ from Monthly Options?
Weekly options and monthly options are similar—the primary difference between the two lies in the expiration dates. Monthly options expire every month on the third Friday of the month, whereas weekly options expire almost every Friday and are issued on Thursdays.
Traders who were previously limited to just 12 options expirations each year with monthly options can now capitalize up to 52 expirations by adding the tool of trading weekly options to their trading portfolio.
Weekly Options are More Cost-Effective than Monthly Options
Weekly options are less expensive than shares of the stock and cheaper than standard monthly options. This is because the time duration (premium) is minimal with weekly options, as traders have only a couple of days to wait for the underlying stock to make the predicted move. Do not be scared off by the quickness of these weekly options trading opportunities. The increased volatility within the weekly options trade holding period presents an increased profit-taking opportunity, more so than an increase in risk.
Weekly Options Listings Feature Popular Stocks and Indices
Weekly options listings change every week, mainly because the weekly options expiration period is limited. The CBOE is always in a constant process of listing attractive weekly options to increase trading volume. Therefore, traders have seen a significant rise in the popularity of weekly options over the last few years. High-volume stocks are the most likely going to make it to the new weekly options list each week. Additionally, the weekly options listings may also include stocks that are slated to announce big news in the near term.
Weekly Options Maximize Profit Potential
Weekly options allow traders to profit during any kind of market environment. The short-term nature of weekly options trades calls for efficiency in a fast-paced stock market that can be highly unpredictable for long-term investments. With weekly options trades, traders can benefit from buying cheaper options and then selling them for more than purchased within a short period of time.
Regardless of the price movement, it is always possible to see triple-digit returns with weekly options buying. Unlike stocks that only benefit investors if the stock price increases, weeklies let traders benefit regardless of the stock price direction.