I’ve read a few option books.
THANKS... This is probably the most comprehensive "greeks" article/book I’ve read.

Wonderful blog. …..
A wonder wealth of knowledge there. Thanks so much for your kindness in publishing it!

Thank you very much for the most concise and simplest option intro. Highly recommended.

So far, yours is the best blog/site on basic options notes in the web that I have chanced upon.

Thursday, September 27, 2007

Understanding Candlestick Formation – Part 3: DOJI & LONG-LEGGED DOJI

Apart from the major candlestick formation discussed in Part 1 & Part 2, there is one more candlestick formation that is important in candlestick chart analysis: “Doji”.

The following are some forms of Doji candlestick:

1) Doji
Basically, Doji is formed when the opening and closing prices are virtually equal. (The open and close ideally should be equal, but not necessarily). The length of the upper and lower shadows can vary. Hence, some doji can look like plus sign, a cross, or inverted cross.

Doji represents indecision or tug-of-war between buyers and sellers. The stock was trading higher and lower than the opening level during the session, but closed at or very near to the opening. That means neither buyers nor sellers could gain control, signaling indecision and that a turning point from the existing trend could be nearing.

Doji by itself is a neutral pattern. Doji could provide a reversal signal in relation to the preceding trend and future price confirmation.
Hence, when a doji forms on the chart, pay attention to the preceding candlesticks / trend:

When a doji appears after an uptrend (e.g. a series of candlesticks with long white bodies) or when a doji forms at the resistance, it signals that the buying pressure is starting to diminish, and the uptrend could be nearing to an end. Because in order for price to continue rising, more buyers are needed. The appearance of doji in this case implies the lack of new buyers. Even after the doji forms, further downside is required for bearish confirmation.

In contrast, when a doji appears after a downtrend (e.g. a series of candlesticks with long red/black bodies) or when a doji forms at the support, it signals that selling pressure is starting to weaken, and the downtrend could be nearing to an end. Even after the doji forms, further upside is required for bullish confirmation.

However, if many dojis are observed in a chart, the appearance of a new doji will not carry too much weight in signaling a reversal.

2) Long-Legged Doji
Long-legged doji have long upper and lower shadows that are almost equal in length.
These doji indicate that prices moved considerably above and below the open during the session, but closed at or very near to the opening price, reflecting a great amount of indecision in the market and that a change of trend could be nearing.
Similarly, this kind of dojis also may signal a reversal depending upon the preceding trend and further price confirmation, as discussed above.

Continue to Part 4.

Related Posts:
* Learning / Understanding Candlestick Charts
* Learning Charts Patterns

Monday, September 24, 2007

Understanding Candlestick Formation – Part 2: LONG SHADOWS, HAMMER / INVERTED HAMMER & SPINNING TOP

The following are some common & important candlestick formation (Cont’d):
(Please refer back to Part 1 for the pictures of each of the following formation)

3) Long Shadows
Upper shadows of a candle represent the session high, whereas lower shadows represent the session low.

Candles with a long upper shadow and short lower shadow (the 1st candle in Picture 3) imply that buyers at first dominated at the beginning of the session and push the price higher from the opening. However, towards the end of the session, sellers became more aggressive and forced the price down from their highs, creating a weak close near the opening.

Candles with a short upper shadow and long lower shadow (the 2nd candle in Picture 3) imply that sellers dominated at the beginning of the session and push the price lower from the opening. However, by the end of the session, buyers came and got more aggressive and drove the price up from their lows, creating a strong close near the opening.

4) Hammer / Inverted Hammer
The 1st candle in Picture 4 is actually another form of Long Shadows candle with special characteristics of long lower shadow, no upper shadow, and small or no body (The shadow has the multiple length of the body).
This kind of candle can form “Hammer” (a bullish pattern during a downtrend) or “Hanging Man” (bearish pattern during an uptrend) depending on the pattern preceding it (uptrend or downtrend).

The 2nd candle in Picture 4 has long upper shadow, no lower shadow, and small or no body (The shadow also has the multiple length of the body).
This kind of candle can form “Inverted Hammer” (a bullish pattern during a downtrend) or “Shooting Star” (bearish pattern during an uptrend) depending on the preceding pattern (uptrend or downtrend).

The above patterns are discussed further in the following:
* Hammer vs. Hanging Man
* Inverted Hammer vs. Shooting Star

5) Spinning Top
Spinning Top is a candle that has small body with upper and lower shadows that exceed the length of the body. Spinning Top signals indecision.
The small body (whether hollow or filled) indicates little movement from opening to closing, and the shadows suggest that both bulls (buyers) and bears (sellers) were active during the session.
Although prices moved significantly above & below the opening during the session, at the end the session closed near to the opening. That means neither buyers nor sellers could gain control, signaling indecision.

Continue to Part 3: Doji.

Related Posts:
* Learning / Understanding Candlestick Charts
* Learning Charts Patterns

Thursday, September 20, 2007

Understanding Candlestick Formation – Part 1: LONG CANDLES & SHORT CANDLES

One of the reasons why candlestick chart gain popularity among traders is because its formation can provide visual analysis of other traders’ sentiments. Hence, in candlestick chart reading, it’s important to understand what the candlestick formations imply.
The following are some common & important candlestick formations:

1) Long Candles / Wide Range Candles
A long candle represents a large price move from open to close. Basically, the length of a candle body indicates the intensity of buying or selling pressure. The longer the body is, the more intense the buying or selling pressure. Long candles with high volumes normally imply high volatility or high interest in the stock.

Long white candles show strong buying pressure. It means that buyers were aggressive and hence pushed the price up significantly from open to close.

Long red / black candles show strong selling pressure. It means that sellers were aggressive and hence pushed the price down considerably from open to close.

2) Short Candles / Narrow Range Candles
Short candles indicate small price movement (from open to close) and represent consolidation. Short candles with low volumes usually also imply low volatility or little interest in the stock,

This kind of low volatility period may lead to good trading opportunities. Because low volatility leads to high volatility, and high volatility leads to low volatility. Hence, a breakout / breakdown after a period of low volatility usually could result in an aggressive movement & strong momentum.

Continue to Part 2.

Related Posts:
* Learning / Understanding Candlestick Charts
* Learning Charts Patterns

Tuesday, September 18, 2007

Understanding Implied Volatility (IV)

Understanding volatility is very critical in options trading. Find out more on the understanding of Implied Volatility in simple explanation yet clear and easy to understand. (And see if you agree with a reader’s comment here: “By far yours is the best blog/ site on basic options notes in the web that I have chanced upon.”) :D
Click the following links to read each topic:

1) Historical Volatility (HV) vs. Implied Volatility (IV): Definition

2) How To Get Historical Volatility (HV) vs. Implied Volatility (IV) Information:
a) How To Get HV vs. IV Info – Part 1
b) How To Get HV vs. IV Info – Part 2

3) Relationship between Historical Volatility (HV) and Implied Volatility (IV)

4) More Understanding About Implied Volatility (IV)

5) How To Determine If An Option Is Cheap (Underpriced) Or Expensive (Overpriced):
a) How To Determine If An Option Is Cheap (Underpriced) Or Expensive (Overpriced) - Part 1
b) How To Determine If An Option Is Cheap (Underpriced) Or Expensive (Overpriced) - Part 2

6) The Behavior of Implied Volatility (IV) & Historical Volatility (HV) Before & After Earnings Announcement

7) Example on How Implied Volatility (IV) Affects Option’s Price Significantly

8) What To Consider When You Are Buying An Overpriced (High IV) Options?

9) Volatility Smile and Volatility Skew:
a) Part 1: Description
b) Part 2: More Understanding
c) Part 3: Why Volatility Smile and Skew Happen
d) Part 4: Implications of Volatility Smile & Volatility Skew
e) Part5: Strike Skew and Time Skew

Related Topics:
* FREE Trading Videos from World Class Trading Experts You Should Not Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Option Greeks
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Learning Charts Patterns

Monday, September 17, 2007

How To Read Candlestick Chart – The Basic

Candlestick charts have been widely used & popular among traders.
I personally also prefer candlestick charts to bar charts, although both charts contain the same information: Opening Price, Closing Price, High Price & Low Price, over a given time interval.

In a stock price chart, you can select the time interval for each candle: weekly, daily, hourly, or even minutes.
Each bar / candle represents the range of price movement over the selected time interval.

The hollow (white) or filled (red) portion of the candlestick is called Body, which represents the Opening & the Closing Price.
The long thin lines above and below the body is known as Shadows / Wicks / Tails, which represent the High & the Low price.

White Candle means Bullish because the stock price increases during the period. The stock closes higher than its opening price (i.e. the stock opens at the bottom of the body and closes at the top of the body).
In some charts, the color of Bullish candle is green instead of white.

Red Candle means Bearish because the stock price decreases during the period. The stock closes lower than its opening price (i.e. the stock opens at the top of the body and closes at the bottom of the body).
In some charts, the color of the Bearish candle is black instead of red.

Normally, the color combinations to represent Bullish vs. Bearish candles are White vs. Red, White vs. Black, Green vs. Red.

Compared to traditional bar charts, many traders find that candlestick chart is easier to see to interpret the price action.
For example:
White candle (i.e. Closing price is higher than Opening price) indicates buying pressure, or in other words, buyers are in control over sellers.

Red candle (i.e. Closing price is lower than Opening price) indicates selling pressure, or in other words, sellers are in control over buyers.

With this article, I’ll start a series of posts to discuss some common & important Candlestick formation & patterns. I’d like to make them straightforward yet comprehensive and easy to understand. Hope it can be useful for the readers.

To read further about each of major Candlestick Patterns, go to: Learning Candlestick Charts.

Related Posts:
* FREE Trading Videos From World Class Trading Experts You Should Not Miss
* Learning Charts Patterns
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

Friday, September 14, 2007

Reading Links

Recent Market Analysis

* CNNMoney.com:. Why the credit crunch may deepen.

* Hans Wagner at Financial Sense.com: Do Investors Really Want The Fed To Lower Rates?

* The Big Picture: Employment Population Ratio & Recessions.

* Bispoke Investment Group: The Business Cycle -- Expansions And Recessions: 1900 – 2007.

* Mattew Rees in American.com: The Hunt for the Black October.

Trading Education

* How to be consistently profitable in the markets by Richard from Move The Market.

* Multiple Timeframes Can Multiply Returns by Joey Fundora a.k.a. Downtown Trader.

*Using Emotion To Change Emotion by Dr. Brett Steenbarger.

* Market Timings and Emotion by Stockbee.

Wednesday, September 12, 2007

Reverse Psychology For Success

I came across a great motivational article that is related to trading on the importance of Goal Setting (Part 1 & Part 2) by Dr. John Eliot in the Weekly Newsletter of Dr. Van Tharp’s International Institute of Trading Mastery.

I truly recommend you to read the full articles.
In this post, please allow me to quote only a part of the article that I personally find very inspirational. It’s about the “Reverse Psychology For Success”.

Here they are:


In the five areas below the opposite of what we normally think may work in our favor.

Having Confidence
The best in every business are likely to strike most people as irrationally confident, but that's how they got to the top.

Richard Branson, Bill Gates, Michael Dell — they first believed in themselves, utterly, and let their belief be their guide. Sure they experienced numerous obstacles and setbacks and failures. Confidence allowed them to keep getting up and looking for ways to move forward.

Legends Never Say They're Sorry
Having a long or frequent memory for mistakes and a short or infrequent memory for successes is a guaranteed way to develop fear of failure. High achievers dwell on what they do well.

Learn from your mistakes? Of course. The road to success is full of adversity from which we can gain significant insight. The key, however, is to set aside specific, deliberate times for evaluation. Process setbacks, errors, and your performance at times when you have planned to.

The alternative is to get caught up in second-guessing, doubt, and worry whenever things look a bit gray. You excel during the tough moments by having a positive blueprint to look at — and to have a positive blueprint, you have to spend a lot of time looking at the image of success.

Where Stress Works
The so-called detriment of stress is the psychological interpretation you place on critical situations, not the stress itself. If you want to perform at your best, change the lens through which you view stress.

Put All Your Eggs in One Basket
Unlikely accomplishments are born out of single-minded purposefulness. Future superstars don't get there by keeping part of their heart in reserve.

Multitasking is merely doing a bunch of things half-heartedly all at once. Isn't the idea to perform at your utmost? If you truly want to find out what your potential is, you've got to pour everything you've got into one thing at a time and be committed to it. If you hold back, you'll never know.

And if you put all your eggs in one basket and drop the basket? Guess what: They'll make more eggs, and there are plenty of baskets to choose from.

For exceptional people, risk equals reward. The challenge of uncertainty is the fun of doing the job in the first place — and where overachievement lies.

High achievers do not look for the safest, most comfortable, or sure solution. That would not push them or their companies to grow. Growth is the key — something stockholders certainly understand. But growing requires going to new places and thinking new things — not succeeding at the new, but learning from the process regardless of outcome.

Michael Jordan, perhaps the most legendary basketball player of all time, based his entire performance philosophy on the notion: "I am a success because I have failed more times than anyone in history."

Perhaps you can find some of Michael in you!?

Monday, September 10, 2007

Stock Watch: KLAC, JAH, NTAP, ASCA

The following stocks look bearish to me. They could be good potential for bearish plays should the market continues its downward moves in the short term. So, for options traders, get ready with your put options, or other bearish (options) strategies that suits your trading style.

KLAC: Just broke down a triangle pattern.

JAH: Just broke down a bearish pennant.

NTAP: Bounced down resistance at 50 MA.

ASCA: Broke down support at around 28 – 28.5 at early Aug. After testing the resistance at 28 – 28.5, it looks like it may continue its downward move in the short term.

High volatility is still expected in the near future. So, trade carefully.

Friday, September 7, 2007

Weekend Reading Links

Recent Market Analysis

* Dr. Brett Steenbarger from Trader Feed: Credit concerns have not gone away.

The stock market has behaved quite well lately, today's drop notwithstanding. But the credit markets continue to tell a different story, one that could have negative implications for some banks and the economy overall. That's worth keeping an eye on.

* Adam from Daily Options Report: Upon Further Review: Options Acting Even Stronger Than Meets the Eye.

No matter how you slice it, there is real fear out there of another September shoe to drop.

* Corey from Afraid To Trade: Brief Index Overview.

Let it also be stated that all major US indexes are STILL in a confirmed downtrend on the Daily Charts. Traders may be missing this if they’re not careful with their interpretation of trends.
Price has not made a higher high, and until it does, price REMAINS in a confirmed daily downtrend on all indexes. Be careful of this fact. This is not the time to leverage long positions to the hilt.

You can become more comfortable with any long positions when price makes a higher high and later changes into a confirmed uptrend.
Until then, we seem to be having consolidation on the daily charts. This will probably be the dominant technical picture until the Fed changes or leaves unchanged Interest Rates in their September 18th meeting.

* Chad Brand in Seeking Alpha: A Fed Cut Is Priced-In; No Cut Will Trigger A Selloff.
….. it's important to understand what is currently priced into the marketplace. If we don't get a cut later this month, which I think is certainly more probable than the markets currently are telling us, then stocks are going to sell-off. That is what we open ourselves up to when the market prices in something as a certainty even though there is still an undeniable fact that nothing is certain about the September FOMC meeting.

And even if we do get a cut of 25 basis points, we could still see the market not react positively because more than half of people right now expect 50 basis points (who knows what that number will be at meeting time). Just be aware that the risk-reward trade off right now in the short term doesn't appear all that favorable as long as you assume two things. One, the fed fund futures market accurately gauges what the market is currently pricing into prices. And two, the market will be reacting to interest rate speculation and action in coming weeks.

Trading Education / Wisdom

* Trading The Wedge by Toni Hansen

* Great trading quotes, shared by Simply Options Trader.

Enjoy your weekend! :)

Wednesday, September 5, 2007

More Understanding About Implied Volatility (IV)

In options trading, it’s crucial that one must understand the impact of volatility on options pricing. Because it’s possible that the stock price has moved profitably, but the option’s price did not.

Options Pricing & Implied Volatility (IV)
In options pricing, it is the Implied Volatility (IV) that affects the price of an option, not Historical Volatility (HV).
IV has a huge impact on the option price. However, it is important to highlight that IV affects only the time value component of an option's price, not on the Intrinsic Value. Therefore, ATM (At-The-Money) and OTM (Out-of-The-Money) options are the ones that will be greatly affected by IV movement, as compared to ITM (In-The-Money) options. How much IV changes affect an option’s price can be estimated from its Vega.
To get data on Vega, as well as other options greeks (Delta, Gamma, Rho, Theta) for various strike prices and expiration months, we’ve discussed it before here.

How does IV influence an option’s price?
Assuming all factors remain constant:
An increase in IV will increase an option’s price (both Call and Put options).
A decrease in IV will decrease an option’s price (both Call and Put options).

The reason is because higher IV implies that a greater fluctuation in the future stock price is expected due to some reasons. And with greater expected fluctuations, there will higher chances for an option to move into your favor by expiration.
Therefore, when volatility is expected to be high (i.e. higher IV), option’s prices will relatively be more expensive.

The Effect of IV on Option’s Buyer and Seller
As higher IV causes option price to rise (assuming other things constant), an increase in IV would benefit option buyers, but will be disadvantageous for option sellers (for both Calls & Puts).
On the other hand, a decrease in IV would have a negative impact on option buyers, but will be beneficial for option sellers.

As a result:
When IV is relatively low and is expected to rise, buy options (i.e. consider options strategies to take advantage of the expected move that allow us to be an option buyer).

When IV is relatively high and is expected to drop, sell options (i.e. consider options strategies to take advantage of the expected move that allow us to be an option seller).

Implied Volatility (IV) For Various Strike Prices
IV is generally not the same for various strike prices, and also between Call & Put options.
For the same expiration month, IVs vary by strike prices.
For some options, the IV of ITM & OTM options are higher ATM options. Hence, when the IVs for various strike prices are plotted into a chart, it would take shape approximately like a U-pattern, which is by glance, it looks like a smile. As such, this is often known as “Volatility Smile”.
Other options may have higher IV for more ITM options and then it’s decreasing as it moves towards OTM, or vice versa. Such pattern is called “Volatility Skew”.
Basically, either Volatility Smile or Volatility Skew is typically used to describe the general phenomena that IVs vary by strike price.

Picture courtesy of: riskglossary.com/link/volatility_skew.htm

To understand more about Implied Volatility, go to: Understanding Implied Volatility (IV).

Related Topics:
* FREE Trading Educational Videos From Trading Experts You Should Not Miss
* Option Greeks
* Learning Candlestick Charts
* Learning Charts Patterns
* Getting Started Trading

Monday, September 3, 2007

The Best Trading System For You

In previous post, we discussed the components & the importance of a trading system.

There are many trading systems / strategies around. No trading system is right for everybody. Often we heard that one trading system is working very well for some people. They can trade for a living with that, and even have made them millions. However, it is also very possible that the very same system can lead others to lose money. Why? Because although people learn exactly the same system even in every component of it, there is always one component that is different – the trader itself, with his personality & emotions.

So, now the question is: Which trading system / strategy is the best for you? The answer is it’s the trading system that best suits you! The one that you’re most comfortable with.

I remember an interview with Trader X by Stocktickr quite some time ago. Here is a part of the interview:

StockTickr: What single lesson did you learn along the way that helped you the most in your trading?
I learned to pick a style of trading and stick to it. I think most traders and prospective traders get lost by jumping from strategy to strategy and timeframe to timeframe. If something does not work one day, they are looking for something completely new. Pretty soon they have burned through a few dozen strategies (or different ways to trade) and have not made any money.
So I learned to pick a style of trading (or strategy) and stick to it. And I am always studying, learning, and refining it. …..

StockTickr: What advice can you offer traders who are just starting out?
* Don’t jump from strategy to strategy, timeframe to timeframe - pick something and stick with it! That does not mean you cannot refine it - you SHOULD constantly refine and improve what you do. But that is different from changing things completely.
* Don’t try to copy someone - even me! Read, study, and learn. And then apply it to your trading. Tweak it, and make it your own.

Dr. Van K. Tharp in his book Trade Your Way to Financial Freedom also mentioned that the search for the Holy Grail is actually an “internal search”.

If you don’t know who you are, the stock market is an expensive place to find out.
- George Goodman

So, in order to find the best trading system for you, it’s crucial to know yourself first. Do take inventory of yourself: your objectives, personality, strengths, weaknesses, limits, emotions, risk appetite & tolerance, etc. Then pick a trading system / strategy that best fits you. Adjust the system and make it yourself. Stick to it and from there, always refine and improve your system along the way.

Don’t forget that the most important aspects of your trading system are positive expectancy (average gains higher than average losses), position sizing (money management), risk management, and self management (yourself, your psychology, fear & greed, emotions, discipline, etc.). Work harder on that. Yes, the key is HARD WORK & DETERMINATION. With hard work and determination, you could create the best trading system, the holy grails for yourself.

Related Posts:
* Why Being Right In Your Trading Does Not Necessarily Mean Making Money
* The Psychological Need To Be Right vs. Making Money
* The Real Purpose Of Trading