The "Daily Call" From Option Alpha

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#570 - 98% Of Investors Suffer From Nearsightedness Apr 15, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about why 98% of investors suffer from nearsightedness. Now, why 98%? Honestly, I have no idea. It could've been 99%, but it looks better than 97% or better than 99% being overly assumptive that just 1% do not suffer from nearsightedness. But the reality is I think that most investors suffer from nearsightedness which is a very common thing and it gets back to this idea of recency bias which I believe we talked about in Show 196 or 197 on the daily podcast here. But what investors do (and I see this in particular with traders all the time) is they get into a position or a series of trades and that small grouping of trades that they get into, it could be as small as one, it could be three or five trades. They assume that because those trades did well or did bad that the rest of their trading is going to follow suit. It's this recency bias that the last occurrence or the last series of occurrences are therefore going to dictate any future performance of a trade or a trading system that they're using, but that's just not the case.

In fact, many times, when people email me and they say, "Kirk. I have 10 trades on and I've won 10 out of 10." I'll shoot an email back to them and say, "Look. You're probably obviously winning at a much higher rate than you would in the future, so just keep that in mind." Or if somebody says, "Kirk. I have made 10 trades, but only two of them have been winners." Okay. Well, you're probably not trading enough yet and that's a low probability win rate based on how you're trading and so, you're going to win more in the future. You just have to keep trading. But it's this idea that a lot of people just have such nearsightedness and don't take the moment or the extra time it's required to step back from the system that they're using and really analyze the long-term numbers. What does this look like if I were to trade it 100, 200, 300 times? How much better would I do in the future if I shaved my allocations a little bit and cut risk? Those are the questions that really, you should be asking if you want to be a serious investor and a serious trader because you're not going to know everything you're going to know about a system in the first 10 or 20 or 50 trades and to look at those trades and then base all of your assumptions off of that is where you suffer from nearsightedness. You don't have the foresight to look beyond just the first couple of trades that you're making. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#569 - What Is An Intra-Day Stock Reversal? Apr 14, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What is an intraday stock reversal?" Lucky for you, an intraday stock reversal is exactly what it sounds like. It is a reversal in the stock price either from low to high or high to low that happens intraday, meaning in the same trading day. And what we've actually found in research, though this research is limited to just earnings trades and how stocks trade around earnings, but it could easily be extrapolated out because we did so much research on this, is that when we see stocks open, there's about a 50% chance that the opening price is the high of the day. We end up seeing that a stock opens at say $100, there's about a 50% chance that that opening price is the high for the day and the stock may close lower or may close higher.

Now, this is irrespective of the day prior. A lot of people would say, "Well, if the stock closed at say $49 and then tomorrow, opens at $50, it's going to open higher and that means that it must rally higher for the rest of the day." But that's not the case all the time. In fact, we see an intraday reversal where a stock may open higher than the previous day, but actually close much lower than the open price and the previous day's close and that's where we get these intraday reversals, to the downside or it can also happen in the opposing direction where the stock opens lower on the day, but for some reason, whatever news came out that day or the sentiment that day, drives the stock higher and it closes higher than the open and closes higher than the previous day's close. Both of those are examples of these intraday reversals that are just more or less, another thing that you can look at, another little data point you can use to try engage a little bit of short-term sentiment in the market, what's happening that's causing the reversal, what new news story is coming out or what new information is now available in the market that caused selling to turn to buying or buying to turn to selling. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#568 - What's The Best Computer Setup For Trading Stocks & Options? Apr 13, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What's the best computer setup for trading stocks and options?" I'm assuming that a lot of people who are listening to this right now or if you've found this online, you're trying to figure out – "Okay. If I'm going to start trading stocks or options, do I need some supercomputers to actually get this done? Do I need some advanced software, some advanced monitoring system?" And the answer to all of that stuff is absolutely no. It's total garbage. I don't think that anybody actually needs these super mega computers to do trading either in stocks or options. This industry has advanced so much so in the last even five or 10 years that the ability to trade from just your phone or your iPad or your laptop is light years ahead of where it was even 10 years ago. When I started trading, I still use a regular computer, but I had upgraded servers and ram and memory and all those things that really nobody needs now because it comes standard. And so, nowadays, I still see people searching for or asking the question – "What kind of computer setup do I need? Do I need five monitors? Do I need this arm that comes out of the desk and hovers over me with the screen that tracks time and sales?" And the answer is of course, no.

In my opinion, I think most of this stuff is actually just a lot of noise. It's meant to make people look and feel like they're really special and important because they've got 17 monitors in their office. I just don't think you need to do that. I think that that creates a lot of complication. It's a lot of analysis by paralysis in many respects. I use just a regular Mac computer. I love my Mac. I've got a MacBook Pro for laptop when I travel. I have my iPhone which has the Thinkorswim and my trading apps on it and that's it. I don't need anything else and I can do everything possible in one of those three devices. Hopefully this helps out. Hopefully it saves you a ton of money by not going out and buying a bunch of garbage computer and software and screens and desktop stuff because you just don't need it. Ultimately, your time and money would be better spent actually making investments and actually doing trading than trying to buy all the fancy equipment around it. Hopefully this helps out. If you have any questions, let me know and until next time, happy trading.

#567 - Social Media Is A Terrible Tool For Finding Trading Ideas Apr 12, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why social media is a terrible tool for finding trading ideas. Now, look. This should come as no surprise to anybody, but social media is an absolutely terrible idea for finding trading ideas. I love the aspect of social media in that people can share the trades that they're doing, but I don't think you should use the trades that other people are doing to be the basis of the trades that you do because you become reliant on them and you don't even know if those trades are going to work out or what system they're trading or if that trade is a hedge or a core position. There are so many unanswered things that go into people posting on social media.

Like I said, I love all the aspects of social media in that it gets people engaged. It forces people to defend their positions to some degree because they can post it and people can add commentary and disagree with it or agree with it, back them up or not or question them. That aspect of it, I love and that's why we do what we do here at Option Alpha which is post our trades after 30 days of being available to pro members. We post them publicly, so people can learn from them and see what we were doing and ask questions and give feedback, try to break it or not and I can defend my position or not or see it from a different angle. I love all that aspect of it, but when it comes to actually finding trading ideas, I think people are going to be very disappointed when they go to social media as a tool for scouting for ideas and that's why I'm not necessarily a fan of things like stock tweets where they actually send out all the ideas that people are trading and to me, it's just a constant bombardment of different ideas which you have no idea what the basis of them are.

My thought process on this is that you would be much better-served to instead spend the time not invested in social media, but invested in learning your own way of trading, your own style, technique, system that you can use to find your own trades. In my opinion, I think you should learn how to fish by yourself rather than hoping that someone else can fish for you. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#566 - What Does It Mean To "Go Short" A Stock? Apr 11, 2019

Show notes

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What does it mean to go short a stock?" If you've been trading for a while or if you've been new to trading and investing, you probably heard this terminology thrown around. You might hear people say that there's a lot short selling or there's a lot of short interest or you might hear somebody say they've gone short or they go long a stock, but what does that actually mean?

Well, I'm actually going to start this discussion by talking about the traditional sense of stock investing which is to go long a stock. And when you go long a stock, you take a long position which means that you actually buy stock first to enter the position. That's the initial entry point for the position. And your hope is that if you buy stock at say $50 a share, you can sell it in the future at say $60 a share and generate a $10 profit. Now, what going short is, is you're doing that process just in reverse. Instead of buying stock to begin with, you can actually borrow shares of stock from your broker and sell them in the open market. Now, when you sell them in the open market, you have borrowed securities from your broker which means you are short securities. You actually have to complete the trading cycle or loop by repurchasing shares in the open market hopefully at a lower price and delivering those shares back to the broker. It'd be no different than if you borrowed money from your friend and you said, "Hey, I need $10." You know at some point in the future, you got to repay that and give your friend back $10. You're short $10 because any time you get money, you got to pay it back to your friend first or hopefully you would pay it back to your friend first.

What happens in stock investing is when you go short, you borrow money from your broker, sell it in the open market say at $60 a share, hoping that in the future, you can repurchase those shares at say $50 when the price goes down and capture a profit that way. It's a different way of actually profiting from market direction and from market movements. Most people are not aware that you can actually go out and short sell stock. Now, there's got to be float, there's got to be shares that you can borrow from your brokerage, but most of the major ETFs and most of the major stocks do have the availability to go short. And so, when you hear things like there's a lot short interest, it just means that a lot of people have borrowed stock and are trying to sell it, hoping that the price goes down in the future. This could be good or it could be bad and we can discuss that obviously on later podcast. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#565 - Understanding Asset Class Correlations Can Save Your Butt Apr 10, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about why understanding asset class correlations can help save your butt. A lot of the stuff that we've been doing recently with our research team and back-testing wise has been in the realm of underlying asset correlations and building uncorrelated baskets of securities. And so, what we've been trying to do is not only study the relationship between different industries and ETFs to one another and what their long-term correlations have been or not, but also trying to understand how we can build baskets of option strategies in different ETFs and sectors that have very little to do with one another, so how can we get as much diversification benefit with as little number of tickers in our portfolio as possible. And so, I think the key that I want to get across today is not necessarily that you have to memorize every single asset class correlation to another asset class, but it's just that you should understand at least the big ones, so the big asset class correlations to one another, bonds to stocks, stocks to oil, oil to bonds, etcetera and you should probably understand anything specifically that you're trading. If you do a lot of trading in say the euro or Mexico and EWW, you should probably understand what those asset classes correlate to, so that you have an idea of – If one ticker goes up, is it likely to make the other ticker or is the other ticker likely to react in the same direction, no direction at all or potentially, the opposite direction?

Here's a couple here that I think will just help and lead you down this path of hopefully discovering a little bit more about this. One of the ones that we like to track a lot is bonds. And so, we like to track bonds which is typically TLT. It's a great bond ETF that tracks long-term maturity bonds, very highly liquid. What most people would believe is that bonds are inversely correlated to stocks. When stock prices go up, bond prices should go down, but that's not actually the case and we actually found this and actually, other people have found this before, but we reconfirmed this, that bonds are actually very highly correlated with stocks. When we tracked the correlation between the bonds, TLT and something like SPY, we actually get a correlation of .63 which means that typically, when stocks go up or when bonds go up, they actually go up more often than not together which is completely backwards from what traditional investing would say. You've often heard even the 60/40 portfolio, so that you diversify out, but how much diversity are you really getting with bonds because they end up actually tracking very much in line with stocks?

Now, another one that you can look at is potentially, the euro and bonds. If we want potential exposure or we want to trade exposure to the euro through something like FXE, we could look at the exposure and the correlation between FXE and TLT and we actually see that the euro is highly negatively correlated with bonds. When bonds are moving higher, we would expect that the euro was actually moving lower and their negative correlation is –.79, so pretty extreme correlation to the opposite end. Again, if bonds are moving higher, the euro potentially is moving lower. If the euro is moving higher, then bonds are moving lower. This is again, not to say that this leads us into making a trade in either direction, but just understanding that these two things might actually move in opposite directions. If we do see that move together, maybe that's a trading opportunity that they're breaking this correlation short-term and then maybe it might react and move in totally opposite directions moving forward. Hopefully this helps out. Again, we publish a lot of this stuff inside of our pro and elite membership, so if you want charts and graphs on all of these different correlations, we definitely send them to all of our pro and elite members. As always, if you have any questions, let me know and until next time, happy trading.

#564 - Should You Avoid Trading Around Major Market Events? Apr 09, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Should you avoid trading around major market events?" I think this ultimately ends up crippling a lot of traders. Many times as people get started or even if you're new to trading, there's always some new story or some new thing to be worried about that's coming on the horizon, some FED statement, some presidential election, some congressional election, some legislature that may or may not come. I mean, it literally seems like there's always something on the horizon that could rock the markets to the core. That's what we hear by talking heads and pundits on TV, but the reality is I don't think necessarily, you should avoid trading around any major market events. I think you should have an awareness, an understanding of what's coming, so you're not surprised if you get a big move in an underlying sector or ETF, but I don't necessarily think you should avoid trading those events.

And the reason I don't… And I maybe had a little bit of a change of opinion over the last couple years as we've started to do more research on this. But one thing I realized when we did a lot of research for our profit matrix report and the Signals report and all the other research reports that we've been putting together is that we didn't code into any of our research software, the ability to read or understand different economic events that were happening during the back-testing period. When we back-tested a strangle for 20 years, we didn't magically say, "Okay. Don't trade the strangle whenever the FED is going to make an announcement or don't trade right before some major election event." We just didn't code that into our software. And so, the system just mechanically made trade entries as it should whenever the parameters were met to make a trade entry and it was irregardless of what was happening in the major markets. And so, I think there's a lot of information that we can derive from that in the sense that we don't need to be so compelled to stop trading because some major market event may or may not be a factor in the markets in the future. We've seen oftentimes where these so-called major events end up having a total opposite reaction in the market than what people expected them to have and so, as a result, many people thought that the market was going to do one thing and it ended up doing the totally opposite thing or nothing at all and so, it became a non-event basically.

Again, to get back down to the answer, I don't think you should avoid trading in any market environment. If you keep your position size small and you are consistently entering new positions, then it doesn't matter necessarily if you have a really great entry today and a so-so entry tomorrow and you miss one the next day. As long as you keep up with the probabilities and work the system, you should be fine, long-term. Are there going to be days where maybe you could have made a better entry? Of course, but that always happens. That's always going to happen in trading and you could never avoid that. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#563 - Healthy Trend Or Runaway Bubble? Apr 08, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about the differences between a stock that's moving in a healthy trend or potentially in a runaway bubble. And I think this can honestly be hard to spot in. By no means am I perfect at spotting market moves by any stretch, but I think over time, what I've learned to realize about markets is that when you are in a healthy market or a healthy trend, you start to see a stock or a security create a series of higher lows and higher highs, but this path of higher lows and higher highs happens on a steady slope. Now, a steady slope for one particular stock or one sector could be completely different, but we all can realize and recognize what a steady or a regular trending stock looks like. And you have these regular ebbs and flows in the stock price. It has a rally. Then it has a little bit of a pullback and then another rally, etcetera, etcetera. And I think where we get into the discussion of runaway bubbles is when we start to see this series of higher highs and higher lows happening too fast in the scenario where the time between the next sequential high or the next sequential low is now much shorter in duration, so they happen very quickly and you start to see the stocks go vertically higher like a rocket ship on the stock chart.

And there's no better analogy for this honestly than probably a couple different markets. You could look at gold a couple years ago, silver almost five years ago, six years ago now and then bitcoin just two and a half years ago at this point and what you see in a lot of those charts… I guess you could even say NASDAQ in 1999, 2000. But what you see in a lot of those charts is you see a steady trend and then it just seems like it accelerates at a much, much faster pace. And when you start to see those higher lows and higher highs not only become shorter in duration, so just a really strong rip higher followed by a really strong, severe correction and then another rip higher and rally higher and those happen really quickly next to one another and the volatility of the stock starts to increase, that to me might suggest that we're in some sort of runaway bubble. Now, the problem with this is and the difficulty in trading this outright is that you don't know when it's going to end. A lot of people saw bitcoin at $10,000 and thought, "Okay, bitcoin at $10,000. That's got to be the top. It's creating this monster bubble move." But it wasn't. It wasn't even half of the potential move that bitcoin had.

It's really hard to pick these tops and bottoms and I do not suggest trying to do that. I do suggest that you at least recognize when you're in one of these states or you're trading something that could potentially be in a little bit of a runaway move. And I think that for my side, it helps out because sometimes we get into situations where a stock moves completely against us very, very fast, but it happens to be one of these exaggerated or rocket ship type moves and we just know intuitively after doing this for over a decade now that things are going to course-correct and at some point, it's going to come back down or reverse or correct and so, I just have to be patient and let risk management take control and let the probabilities work themselves out. I think for me, again, when I look at if something's in a healthy trend or zone, it's making a series of higher lows and higher highs, but it's doing so on a steady slope and it's not going either way, way, way too fast or just completely bananas as far as price movement. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#562 - What Are Valuation Multiples? Apr 07, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What are valuation multiples?" Valuation multiples are simply just another mechanism by which you might be able to value related companies in an industry. If you're going to value a company, you could value it based on free cash flow. You could value it based on its assets or the income that it produces from the assets. But oftentimes, you also see that companies are valued based on multiples.

And so, multiples are a way to use related industries or related sectors and try to figure out a like kind valuation when the companies are not exactly at the same level, whether revenue wise or in their life cycle or a product wise. And so, it's another metric that you can use for valuing. Oftentimes, you might hear that a company was sold at two times revenue. If their revenue for the year was $1 million, the company might have been sold for two times their annual revenue, so it was sold for $2 million. Oftentimes, you might hear revenue multiples or even EBITDA multiples which is earnings before interest taxes and appreciation. And so, oftentimes, this is a good way to break down companies to more of a core component of what they actually do before they have the corporate structure and the depreciation lumped n which are oftentimes, things that can be changed or adjusted with new mergers and acquisitions. Sometimes companies will trade at different various multiples, so 20 times EBITDA, 30 times EBITDA. Again, it's just a benchmark to figure out if one company might be more or less valuable than a peer in the industry. If you're building a company and you think you want to sell it, it might be a good idea to look at what are the multiples that some people might be able to get by selling their company in that industry. Maybe if you're in the technology space and you're in aerospace or some very niche market, you might get a 25 or 30 multiple on revenue. If you can grow your revenue to a certain amount and you want to sell, you might be able to sell for 20 or 30 times the revenue annualized.

Again, it's a good way just to use another metric for valuing a company. It's not always perfect. There's always a lot of subjective nature that comes into valuation based on growth and forecast and earnings and expenses, but it's just another tool that you could potentially have in your toolbox more on the private side I guess in most cases when it comes to valuation. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.

#561 - Start Trading With A Comfortable Account Balance Apr 06, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and today, I want to talk about why you should start trading with a comfortable account balance. Undoubtedly, one of the biggest questions I get all the time is – "Kirk, what account balance should I start with? How much money should I start with if I want to trade options?" And everyone's looking for me to give them a perfect answer, something like – "You need to start trading with $25,000 or you need to start trading with $100,000." But the reality is you can start trading with as little as $3,000 to $5,000 as long as you understand that you're not going to quit your job and pay off your home and mortgage and buy a yacht with the profits from a $3,000 to $5000 account. You have to be realistic with your expectations. But I often find that people who are starting have this weird thought process that when they have more money to trade with, magically, all their mechanical problems and issues will disappear. Like if I had more money to trade with, then I could make better trades. If I had more money to trade with, I could trade more contracts or more ticker symbols or a variety of different strategies that might help improve my performance beyond what I can do right now.

But I can tell you one thing is 100% true from all of the experience and people I've seen come through Option Alpha. If you can't learn to first trade with a small account, adding money is not going to be the answer. If you can't learn how to properly allocate and distribute money on a $3,000 account which you can easily do… You're not going to make millions overnight doing it. You're going to make a couple hundred dollars over the course of a year and have decent returns. But if you can't learn how to do that first, just throwing more money at the problem is not the solution and ultimately, will lead you to losing potentially more money. I would suggest if you start trading options to start with a comfortable account balance. That might mean if you think you're going to start with $20,000, start with $5,000 and learn the mechanics and learn the processes that are required to be a successful trader before you start throwing more money at the problem. Having more money, a larger account balance, more funds to trade is not the answer and ultimately, if you haven't fixed the root of the problem, the mechanics, the strategy, the portfolio diversification, the allocation of position-sizing, if you haven't fixed that first with a small account, it's not going to get any better as you start increasing your account size. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

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