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Today we'll focus on contrarian trading which doesn't mean you don't follow the trend. That is going to be the core of the discussion.
I'm going to also focus on a few questions that you have for me.
These are some topics:
- how to monitor and close positions on the losses
- more about Vega and
- setting up the position
We'll target that for contrarian trading as well.
Before we get into any examples, keep in mind that all these examples are strictly for just educational and illustrative purposes. I think you guys are smart enough and understand that. Take that with a grain of salt and look at your trades that you're doing. And apply those concepts based on your risk tolerance and levels.
What Is a Contrarian?
In the marketplace, we have two main kinds of traders. You could say if we're talking about contrarian traders or people who follow the herd - the herd mentality.
I typically don't like to use the word herd. I don't like the appeal of that word. In either case, it's people that are usually contrarian or people that follow the group of other traders.
We know that 90% of traders lose out and only 10% win (profitable in the markets). I'm not saying they don't ever lose. I'm assuming they're consistently in the game for the future to be able to make money for the long haul.
If 90% lose out and only 10% win in the markets doesn't it make sense to be a contrarian?
Contrarian means that you go opposite of the group or the herd mentality.
But how do you do this in the marketplace if all those idioms or all those phrases always say follow the trend. It is telling you don't want to go against the trend. And that is true.
You don't want to go against the trend. The thing is you want to go with the trend, but that doesn't mean the risk management that you have on your stocks is not contrarian.
Examples That Will Help You Understand
I'm going to share with you some examples on charts as we get into this. You'll see what I'm talking about.
For many people, as they get into the marketplace, they usually will get into higher levels. I will use Amazon here as an example.
As the market starts climbing higher this is when they get interested in the stock market.
This is where they say: "Wow, things are climbing. Let me set up a trading account."
Then they start setting up a trading account. They think about their decision as this continues to move higher.
Soon they say: "Okay, I'm going to fund my account."
They slowly start getting into their positions. At this stage and this point, you may think that this is silly. But if we go to the original concept and understand that 90% of traders don't make money, then this is not such an unrealistic statement to make. Many people get in, or the retailers get in by this point or at this stage.
Even if you play a little more conservatively, you could say they're a little bit smarter. They get in somewhere at this stage. But then what ends up happening is they get this before a crush just like we have here in Amazon.
It doesn't matter which stock you apply it to; it could be:
They get into the stock, and they might have a few days a few weeks of a nice run. And then eventually things start to roll over. Because they have less experience, they're following the trend.
Although this was the trend, their process was incorrect. The method of making the trade was wrong. When you look at it, and they get into it eventually these things roll over. They end up selling at the lows.
They're breaking even or even losing out. If we get into daily and you can see Amazon starts climbing here.
It's going higher, and now you see it spiking. It's spiking and breaking out at a certain level, and you might decide to get in it. If you didn't bother checking the weekly charts, you don't see this stock hits some highs and had a big rollover.
When we had the support coming in that ended up getting taking out, and now you get emotional about it. And this ended up continuing going even lower to this point to the fact of you creating an even more significant loss.
This creates some significant problems with traders especially if you're new or if you don't know how to manage the trades. If you're not experienced, you're constantly taking losses.
Many beginner traders lose out, and 90% of traders lose. This is one of the big picture concepts.
The Contrarian Mindset
Let's say you were buying things when everybody was screaming to buy. You're following the herd, and you're going with everybody else. You're buying what everybody is buying.
Well, they don't go straight up. They don't go straight down. When everybody is buying, and you're buying eventually, it rolls back over. That's because we know that the rubber band gets stretched so then the opposite happens.
The main question: What happens if you're the contrarian?
Well, the contrarian works opposite of this. You're typically a buyer when everybody is a seller and vice-versa. You're usually a seller when everybody's a buyer.
Even though we look at the trend that is heading higher this is what you need to do.
They call this - buy the dip mentality. But you don't want to buy like every little dip.
I think people on social media get a little bit too extreme with buying the dip. You can't think of it that way. You're looking for legitimate beautiful pullbacks that have some substance. And a pullback such as this one has some substance.
It's important to say that I don't think Amazon's going to go bankrupt in the next six weeks or the following year.
But that's a pretty lovely pullback, and this one is 14.3%. What you do as a contrarian is you're buying as things pull back. You're not going to hit it perfectly. It's evident that you're not going to hit the tops on the stocks when you're selling.
Even if you're going long and you're not going to buy at the bottoms if your bottom fishing. You might buy a third of your position here and there.
At least you have an average position of somewhere over at this price point. That way eventually as the stock comes higher you're taking off a third here a third here and a third over here.
As we get into resistance, there's your third, and there's your third. That means as we start hitting things you're taking off most of your positions. Or maybe you do two of those thirds and let the rest ride and see how far you can get. You can add on to it on the next pullback.
That's the contrarian view and the contrarian concept to trading. That doesn't mean I'm going against the trend. It means you're putting on trades at a different point in time than everybody else.
This is where you make money. This is the way money is made in the market. It is going against the majority. It also depends on your trading style. If you're more of a day trader, then you might want to play things a little bit differently. But the same concepts and theories still apply.
The reason is that because when the market is high and overstretched, you'll see prices head lower. When the market is, or prices are overextended from our moving average you're going to get that bounce.
The same thing happened when you look at the Trump era and the Brexit time. When you're too far extended you get that whip back.
And the same thing on the upside. If you're too far extended what happens while you get the pullbacks. And then again you get this little consolidation. But you get the pullback - eventually, that's what happens.
The Current Market Conditions
This market is robust and relentless. It wants to keep grinding higher. But if you watch the tulips and the bubble episode we talked about how far can they stretch it.
They can stretch it awhile, and they can keep extending it. Maybe for another year, two years, but keep that in mind that the more you stretch you want to be taking profits into these moves.
People call it the dumb money versus the smart money. The dumb money usually is the people who are getting in with this euphoria where stock is hitting highs. Then eventually it rolls over and then they're trying to buy back their shares. They take their loss. That's typically the dumb money.
The smart money is the ones try to buy on value. Then as prices continue higher, they're patient, and they are taking their thirds.
The same thing here when I look at a market like this. This is our current market situation.
I'm looking at:
- how far stretched is it?
- how far can we continue going?
Some people might ask:
Can we get to 2500 by the end of the year?
Well, possible. That's reasonable and realistic.
Others might ask:
Can we go to 2600?
I would say fewer people would say 2600 is reasonable.
Maybe some people think something like this:
Once you keep stretching things further and further, you start creating that effect. And that's where you have to look at that in a bigger context.
Consider things like this:
And this goes back to our question here initially is:
Well, you're taking profits always into strength. I didn't understand this the first few years of my trading. I would get in a full position and get out a full position. I didn't realize that when having a hundred shares, I could take off thirty and another thirty and reduce my risk.
And the same thing here. If you're trading in this and you got in it here. It doesn't matter where you got in it, but you could take a third or half off or a quarter. You take your profits because you don't know if you might get a down day.
Sometimes you get a mini pullback, and they can wipe out a few months. I've seen this happen in stocks where it wipes out years of gains in one day.
That's why you're always peeling things off in the strength. The down moves are still more violent. In either case, if you're following the trend doesn't mean the way that you handle your process has to be with the same way that people follow the trend.
Most people who follow the trend if it's an up day they buy on an up day. If it's a down day, they sell on a down day. They're in panic mode.
If you're looking at this market and if you're not winning out then usually it's because of these. Think of trading differently. And doing the opposite of what it is that you're currently doing. See if that would make sense.
Pro tip: I don't know you, and I don't know how you're trading. Maybe you're doing the same things, you've been training for a year or two, and you're making the same mistakes. You're buying on green days, and you're selling on red days.
After a massive couple of green days eventually, you know that things pull back to reverse. It doesn't matter which stock is.
Example of Tesla stock:
Take a look at this. After you get that massive explosion eventually that stock comes back. They don't go up forever.
The Bigger Picture - Emotions Involved
In either case, that's just some insight on the contrarian side. But here comes the more significant insight. We have this concept in mind, but what do we do as far as emotions go?
Sometimes emotions get the best of us, or they start playing tricks on us. This is what will happen. Maybe you got into this market, and we're just pulling here on this down move.
Let's say we're talking about this down move. It's having this little pullback, and you get in it on day three or four. It's had a small pullback, and you got it on day three. You got in a little bit on day four. Then you got it on day five, and it's still going down. And your position continues to be harmful, and emotionally this is very difficult.
That's why trading is so difficult. It plays on these emotional concepts that are naturally against you. But you have to understand the bigger picture on the long-term scale what's going to happen to these markets.
You're buying it so far down. If prices are stretched to the bottom or low even though they're at low points doesn't mean they can't go lower. But eventually, they'll get into higher territory. That's the case because stocks are looking to appreciate. And that's what you're doing.
What you're trying is to get it at a lower range. If you can get it at that lower value eventually, we're going to snap back. And this is the hard part. Emotionally you see this day in and day out.
It's painful, and then you might want to wait. And then again it's painful. Now, this is called averaging down.
I wouldn't recommend averaging down unless you have the appropriate process in place. That means you have that plan in mind that you're doing it quarters or thirds.
For many people averaging down is something like this: If they have $10,000 they buy $10,000 of stock. Then the stock goes down and then they put in another $10,000 from their bank. They average it down again a week later.
That's emotional trading - that's trading without a plan. When I'm talking about averaging down, I'm talking about creating a position - like in chess.
You're creating your position. First, you set up your position. Once your position is set up, you attack. After that you set up that position, you further attack and then eventually you conquer, You get your trade. Here's the same thing.
You're building out your position to where eventually you get that snap up, and then you start taking shares off. And then you see if you let the rest ride. If you get a pullback, you're buying, and then again you get the snap up.
That's what you should look at. When this happens, you're emotional. Many people are constantly getting beat.
The same thing is if you're doing this on the short side. Let's say you're in this market and you're short this market, and sometimes it can be brutal. It can be emotionally damaging and emotionally tired.
You have to know when is it that you're either:
- A - taking a loss or
- B - where is your adjustment
Because if you have no plan in mind eventually things will burn you. You need to have a plan for what if things go against you. You might need to endure that pain for a little bit, and then you'll get that snap down.
It's something like Amazon. If you're were looking to short Amazon, you're in pain now. If this is the two times you shorted and now the stock continues to head higher, and you're short you're in pain.
You're feeling that. That can be emotionally problematic and very stressful on you. But eventually, you either have to know where that loss point is. And where you take that hit. Or you need to know where you adjust. Once things kick in and if you were able to hold out now you let things cook and let things work.
And then you have to retake your profits. It's the same thing into strength because those things can whip back.
Your Ideas - Do It Your Way
That's the nature of doing things a little bit more contrarian or thinking about things in a contrarian way.
If you're always following the herd, this is one of the main reasons why a lot of people lose out.
They follow people on stock twits on Twitter. I always say you don't want to follow me blindly. You can follow people. There's nothing wrong with that if you're looking to have a newsletter or something like this.
I know even my newsletter is not every day. I don't release a daily newsletter because stocks whip around on a day-to-day basis. But if you're following people on it day-to-day basis, you can get whipped around.
And it's okay to do that, but you have to have the bigger picture in mind for your ideas. Otherwise, the market is going to whip you around.
In either case, if you're always getting in with the herd and you're following it's the same thing. You're buying on the up days, and you're constantly getting burned only to see the stalks roll over.
You're probably buying too late. And the same thing if you're shorting. If you're shorting on down days, it might already have been too late. The time to short was probably when stocks are making incline move to the upside.
Endure a little pain to get that reward later. You sacrifice a piece or two on the chess board to get that reward then. And the same thing here. If you're looking for a long position endure a little pain so that you can get a lot more pleasure.
I hope that makes sense in today's lesson. I do want to cover this more with the Vega, the options, when it helps, when it hurts - just selecting a good position as well. You want to do the same thing when it comes to an option — the same way when you're talking about options.
I'll talk about this on a calendar position. Calendars have a pretty good Vega. Typically if you look at a calendar, we have an April, and we have a May.
We'll buy a calendar. We'll sell April and will buy the May. Then we want to analyze the trade. Let's take a look at what that looks like.
The current price is 853. Our calendar is 860, and that's ok. When it comes to a calendar here's the baseline for putting on option positions when you're looking at your Vega.
Usually, I would say you got to be a contrarian if you're putting on option positions you want to be a contrarian. Because you're typically not holding these for three days. You are generally holding these for a week, two weeks, five weeks six weeks, eight weeks. It could be half a year.
You're putting these on, and you're holding them for quite a bit of time. When you look at a calendar, this position has a positive Vega. If you look at an iron Condor, it has a negative Vega which I'll cover here real quick in a second.
Well, here I'll show you an example. First, let's look at how the Vega works. I want to take out this more parameters area.
When does it help you to the calendar in terms of just volatility as far as this calendar? Well, if I bump the volatility up, look at what happens.
We're up about three points on volatility. The calendar expands and grows. You can see calendar expands and grows as I bump the volatility. As I decrease the volatility of the calendar contracts.
We want to put on a calendar when the volatility is low. That's what we want because we're buying time. We sell one in April, and we buy one in May.
This is what happens:
- we sell 51 days worth
- we buy 79 days worth
That means we have a positive excess of 30 plus some days. Anyways you're positive time which means you're positive Vega.
You're positive volatility because you have more time - you're purchasing additional time premium. It's not in one month. You want volatility to go up.
Well, with a positive Vega it's better to put on calendars when volatility is low. That's the case because we want volatility to go up. After that calendars would be better to put on when volatility is low.
The lower the volatility, the better to put on the calendar.
On days that are massively up days - like today. Today we had a massive up day.
How is Vega related to the VIX?
When you look at the VIX, it depends on how options are priced. And maybe this will answer that question. As stocks pump higher, the VIX drops typically. If you look at the VIX today, you can see we dropped about 0.38. So as things go higher, the Vix usually drops.
That is usually an excellent time to put on a calendar because we're positive Vega. What's more, we anticipate in the future rise in volatility.
When you look at how Vega compares to the VIX is the higher the VIX, the more the option premiums are sold for. We're buying Vega, and we're buying time. It works a little opposite. Maybe with the iron Condor example, it'll answer that question a little bit better.
In simple terms, if you have a calendar and you have a positive Vega position you want to put these on massive up days. Because the VIX gets crushed and eventually we're expecting a higher VIX.
After the markets go up two, three, four days, this is an excellent time to put on a calendar. And the same thing on the opposite side is true if you're looking to create an iron condor.
Iron Condor Example
Let's do an Iron Condor. We sell an iron Condor just as an example - analyze the trade. We'll do the calls on 910, 920, 825 and 795. Let's see what this looks like.
We have volatility that's adjusted. Let me bring this volatility back to zero.
If I move this down the volatility down that means prices contract. That means the prices of the options contract. Then the speed (because the volatility refers to the speed) of the market slows down.
The more and higher you keep pushing prices the slower the market, in theory, should get. If you have a super low VIX, it means everybody knows that the market is heading higher.
We're only heading higher by like:
- three points
- one point
- fifty cents
- a dollar
- two dollars
Not like twenty, fifteen points. Sometimes you'll get those blips of ten, twenty points but it usually slows down the market. That's why professional traders love sell-offs. They love a higher VIX because you're able to buy on the dips. Or now the option premiums go up.
If you had higher volatility, you could see how you're losing money. But that also means that this premium would cost more. This premium would cost more, and if you're a seller of premium, you would be selling this for more money.
I know it's a little bit confusing. There's a lot of elements - cause and effects. But basically, instead of selling it for 2.70 this would sell for 3.40 depending on the VIX. That's how the Vega helps or controls the VIX.
Important note: It's not directly tied into it from my understanding. It's more along the lines of how much time value you have. But if the VIX is low, you typically don't want to sell iron condors. The main reason is when you sell iron condors with a low VIX the picture would look the same with but it would be tighter.
With a high VIX (I'll make it in orange) would be right here. But with the low VIX, it would be more like right there right within the yellow. And you'd get the same amount of money.
With a higher the VIX these option premiums become more expensive.
Well, when you have a high VIX, it's usually because well people want to buy protection. It's the put to call ratio. It's demand for those puts.
When the market is selling off in a big way, people want puts, they want puts, and you're a seller of puts it drives the prices of those puts higher. You being a seller creating an iron condor it allows you to sell those puts or calls for more money. It will enable you to sell those options for more money.
I hope that ultimately makes sense. As you can see how even relating it to options, you're still a contrarian in the marketplace. Because when everybody else over here is selling off in a big way and the market is selling off, you're selling the puts. When they want puts, you're giving them the puts.
On the flip side when the market is heading higher, you're buying time premium — something like calendars or diagonals. You're buying time premium because volatility is cheap which means prices of options are affordable. You can afford to purchase a time premium.
That's what it means to be a contrarian whether you're trading stocks regularly trading you know positions and shares or even in options. It comes down to the personal preference of what you're doing. It doesn't matter whether that's shares or whether that's options.
Keep in mind you're always looking to hedge your position. Be careful if things go against you. If things don't work out in your favor what are you going to do?
That's the big question you always want to keep in mind.
This is the way that you do things in the market place to capitalize from being a contrarian and also to make things work out in your favor. Even if you have the upside and you went on and put on some calendar positions eventually, you get a higher VIX pop - a pullback. And your calendar decayed a bit, and you get out. If you had two calendars, you get out one calendar, and you can hold on to another one. And if it gets outside your range, you're out of that position. You could create it the next.
I hope it was helpful and gave you some insights to looking at the market in a contrarian way. And how you would ultimately go in on a contrarian basis. Those are some of the things that I've gone in and discussed.
It doesn't mean that you can't follow the trend. It means you don't follow the actions of the group. If it's an up day, it doesn't mean you buy right away.
A lot of the issues, the emotional problems are difficult in the marketplace. Sometimes it's weeks where you're feeling these things. But then eventually it all works out because you know the bigger picture.