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Three Key Concepts For Profitable Summertime Trading

06/07/11 10:13:47 AM
by Billy Williams

Summertime trading presents several challenges, but if you keep in mind three key concepts, then this seasonal pattern can present you with more opportunities.

Security:   AAPL
Position:   Hold

Summertime trading presents a number of challenges that, sadly, most traders are simply unaware of. On Wall Street, at the beginning of each new year, managers of large mutual funds, hedge funds, and pension funds create anew for their annual investment objectives that is typically followed by a rebalancing of their existing portfolios. Around June, many investment managers will sit back and sit tight in order to survey their stock holdings, making adjustments when necessary but content to do little else except go on vacation; this causes trade volume to decline during summer months, which results in a back-and-forth trading range.

Worse, according to The Stock Trader's Almanac, the June rally is the weakest of the four seasons and is prone at the end of that month to "portfolio pumping," where larger funds attempt to push the market higher by bidding up shares, only to see them later become range-bound once again. See Figure 1.

FIGURE 1: AAPL. In May 2010, AAPL's price action started to break down and become range bound. Over time, major support was easily identified as price traded above the 200-day SMA and the opportunity to put on a low-risk bull put spread presented itself twice. Each time, the position was carried through to expiration profitably, which maximized the full profit potential of the trade by effectively utilizing three key concepts for trading during the summer months.
Graphic provided by:
If you are a holder of a given stock whose price action suddenly shifts from a period of expansion to a period of contraction, you are facing a dilemma on whether to hold your position in the hopes that the stock will continue in a favorable direction for you or whether you should exit the trade altogether. Tragically, this is where a lot of traders fall apart in that they either don't have a set of rules to dictate their actions beforehand and decide to defer making a decision until a later time. Of the two possible scenarios, the latter is the most dangerous and, unfortunately, the one most chosen.

During the summer months, starting in May, it is vital that you become selective on the trades that you take and, more important, you adapt your approach and adopt strategies where you have a quantified edge to increase your performance during this seasonal pattern.

First, make sure that you identify all major and minor points of support and resistance. Summer trading is symbolic of range-bound trade action where neither buyers or sellers have control of the market so you want to make sure that you trade at these price levels. While neither bulls nor bears may have full control of the market at this point, there are enough buyers and sellers that control huge shares of stock at key price levels that can reverse price when contact is made. Knowing this, you can exploit these levels profitably provided that you identify them in advance and plan your trading approach accordingly.

Second, this is the time of year when the option trader has a distinctive edge over the stock trader due to the versatility of options in the ability to place low-risk spreads in play. While there may not be much chance of making home run trades during the summer months statistically, you can implement option strategies that put time on your side and generate income while controlling your level of risk.

Bull put spreads and bear call spreads are two income-generating strategies that can produce solid returns at a relatively low level of risk by selling a higher-priced at-the-money (ATM) or in-the-money (ITM) option in order to collect the premium offered while simultaneously buying a lower priced out-of-the-money (OTM) option at the same strike price in order to hedge against a sudden move in price action against you.

There are many others, but these two strategies can be used quite effectively at the support/resistance level you identify in a stock's price.

Finally, in the book "How The Stock Market Really Works" by Larry Connors, it was statistically proven that the overall general market has a upward bias and that by trading stocks whose price is trading above the 200-day simple moving sverage (SMA) you can increase the odds of a successful short-term trade by a factor of almost 5. By confining your selection of stock trades to those who are trading above the 200-day SMA, you can put the odds on your side that price will move in an upward direction that is favorable to you.

Keep in mind these three concepts in the upcoming months now that June is upon us. Identify stocks that are trading above their 200-day moving average who are near their level of price support and implement an option spread strategy that will let you generate income during a lackluster trading period. If you do so, by the time September rolls around, you can look back on this as a very good summer.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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