A new study for Stock, FOREX and Futures.
Used to initiate Back Spreads or buy calls/puts.
The Dynamic Trend Profile is designed to find potential trade setups, calculate the entry and stop levels and provide projected target prices. The software performs this very efficiently and updates this information in real time. Along with this information, the software provides strength and momentum levels to evaluate the trade potential before taking the trade.
We have taken this one step further by asking the following questions: What are the odds for a price recovery to the target? If the prices recover to the target, how fast would it recover? Would the price recovery be average or below average? To answer these questions, we have developed the Recovery Factor (RF), a mathematical model that predicts the potential recovery speed. A very high RF value typically generates a very fast price recovery.
For the stock, futures and Forex trader: A fast recovery implies your capital is tied up for less time. In addition, a fast recovery eliminates the potential of sitting through a trade that seems to go nowhere and consumes your time and patience. Also, trades that recover faster tend to be positive right away and reduces initial draw downs.
For the Options trader: A fast recovery means a potential increase in volatility once the recovery starts. This increase in volatility is created by the increase in the rate of change of prices in the underlying equity. Higher volatility usually leads to a higher premium for options. In addition, different options strategies can be implemented based on how the prices are expected to recover.
For example, trades with a very high price Recovery Factor tend to trade quicker to its target. A high price Recovery Factor indicates a great deal of interest and strength in higher rooms that are currently subdued due to a pull back. As soon as the recovery starts, the strength in the higher rooms quickly re-emerges and the volatility tends to pick back up. With this renewed interest, the prices recover faster to its target which, in turn increases option premiums and potential profits. With a very high RF value, one could consider buying straight calls or initiating a Back (credit) Spread options strategy or other bullish option spreads.
Trades with a low price Recovery Factor may still trade to its price target. However, the recovery tends to take a longer time and usually a great deal of sideways price action is seen during this sluggish recovery phase. With a very low RF value, one could consider option spreads that take advantage of moderately bullish to sideways markets.
Now we will discuss the Recovery Factor (RF) and show how this value can be used for selecting better trades.
consider a common situation of recovery.
This chart illustrates an estimated recovery time for
Immediately after the ankle surgery, the average person’s ankle is completely immobilized and has zero strength. As time progresses, the surgically repaired ankle heals and the patient goes through physical therapy to regain strength. In about nine months, the average person regains close to 100 % of their ankle strength back.
Now refer to the healing process of a professional athlete. Many professional athletes have been able to regain 100% of their ankle strength in three months. In these cases, the professional athlete recovered faster than the average person. This may be attributed to the peak condition of the professional athlete prior to the surgery and the strong dedication of the professional athlete to return to their competitive lifestyle.
As in the analogy discussed above, stocks and futures tend to exhibit either an average price recovery or a faster price recovery. Similar to the factors influencing the pro athlete’s recovery, the interest from higher rooms (peak condition) and rate of momentum (dedication) dictates the speed of the stock’s price recovery.
We have taken this concept and developed a formula to measure the interest from the higher rooms and the rate of momentum. Through empirical testing, we have further refined this formula to create a price Recovery Factor (RF). By reducing this concept to an equation, a trader can easily identify trades with high recovery factors. On a normalized scale, the price Recovery Factor (RF) ranges from -15 to + 15.
On a normalized scale, the price Recovery Factor (RF) ranges from -15 to + 15. Positive RF numbers are used for long positions: negative RF numbers are used for short positions.
An RF of +13 to +15 indicates a very high interest in the stock and price recovery should be very strong and quick. An RF of +12 indicates an average interest and price recovery should be average. An RF of +11 is borderline and an RF of +10 or less would indicate a below average price recovery.
An RF of -13 to -15 indicates a very high interest on the short side and price declines should be very strong and quick. An RF of -12 indicates an average interest on the short side and price declines should be average. An RF of -11 is border line and an RF of -10 or higher would indicate a below average price decline.
This is a screen capture of the Profile Screen for Halliburton (HAL). Based on the Profile rules, a highly reliable Buy trade set up is located in the PA room. The following is a quick review of the Profile rules posted in lesson 2 on our website:
A very high RF value would indicate that the prices should recover faster as illustrated by the blue line.
A very low RF value would indicate a slow price recovery with sideways or sluggish action during the recovery phase as illustrated by the red line.
For LONG TRADES, a positive RF such as the following indicates:
For SHORT TRADES, a negative RF such as the following indicates:
In this example, the price Recovery Factor (RF) was +15 (a very high RF number). A RF of +15 indicates a very high interest in Halliburton from higher rooms. Price recovery should be very strong and quick. As projected, the price recovery was very quick and the stock traded to its target very quickly.
For Stock and Futures traders: Trades with a very high RF value usually indicate that the trade should start being positive right away. This allows the trader to focus on locating the next trade setup instead of micro managing an existing position.
For Option traders: A very high price Recovery Factor tends to increase the volatility once the recovery starts which, in turn increases option premiums. This creates an opportunity for option traders. Trades with a very high Recovery Factor (near 15) are good candidates for buying outright call options and perhaps a Back (credit) Spread.
In the case of Halliburton, the entry price was 56.69 with a target price of 61.66, indicating a 60 call option would be in the money if the prices trade to the target. In addition, (if enough time is left) you would expect a substantial time premium due to increased volatility once the recovery starts. The actual option prices for the 60 calls are shown on the next page.
The October 60 call traded around $1.60 and the same options traded as high as $5.00 when the stock traded to its target. Again, the fast price recovery increased the volatility, and substantial time premiums were present in addition to the intrinsic price value.
Recovery Factor (Matrix display) for stocks & futures/Forex
In the Matrix, select stocks or futures (including Forex) and the room size you want to trade in. The Matrix will display all trade setups in that room along with their RF values. You can also sort the RF column to list trade setups with RF values of 15 at the top.
Recovery Factor (Matrix display) for Options
In the Matrix, select options.
The next column is Options Reward Risk (ORR). We estimate what the options prices should be worth if the underlying equity trades to the target and have developed a formula to calculate the potential Reward. Trade setups with ORR values greater than one are ideal trade setups. If the ORR value drops below one, the Reward Risk potential is very low.
Recovery Factor Rules for stock, futures and Options
Using the Recovery Factor (RF) for shorter term Stock trades:
This example shows a trade taken in the Day Trading Room DD. The profile for Goldcorp Inc. is displayed below. The trade setup is in the DD room and all the Profile rules apply. The RF value is +15 and therefore the low star rating of one can be ignored.
Using the Recovery Factor (RF) for shorter term E-MINI trades:
This example shows a trade taken in the Day Trading Room DC. The profile for S&P 500 E-MINI futures is displayed below. The trade setup is in the DC room and all the Profile rules apply. The RF value is +15 and a fast price recovery is expected.
Using the Recovery Factor (RF) for shorter term FOREX trades:
This example shows a trade taken in the Day Trading Room DA. The profile for EURO/USD is displayed below. The trade setup is in the DA room and all the Profile rules apply. The RF value is +15 and a fast price recovery is expected.
Using the Recovery Factor (RF) for longer term trades:
This example of Valero (VLO) shows a highly reliable Buy trade set up is located in the PB room. All the Profile rules apply to this trade setup.
The PB room also displays the Recovery Factor. The RF is 15 and (as discussed earlier) is a very high value indicating a very strong and fast recovery potential.
The entry trigger is 68.88 and the projected target is 88.71. With a high RF factor of 15, you could enter the trade at the trigger level and expect a very fast recovery to the target. Since this trade setup was located in the PB room, the average time required for trades to complete is 5 to 10 weeks. In this example, the stock reached its target in 11 weeks.
OPTIONS OUTLOOK for this trade setup:
The high RF value of 15 indicates a very high interest in the stock from higher rooms and price recovery should be very strong and quick. In addition, once the recovery starts, you can expect the volatility to increase along with increases in the option premiums. Therefore this trade setup is a good candidate for options strategies.
The first task is to see if there is a suitable strike price between the entry trigger (68.88) and the target (88.71). The suitable strike prices are the 70, 75 and possibly the 80 call. The option prices of these strike prices are shown on the next page. Since PB trades require 5 to 10 weeks for the trade to complete, you would select a strike month to allow a minimum of 10 weeks plus an additional two to three weeks for option expiry. The Matrix screen automatically calculates the ideal strike price and expiry month (in this case the ideal expiry month is September).
This type of Trade setup also creates opportunities for initiating Back Spread Option strategies. This is an option strategy where you would sell one in the money call option and buy 2 or more of the out of money call option, usually for a credit. Many option related sites such as Optionetics.com and Optionvue.com provides education on this type of strategy.
Again, the key is to find trade setups with very high Recovery Factors and a projected target that will be in the money if the target is met.