Surprises Can Be Golden

We trade technically here, but it’s still helpful to have a general sense of what factors are influencing the market at any point in time, if only because doing so can generate some trading opportunities. One of the factors that virtually all traders pay attention to is Federal Reserve policy, since the price of short-term funds is set by the Federal Open Market Committee, which has a huge impact on bond prices, on the cost of margin, and on the outlook for stocks.

 The FOMC released the minutes of its most recent policy meeting at 2 PM EST today, and this created an interesting trading opportunity. I have been short a bear call spread on GLD, short the April 165 calls and long the April 167 calls. I was paid an average of $0.51 for the position, which is the maximum that I can make on the trade; since the distance between my short and long strikes is $2.00, my maximum loss, if I stop paying attention, is $1.49. Commissions are very low, but they of course reduce the proceeds and add to the possible loss.

 A look at the daily chart shows that after topping out at 165, GLD was rejected fairly hard, and now shows potential resistance around 164. The 61.8% Fibonacci retracement level is at 168 and a move through that level would suggest that a short position might be ill-advised.

 I was more or less resigned to seeing one more test of the area around 164/165, although I expected it to fail; on a break above 165 I was prepared to cover the short calls, leaving the 167 long calls in place in the expectation that the price action would continue moving up in an effort to retest the 168 level. I would of course have lost some money on the short calls, but a move higher would enable me to at least break even on the position due to the appreciation of the long 167 calls.

 One element that I was keeping in mind was time decay; Easter is coming, and apart from flurries around economic releases, I would expect trading to be subdued until next Tuesday. That’s a lot of time decay for options that are set to expire on April 20, and on balance I was quite happy with the risk/reward. In fact, I was hoping to add to the position both yesterday and today, but got a little too aggressive on price, and missed, to my subsequent regret.

 

Most market players expected the FOMC minutes to express a degree of caution about the economic outlook.  This would increase the likelihood of additional quantitative easing – roughly speaking, adding long term funds to the money supply – which would normally be positive for bonds (since the Fed would be buying them to create new money), positive for stocks (money could be borrowed cheaply for margin, and stocks would become more attractive relative to the interest rate offered by bonds) and positive for Gold, because of its role as a hedge against inflation, which the Fed’s actions could make more likely.

 In the event, the first headline that crossed the tape at 2 PM EST indicated that the FOMC had decided that no further easing was warranted unless the economy showed additional signs of weakness. That caught the market flatfooted, and futures were sold, bond prices dropped, and spot Gold (XAU) and of course the GLD ETF were crushed. One of the tools that Todd teaches in his course is the “first half hour breakout”, which I have used successfully. The same approach can work for economic numbers or important releases (such as today’s Fed minutes) when the timing is known and an identifiable range is in place beforehand.

 Without going into too much detail, a stop limit order placed below the bottom of the range can take advantage of a sharp move; I didn’t bother to place a stop limit order above, since there was a low probability of a surprise that would pull prices in that direction. I was able to get short at 161.93 (the low just prior to the release had been 162.06) just after 2 PM EST; using the methods taught by Todd, I covered the short around 2:24 PM at 160.33, although the price action continued lower, bottoming at 159.17.

 In any case, this trade was immediately profitable, and the only question was when to cover. I had initially placed a “catastrophe stop” at 162.45, since an ambiguous statement could have resulted n a whiplash effect, but this one was direct, to the point, and the right way for what I planned to do. That isn’t always the case, but it’s definitely more fun when it is. It can be annoying, and expensive, when a trade that is proceeding well pivots because a new headline comes across, and I progressively moved my stop down in response to the price action, something which Todd goes into in great detail in the course.

 This is a pretty long post, but I wanted to give a sense of some of the thought process involved in trading in various time frames, and in response to different inputs. There are lot of ways to make money (and yes, lose it) trading, but the techniques taught by Todd can be applied to any trading situation that I can think of, and not only help to generate profits but even more importantly control risk.

About the Author Brian Keith

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