ADX and Options Trading
Dr. Charles Schaap, the father of the “50-50 Strategy,” has been a writer for financial publications such as Stocks & Commodities Magazine, Working Money, and StockMarketStore. Dr. Schaap utilizes theories concerning the nature of different time frames and indicators to create experimental strategies for trades that can go to any point of profitability. His book ADXcellence – Power Trend Trading is a great read that delivers the message that trading in the face of overwhelming odds is foolish.
Please enjoy my recent interview with veteran options trader Dr. Charles Schaap. This is the second part of our two-part conversation.
Optionetics: What is your most memorable trade?
Charles: My most memorable trade occurred in Italy. I was trading the Emini Nasdaq. My wife found a fantastic hotel in Taormina, Sicily, which overlooked the Mediterranean and had a gorgeous view of a “smoking” Mount Etna. But the room was $400 per night and over our daily budget. So I went to an Internet café and made a one-hour trade to pay for the room for a week and we lavished ourselves in comfort. It was my most memorable trade because I thought trading would always be that easy; but it wasn’t. I found out that I had been luckier than good. Trading is not that easy, and humility goes hand in hand with profitability.
Optionetics: With all the different technical as well as fundamental analysis tools out there how does a new trader avoid information overload or "analysis paralysis"?
Charles: When trying to improve as a trader, most people look outward, but the only way to succeed is to look inward. There is only one source of useful knowledge that a trader can use, and that is his or her own brain. New traders should learn the basics well and understand there are no shortcuts to becoming a successful trader. There are not magic systems or gurus that will make you profitable. One of the most important lessons of trading is the need to be self-reliant. For technical tools, first learn to read a price chart without any indicators. When you understand that, then add an indicator you understand fully. Fundamental analysis should be quick and easy. Most people are not economists. I use the IBD ratings to check fundamentals before buying a stock and it takes me about 30 seconds. Why make it harder than that?
Optionetics: How would you characterize your technical approach to the markets?
Charles: Trading is simple, but getting to simple is complicated. While I have studied intensely to understand technical concepts, I focus on what I can effectively use when trading. I use trend and momentum principles to analyze market conditions. I always use ADX to distinguish between strong trends and weak trends. I use DMI momentum signals for entry and exit. While I usually have a directional market bias, I never predict direction. Instead, I focus on what I am going to do when price does what it does.
Optionetics: What do you think are the greatest misconceptions beginning traders have about trading the markets?
Charles: Trading is easier than most people think, but harder than they can imagine. I think the biggest misconception beginning traders have is that you can make a lot of money with very little experience and very little starting capital. New traders just don’t have the mindset, experience, or knowledge to compete with the professionals on Wall Street. Beginners read a book and it looks easy if they just follow the indicator signals; but real trading is infinitely harder. Unless there is a strong bull market (like in the nineties) beginners will have trouble being profitable because they don’t understand trend and risk management, and they aren’t prepared for the emotional toll from trading losses and being wrong much of the time.
Optionetics: What kind of advice would you give a person just now beginning in trading the markets?
Charles: First and foremost, protect capital while learning. Baseball players take hundreds of practice swings for every swing they take in game. Trading is no different. Start with practice swings in trading (paper trading). Study the basics of price and trend. Don’t risk any capital until you are consistent with trade analysis; know the premise of the trade, the technical setup, and prices for entry, stop-loss and first target. Find someone who is successful trading for a living and get guidance. Because trading is a solitary pursuit, we have no protection from ourselves and it is easy to get off track. The trial and error method of learning the stock market will drain off precious capital. When risking capital, start small. If you can’t make money with 100 shares, you can’t make money with 1000 shares.
Optionetics: Can you describe what your average trading and analysis day entails from preparation to execution?
Charles: Every day after the market closes, I record key information on the S&P as my overall market view. I look at trend conditions, support and resistance levels (weekly, daily, hourly), and I also look at advance/decline, ticks, and TRIN. This becomes my big picture view and roadmap for trading. For individual stocks, I do scans such as new 20 day and 52 week highs. I look at charts and check fundamentals on the charts I like. These stocks get added to my big list of 50. I take time to review current positions and adjust stops and plan for exits and/or profit taking. In the morning, I have a checklist with key information on the S&P, stocks, and options I plan to trade. I use checklists to double-check myself before pulling the trigger.
Optionetics: What kind of decision-making process do you go through before deciding on a particular trade and a particular sector of the market that would be worthy of putting on a position?
Charles: In market cycles, the same sectors and stocks tend to work over and over for trades. Many traders are constantly searching and scanning for the perfect stock setup. I look for sectors in strong trends and keep playing the high relative strength stocks over and over. I also like new emerging stocks under $20 that are stories in the making and which haven’t been discovered yet by the large institutions. For entries, I wait for the right technical setup according to my trading strategies.
Optionetics: What type of analysis methodology do you employ to find great trading opportunities?
Charles: I have specific scans I do on my charting software to look for certain trend and momentum conditions; but beyond that, there is no substitute for looking at charts. I keep a main list of about 50 stocks that meet my minimum criteria. During any given week, I find about 10 that look setup for trading and I only focus on them. I don’t want to be distracted by the news of big movers on the day. Most of my trading setups are based on ADX and DMI. I look for low ADX consolidation periods for breakout trades, and high ADX swings for entering pullbacks in a strong uptrend. When I see a low volatility breakout setup, I will buy options because they are less expensive. In high volatility, I sell options at areas of support or resistance.
Optionetics: Thanks Charles for explaining your trading methodology and sharing your trading wisdom to our Optionetics reading audience.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
