How to Qualify Stock Trends For Huge Stock Option Trading Profits

by Billy Williams

Successful stock option trading, trading momentum stocks, or trading of any kind can usually be defined at its basic level of developing an eye for the trend of a particular commodity. Often, aspiring traders (or even veteran traders if they are not careful to keep their eye on the ball) can get caught up in obsessing over the perfect formulas to define a trend. They become such puritans to their respective trade setups that if a stock isn't exactly at its 3-year high or whatever then they won't take a trade. The truth is there are no exact truths or set of answers in defining a trend much like trading. However, there are some distinctions that can help determine potential explosive moves in a trend that has yet to occur that can be exploited for huge profits especially with stock option trading.

There are nine individual price patterns on daily bars that I look for and when combined they offer me huge clues as to whether a stock has the potential to make huge bull or bear run (for the sake of length of this article I will emphasize bullish moves to the upside). These price patterns act as trend qualifiers and are base breakouts, price gaps in the direction of the trend, price laps in the direction of the trend, new highs, spikes in price or percentage moves in the price of the stock, strong closes, daily bar price thrusts, the "Picture of Power" moving averages, and slope of the stock's price action.

A base breakout occurs when price on a given stock has been moving back and forth between two determined price points for four to eight week, give or take, and then price explodes out of the top of that price base to a new high. Typically, this happens as the big institutional traders have decided to enter the market and take a position in a stock which is preceded in a large of amount of volume accompanying the breakout. It indicates that the bulls or buyers have taken control with the likelihood that a trend is developing.

A gap occurs when a stock opens above the previous day's high and when this happens in the direction of the uptrend, it reveals a strong demand for the stock as buyers are bidding up the stock before it opens. When the lows of the gap are even higher than the previous day's high it shows even more strength and conviction in the direction of the uptrend. This pattern can yield huge gains as it often reveals a continuation of the prevailing trend or the beginning of a new trend. If a stock gaps in the opposite direction of the prevailing trend while breaking a trend line or some other trend indicator it can reveal a new trend taking place. If timed right, tremendous gains can be made by getting in early on this new trend.

A lap occurs when a stock opens greater than the previous day's close but less than the prior day's high. While not as strong as a gap, a lap in the direction of a uptrend lets the alert trader know that there is momentum to the upside that can be exploited with stock option trading. A skilled trader can also watch for consecutive laps that take place within a given time frame to gauge the strength of an impending move. For many traders who trade only at a new annual high in a stock's price by watching for these consecutive lap patterns during a pullback can allow them to get in earlier a trend about to resume its upward move. Once a stock goes thru a correction from its high but watching for laps in the direction of the primary up trend it is possible to time an entry with relatively low risk as the stock approaches its old annual high and potential surpasses it.

A stock must hit new highs if it is an uptrend. By watching stocks approach both a one and five year is good guideline for gauging its trend. However, combining this guideline with good chart reading can also allow a skilled trader to time there trade on a smaller time frame. For example, if the weekly stock chart shows a stock in a correction from its primary up trend then observing price bottom and begin the slow ascent to the upside again then a skilled trader can drop down to the daily chart for a possible entry. If price begins to retrace back to its 50 Fib retracement level while forming a small price base watch for a clues in price action (like those featured in this article). If there are complimentary price patterns then use a six to eight week high as a guideline to time breakout trade with options or trade on a pullback if price spikes up from there but offers a slight pullback before moving higher. These moves are common and offer easy low-hanging fruit for traders with low risk.

It's also important to gauge the percentage of the move in the respective stock. If a stock trades at $90 and then explodes to $180 a share within two months it doesn't take a genius to figure out that the stock is in an upward trend. By being aware of how far price has accelerated in a given time frame you can get a strong sense of the strength of the move and adjust your trading strategy accordingly.

In addition, you want to observe and record strong closes that occur in the upper 25 percent of its range. The more days in a row that this occurs the stronger the uptrend because it shows how many investors and traders are willing to hold the position overnight. It shows strong demand for the stock which could grow stronger as more traders catch on to the stock's price movement and decide to participate in the buying which further strengthens the upward movement of the trend.

Thrusts in price movement also reveal strength in an impending uptrend. A thrust is a daily chart bar that is almost or greater than the average daily price action than the previous five days. These thrusts reveal a frenzy of buying and often occur during price base breakouts as a stock gets ready to take off on a big bull run. Thrusts are common in base breakout occurs but they can also give you a clue to winning pullback trades. When base breakouts take place with thrust bars leading the way if there are more than two or three thrusts with strong closes then price will often pause with a slight decline of two to five daily bars before the trend resumes itself. By watching for these thrust patterns you can begin a watch list of breakout stocks for pullback trades. The persistence of the trend can also be measured using moving averages. I use the 8 period EMA, 21 period EMA, the 34 period EMA, the 50 period SMA, and the 200 period SMA. Statistics have proven that stocks trading above their 200 period SMA are bullish and I use the 50 period SMA to help me compare the slope of their readings in relation to each other to judge the persistence of the stock's trend. I then use a combination of the 8, 21, and 34 Exponential Moving Averages to judge the short-term strength of the stock's price action. If all moving averages are stacked in their proper order then they reveal the Picture of Power that I am looking for. If a stock explodes out of a base and all MA's are in order then any pullbacks that do not close below the 21 EMA then I will be looking to enter once price rises above the high of the lowest bar without violating its low to ride the resumption of the trend that is in place.

The slope of the stock's price action itself is also an important indicator of momentum to the upside and whether that momentum will continue to gain strength. A price slope of 90 degrees roughly shows a healthy amount of relative strength so if price declines slightly or if a stock begins to form another base then an alert trader can plan determine the health of the uptrend for trading call options. However, if the price slope goes to 45 degrees or higher, the skilled option trader knows that these accelerated moves often spike higher before crashing and adjust their option trading strategy. When stocks go thru this Bump and Run setup I will use short term option plays with small targets while waiting for a trend line violation or gap reversal in the opposite direction to short.

In closing, it's important that you understand that there are very few secrets in trading but the ability to spot subtle distinctions within a trend or just before a trend begins can bring your trading profitability to whole new level. Warren Buffet, the famed Oracle of Omaha, has made the comment that it's not the investor with a 160 IQ that always does better than the investor with a 130 IQ but it's the investor who exhibits a combination of superior emotional discipline and ability to see further into the future. By developing your ability to spot four to six of these price patterns within a 3 week period while a stock is in a slight decline from its high or in a price base it can reveal that the stock may take off on a huge bull run. It can be invaluable in helping you gain a glimpse of future trends to determine which trade to take between two similar companies if one stock reveals some of these clues and the other one does not. Combined with stock option trading and an effective money management method you have the potential to make some spectacular profits.