Hi-Lo Breakout Strategy GOAL To take advantage of price momentum in a prevailing trend. We enter a trade in the direction of the trend the day after a breakout of a major high or low occurs (as explained below).
SUMMARY This strategy requires going through daily futures charts, marking their 12-month highs and lows (or contract highs and lows for markets that have traded less than 12 months - but for at least six months). If and when prices in a market close above or below the marked high or low, that’s the signal to enter a trade in the direction of the trend the next trading day. Remember - for examples of current trades using this strategy see “Jim’s Chart Book” as well as our Premium Alert Service Videos™.
CHAPTER ONE
STEP-BY-STEP INSTRUCTIONS 1 Using the Interactive Chart Feature on US Charts Online, go through the daily price charts, and for each market you wish to follow, mark the 12-month contract high and low points on the chart (see explanation in the previous section). For our example we’ll use a chart of the December 2007 Wheat market. Notice how we marked its contract high and low. Note: To ensure you’re seeing as much historical price data on the chart as you need, scroll below the chart, select the “1024 x 768 (large)” option, and click the “Resize This Chart” button.
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[Chart: December 2007 Wheat thru July 9, 2007]
2 Periodically check to see how prices are progressing. If prices are in an uptrend, we’ll pay attention as they near the high we marked to see if they break and close above that high. If prices are in a downtrend, we’ll pay attention as they near the low we marked to see if they break and close below that low. Be patient. 3 The day after prices close above or below the marked high or low, we’ll purchase an option that meets our budget criteria. If prices close above the high we’ll purchase a call option; if they close below the low we’ll purchase a put option. In either case, we’ll be trading with the prevailing trend. Look at the chart of December Wheat on July 24, 2007, the day prices closed above the high. The next trading day, July 25, is when we would purchase our call option.
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[Chart: December 2007 Wheat thru July 24, 2007]
4 To find a call option, go to the Option Quotes page of US Charts Online and select the market and month you wish to trade. Choose an option that has from 60 to 90 days remaining before its expiration. For our example, we would choose an option in the December contract. We’re looking at the chart at the end of July, and December options give us well over 90 days before expiring on November 20, 2007. The screen shot below shows a sampling of available options in the December Wheat market on July 25, 2007. Purchase a call option that is as close to being “in the money” as you can afford. In this example, we might have decided to purchase the 680 call for 35.625 points ($1781.25), or the 690 call for 32.75 points ($1,637.50). We enter the trade into Trade Tracker to follow its progress.
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[Option table for December 2007 Wheat on July 25, 2007]
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[Screen shot of Trade Tracker sample trade entry]
5 Continue watching your charts and wait for your signal to exit the trade (See Possible Exit Strategies below.) 6 In deciding whether to enter a trade, look at the overall picture of the market. If a market has moved straight up or down without any pullbacks from a breakout, don’t be too quick to enter. This is like trying to jump on a moving freight train. Instead, wait for a pullback in prices followed by a continuation of the trend. Then let the break of the previous high (or low) be your signal to enter. This pertains to adding to positions as well as entering new positions. If prices gap open above the prior contract high in an advancing market (or gap open below the prior contract low in a declining market), consider waiting to see if prices retrace to a level equal to the prior contract high (or low). If prices do pull back, you might consider using the “Fish Hook” pattern or the “Robo Entry” method. Training videos for both “pullback” entry techniques can be found at the GBE website.
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[Close-up schematic of when to buy]
CHAPTER TWO
POSSIBLE EXIT STRATEGIES In a Market Moving in Our Favor This exit strategy is based on using points of support and resistance as they naturally develop and/ or a break in the trend line on the daily chart we’re trading. We watch our charts each day. In the case of a call option in a rising market, each day prices will rise and possibly fall, but overall the direction will be up, with falling prices hitting a floor that they can’t seem to break below. This floor is support. When this support level is broken by a price that does fall below it, we exit the trade. In the case of a put option, futures prices generally fall, and even when they rise, seem unable to rise above a ceiling, which is resistance. When this resistance level is broken by prices rising above it, we exit the trade. A trend line is really a graphic representation of areas of strong resistance or support. When it is broken it indicates a possible turnaround (and change in trend) of that market. Note: Selecting exit points is a highly individual process. Traders may use daily, weekly, or monthly charts to find exit points, and they may read their charts differently. The best way to determine the approach you prefer is to paper trade as many trades as possible.
In a Market Moving Against Us An easy exit strategy to implement is to simply decide upon a dollar amount that we’re willing to risk, and if the premium of our option falls to that amount, liquidate it.
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CHAPTER THREE
SAMPLE TRADE Let’s look at our hypothetical December Wheat trade to see how it might have turned out. Look at the chart for the market as of August 23, 2007. As you can see, after a brief pullback, prices rose sharply from our entry point on July 25. We would have begun looking for an exit point as prices continued to rally and our call option increased in value.
[Chart – December Wheat Thru August 23, 2007]
As prices rose, we would have looked for a signal to exit. We would have seen that on August 23, Wheat prices hit a monthly resistance target that was made in 1996, and on that day we could have liquidated our 680 call option for 82.75 cents ($4,137.50), or our 690 call option for 76.625 cents ($3,831.25). That would have meant a profit of $2,356.25 and an ROI of 132% on the 68 call, and a profit of $2,193.75 and an ROI of 133% on the 69 call (not including exchange fees and commissions.) In this particular trade we selected a fairly conservative exit point. A trader who was willing to take a greater risk could have hung on longer to see if prices continued to rise. This is all part of the art of trading. (Check the weekly or monthly charts at US Charts Online to see what Wheat prices went on to do.)
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[Chart – Monthly Wheat through August 2007]
Notice: Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Hypothetical trading results are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.
CHAPTER FOUR
POSSIBLE ADVANTAGES OF THIS STRATEGY 1 By trading with options rather than futures contracts we can limit the amount at risk in a trade — the amount of the premium plus commission and fees. 2 This strategy is easy to follow and doesn’t require much time each day to carry out.
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CHAPTER FIVE
POSSIBLE DRAWBACKS 1 Since we’re purchasing options close-to-the-money in the direction of a strong trend, these options will tend to be more expensive. 2 We may have to monitor markets for some time before a breakout of a contract high or low occurs. 3 Since we’re entering the market at an extreme level, we could be close to the end of the trend, which means our option could quickly lose value if the market turns. If this happens, we use the exit strategy for a market moving against us to minimize losses. Remember - for examples of current trades using this strategy see “Jim’s Chart Book” as well as our Premium Alert Service Videos™.
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