Around the middle of this summer I first heard about the new rules that are going to take effect this fall.  New Rules Explained  From reading the explanation of the new rules, you can see that part of the new rules are for an increase in margin to give people more buying power.  I looked at the new margin rules and saw that they do have some teeth to them if you get a margin call, so people need to be extremely careful about how they use this expanded margin.  What concerned me was the rules about the definition of what makes a person a Pattern Day Trader (PDT) and the equity requirements that much be maintained once a person gets designated as a PDT.  

    First let me start by explaining what my trading style was like.  I was not a true "day trader" I did not make it a habit of scalping for 1/8's or 1/4's.  I looked for trades that were showing the potential for points, and when appropriate, ones that I could hold for a day or two to take advantage of a bigger move.  I have 7 price signals that I use and I was concentrating on the momentum signals for my trades.  The stock would make an initial move to get the momentum going, and then I would look for an entry so I could take advantage of the momentum and then the follow thru to the move.  I did make a lot of intraday trades, where I would enter and exit the position in the same day.  Sometimes the move would play out in one day, there were just some days when I wanted to be in cash overnight.  And because of my aggressive style there were plenty of trades I would enter, only to get stopped out of for a small loss, and quite often this stop would get hit the same day I entered the trade.  After reading the PDT rules, I realized that I would be classified as a Pattern Day Trader.  From talking about this with the members of the web site, I found out that quite a few of them would be effected by this rule, so I decided to start working on strategies that could be used so they could continue to trade.

    In early July I decided to just see what it would be like to trade my momentum signals while living under the new new PDT rules.  This would give me a chance to see what changes if any would need to be made to my trading strategies.  I created a $10,000 account and imposed some rather strict rules for myself on it.  Most importantly, I imposed the PDT rules on myself.    Trading Account Rules   The full details about this account are in the members section of the website.  

    I started trading the account on 9 July 2001.  And decided to take it to a cash position at the end of Aug. so I would be able to accurately show the results for 8 weeks of trading.  I started with $10,000 and the balance is now at $13,084 This is a 30% gain in 8 weeks.  This was done without placing 4 day trades within 5 days, and was done without using margin.  I am very happy with these results, I could stop here and would surpass the historical yearly gains for the S&P which many use as a benchmark.  What this shows is that I did find a strategy that works, and this was during a period when the markets were under a lot of selling pressure too.

    Lets take a few minutes and examine how the trading activity went.  I am not going to go into the details of each trade here, that information is in the Members Section of the web site.

    The first group of trades were rather disappointing, the results were just the opposite of what I was expecting.  The first 3 trades I closed were for a loss on each one.  Then I did hit 4 in a row that had gains.  One more loss, and 3 gains, and finished the first week up with 2 more in the red.  I was batting about 50% and at the end of the first week was ahead by $123.00

    The 2nd week I opened some new positions, and was stopped out of one for a loss on it, and held the others over the weekend.  What was key during this week is I showed how to "stop out" on the same day WITHOUT creating a day trade.  The details on that will be explained shortly.

    The 3rd week I closed the position from the 2nd for some pretty good gains, the account was showing nearly a 20% increase.  Then at the end of that week, 5 straight losses took away those gains.  The account was back to only being ahead by $143.00.  I was feeling devastated by this.  The scans that I had been using to generate tremendous profits just were not working when I was forced to hold the positions overnight.  It was time to stop and review what was going on.

    First I reviewed how I use to trade.  I discovered that the momentum plays I had been making, in many cases I would take the profits on the same day, and in the other cases, the stock would follow thru on the buy signal.  Also, because I was aggressive, there would be some cases where I would get in, get stopped out, and get back in on the same day to get positioned for the move that I was expecting.  Then I examined the positions I had taken over the previous 3 weeks.  One thing the market was whipsawing up and down and the stocks just were not following thru from their initial moves.  The early strength that would generate my trading signal, was just about all of the move that the stocks would make.  I am primarily a short term trader, what I am looking for is gains from a 1 to 3 day period.  These primary moves were just what I had been looking for, so by the time they generated the momentum signal, the short term move was just about over.  This lead me to examining the charts to see if there was any way to find when these moves would begin.

   Now we get into the 4th week, the end of July and first of Aug.  I really slowed down on the activity and started concentrating on a relationship I had noticed on 2 intraday time frame.  I had 5 gains vs. 3 losses, and the account was now up to $10,727.  A $584.00 gain for the week.  This is starting to look a bit better.  The 5th week I place 2 trades, and both were gains, another $620 added to the account.  This was the week where I was very focused with the new relationship I had found on the charts, and I just focused on watching it develop to make sure I was on the right track.

    I then used this relationship to finish up the next 3 weeks, and wound up with 12 gainers and only 4 losses.  This put the account balance at the end of Aug. at $13,084, that is a total of a 30% gain in 8 weeks.  And as you can see, just about that whole gain came after the first 3 week, and over half of it in the last 3 weeks.  Also the win/loss ratio really increased in the last 3 weeks..

    I did find out that the requirement of holding overnight does change the whole ballgame.  I was finding out that the momentum needed to start a move, was not working so well when it came to holding overnight for the follow thru.  Part of this is due to the market conditions at the time, this just shows that you have to adapt to what the market is giving you.

    Money management and stock selection becomes very important.  When you have a small account, one under this $25,000 limit, you are limited in the positions you can take.  Let's use a $10,000 account and the QQQ tracking stock for the nas100 as an example.  If you wanted to go long on the q's and the price is at $40.00, it would take $4000 to buy just 100 shares.  That would be placing too much of your account into one position.  Another issue to consider is when the price is falling, many people are not familiar with shorting, or are just afraid of the unlimited risk of shorting, and they miss out on the downwards moves.  Another factor with shorting is that on most stocks you have the up tick rule that means you can only sell when there is an up tick.

    Some people would say that with the new 4X margin, the $10,000 account will have $40,000 in buying power.  So that 100 shares of the q's at $4000 is only 10% of the account.  And since it is acceptable to have a position take up 20 to 25% of your account, you could actually buy 200 shares of q's.  This is technically correct.  BUT, there is a serious problem with it too.  When you rely so heavily on margin, it very quickly turns a small loss into a much larger one.  I refer you once again to New Rules Explained and the Margin section as to how a 5% stop can result in a loss of 20% of your capital.

    So, the difficulties for a small trader is you now have to hold overnight, you have limited funds so that prevents you from getting involved with the more popular stocks, and you can't rely on margin, because it will just hasten the losses and lead you to the poor house.  This leads us to the first part of the strategy that I am using.

Options.

    There are many sources that fully explain what options are, so I am not going to go into Options 101 details.  I will refer you to CBOE (Chicago Board Options Exchange) for the basics on options.  What I want to do is talk about how options can be used, and my approach to options.  Also I will talk about some of the risks of using options.  I am not going to try to get into complicated options strategies, just simple buying of calls and puts.  

    Lets begin with some of the ways that options can be used to our benefit.  The first and most obvious benefit is the leverage that you gain from using options.  Earlier we talked about buying 100 shares of q's for $4000.  With CALL options you can buy one contract for around $400.00.  Buying the actual stock or buying calls both allow you to take advantage of an upwards move in the price of the stock.  And as you see, $400 is a lot more affordable than $4000.  With that $10,000 account, you could buy 5 contracts representing 500 shares, and still maintain good money management practices, while buying just 100 shares of stock would not be following good money management practices.  Options allow you to get involved in the higher priced stocks for an entry that is only 10 to 20% of the cost of the actual stock.  

    The next benefit of options is that your risk is controlled.  The maximum amount you can lose is what you paid for the contract.  Example, if the q's are at $40, and a call contract is at $4, then if you bought one contract of Calls on the q's you would pay $400 for the this contract plus commission.  If the q's collapse and fall to $20 from $40, your total loss would be the $400 plus commission.  If you were long 100 shares of the actual stock, that plunge from 40 to 20 would have resulted in a loss of $2000.  This is really good for the sudden surprise moves that can happen from an earnings warning or some other bad news.

    The next benefit of options comes in the ability to take advantage of a falling price.  When you think or see that the price of a stock is falling, options present a good way to "short" the stock.  To do this you buy puts to take advantage of a falling price.  And with options, there is NOT an up tick rule, and as with calls, your maximum loss is limited to the cost of your contract plus commission.  We all know that prices do fall, whether it is just a retracement to an uptrend, or whether it is from a serious downtrend.  With options these downward moves can be taken advantage of, and can be done with peace of mind knowing that you are not exposed to an unlimited risk.  When you short the actual stock, it could double or triple in price overnight.  A prime example was with yahoo quite a while back.  It was added to an index, and overnight the price exploded to the upside.  A person that was short the actual stock took a brutal beating.  A person that had some puts, they took a loss, but at least it was not counted in over a hundred points, it was capped to the cost of the put contract.

    And the biggest benefit to options, is they allow you to "stop" your loss without creating a day trade.  How is this done, it is quite easy.  A quick example, if you enter a "long" (either from buying calls or buying the stock) position on XYZ today and it starts going against you and hits your stop, instead of closing the position by selling the calls or stock, which would create a daytrade, you can BUY PUTS on XYZ.  The idea here is to balance out the trade, to make it delta neutral, so no matter which way it moves, the "long" and "Short (puts)" sides balance each other out.  This effectively "STOPS" the losses on your long position.  If the price continues to fall, the puts make what the long loses, net result, your are not losing any more money.  This way you can continue to hold this position overnight, and then the next day you can close the position and you have controlled your loss, and not let it turn into a big loss, and you have not committed a day trade.

    I have talked with many people about options, and there are very few that fully understand options.  There are many that "tried" options, and lost money, so they have sworn them off.  I have heard "I couldn't do it so options are bad".  And there are many that have heard the horror stories or just don't know anything about options, and are afraid of them.  Options can be as simple or complex as you want to make them.  My personal style is very simple, just buying calls and buying puts.  And I am constantly reading and learning more about them.

    I have found out why so many people lose money on options.  Lets start by stating the fact that there are some inherent risks to buying calls and puts.  The number one risk is that they have a time limit, and it is possible for them to expire worthless.  From what I have seen the biggest problem people have with options is they develop a "lottery" syndrome.  What causes this infliction is that people start looking at how big of return they can get.  So they buy the "cheapest" option that they can.  Its like buying a $1 lottery ticket that has the chance of "winning" millions.  Most people use options to speculate and the do it wrong.  They buy the Out of the Money options for next to nothing.  Yes these are the cheapest to buy, and the reason is all they have is time value, and not much of that.  And the time is constantly ticking against you.    You want to pay as little as you can in time value, you need to buy the intrinsic value, which you can think of as the real value that will remain if the stock expires at the exact price it is at right now.  By buying these cheap options, they have stacked the odds against themselves.  This can be determined by the delta value of the stock.  The delta represents the "odds" that the option will expire in the money.  The ones with the least amount of time and compounded by being out of the money, have deltas under 50.  This represents they have less than 50% chance of expiring in the money.  Or better said, they have MORE than a 50% chance of being a loser! 

    I have found the best results for me, have been to buy at least one strike IN THE MONEY, and it doesn't bother me to buy 2 or more strikes deep in the money.  As to time, I want at least 3 weeks before expiration, and I have found that 4 to 8 weeks before the contract expires has proven to give very good results.  This gives me a favorable level of the delta, and I am buying intrinsic (real) value.  I have also found out that by buying the real value, if the position moves against you, the loss is not as severe as the loss from a contract that is primarily made up of just time value.  What I have found is that with options you can LEVERAGE your capital.  This doesn't mean buying $1 lottery tickets.  Let's use the $10,000 account and the q's at $40 once again as an example.  To buy 100 shares of the q's it would cost $4000, and that exceeds the 20% - 25% position distribution that I have set as part of my money management guidelines.  Since your maximum dollar value of each position should be $2000 to $2500, I will start with that.  Next I look at the option chain for the next month (this will give the 3 - 8 weeks of time).   For a long position I will look at the Calls, I then look at the strikes BELOW the current price of $40.  I find a strike where I can buy 2 or 3 contracts for a total cost of under the maximum of $2500.  What I have accomplished is I have a position in an expensive stock, and it is not a lottery ticket, it is one where the odds are not stacked against me.  I do use TA to determine when to buy, and what my stop will be.

That brings us to the Relationship that I found on the intraday charts and a discussion of TA.

    We study the charts to see what has already happened, and quite frankly the biggest reason is to try to speculate what is most likely going to happen next.  This can be done from patterns, indicators, moving averages, etc..... I have believed that just one chart does not paint the whole picture.  You can have a daily chart that looks great, looks like the stock is going to take off and go higher.  But the stock doesn't do that, and when you look at the weekly chart, you find out that what looked so good on the daily chart was nothing more than a relief bounce on the weekly chart, and that the long term trend took over and pushed the price lower.  This weekly - daily relationship is one that I had been using for quite a while, and one of my scans was written just for this.  I would look for charts where the daily chart was showing a potential move in the same direction as the weekly chart.  Before the PDT rules, this was great, when I had a candidate to watch, I would use the 15min chart, and would trade in and out of the stock until I got a good position that I could hold while it made its move.  And as we all know, there are just some stocks that don't live up to the expectations, they will look good, and then just fail, and go the opposite way.  On some of these, I would be ready, and would just flip my position to go in the direction of the failure.  Because I was not worried about how many intraday trades I made, this was not an issue.  But once I imposed the PDT rules on myself, I quickly saw that my footloose and fancy free methods would not work.  To be able to live by the PDT rules, when you enter a trade, you really need to be able to hold it overnight.

    I found out that by using just the 15min chart as my main chart, it was creating too many whipsaws during the day.  Trying to use a smaller time frame is just out of the question, no way to catch good moves with them.  One day I was following a stock.  On the 15min chart it had already given a buy signal, made a small move, and then fell back.  (In the lessons section of the web site, I show the 7 price patterns I use as buy / sell signals)  A little later I was looking at a different chart on the same stock and looking at different time frames.  I stopped when I came to the 60min chart.  On my screen I had both the 60min chart, and the 15min chart of this stock.  I started to watch real close, because the 15min chart was shaping up to give another buy signal, and I noticed that the 60min chart was just now shaping up to give a buy signal.  I noted the time and price, and decided to watch what would happen.  Sure enough, this time the buy signal was one for a move that "had some legs" and would have made for a great overnight hold.  I quickly started tracking a few other stocks with this 60min and 15min relationship.  I was getting quite excited, over and over when BOTH generated a signal for a move in the same direction, it was for a move that lasted at least one day, and in quite a few cases, moves of 2 to 3 days.  I very quickly started using this for my entries for the Trades account, and the results of the last 5 weeks show that it is pretty reliable.  Is the 60min and 15min relationship the "Holy Grail"?  NO, not by any means.  I have found that it does show a high probability of giving a good indication of when it is good to get in and out of short term trades, but there are occasions when a signal will be generated, but the stock will fail to follow thru on the signal.  Also, because it is a short term relationship, it is not very good for longer term moves, it quickly becomes overbought or oversold.  

    I have been asked why I use the 15min chart so much and not the shorter 5min, 3min or 1min charts.  The reason for that, is as you drop to a smaller time frame, they have their up and down cycles, and a 1min chart will have many cycles just to set up one cycle on the 15min chart.  And I have always believed that the better profits are generated by time, the longer you can stay in a move, the more you will make.  This relationship of 2 charts could be used for daytrading, you could use a 15min and 3min chart, or a 5min and 1min chart.  But with this small of a time frame, you would be getting in and out of a stock quite a few times during one day.  And you would be looking for profits in the range of nickels and quarters, instead of 1/2's or points.  By looking for moves that last 1 to 3 days, I am primarily looking for moves that give the 1/2's preferably the points.  This relationship could be expanded for a longer term trader, instead of 60min and 15min charts, a longer term trader could use daily and 30min charts, or for real long trades, weekly and daily time frames.  When you go to a longer time frame, the shorter time frames become "noise" and will cycle thru the smaller up and down moves that make up the larger move.

    You may be asking, "Just how do you find charts that are showing this relationship?"  I have a background as a programmer, and the charts that I use during the day have a real time data feed, that also has the ability to be used in a custom program.  So, I started writing my own program to get the data for 2 time frames, and compare the relationship of these 2 time frames.  I have set this program up so that I can select any two times frames to use to run a scan.  I still have some more work to do on this program, I am going to get it to where it will save the results in a watch list and I need to clean up the user interface to make it more appealing.  Then the next version of this program will be to take a watch list, and MONITOR it during the day.  And let the program issue an alert when one of the stocks on the list sets up a relationship signal. 

    I have experimented and used many different chart settings, I have found this to be an ongoing process.  I will now show what my charts look like, and what some of these relationships look like.

I use qCharts during the day, and I have found them to have one of the best platforms for charts, and the features that the charts offer.  In qCharts, they have a way to save a screen as a workspace, and I have 2 primary workspaces that I use, one for analysis, and the other for intraday watching.  This first picture is from the analysis screen.  It shows the relationship of the 60min and 15min charts on PWAV from Fri. afternoon 7 Sept. 2001.

First, a quick run down of the settings.  I have found that the 50ema is one of the most importance moving averages that there is.  Over and over, it has proven its importance to me.  Next I have a 7ema, and I have found that for the short term signals, it is a good one to keep an eye on.  Of course, you always have to have volume to find out what the sentiment of a move is.  On the macd, I use 6,13,8.  This is a "fast" setting, and is just one I have come to like thru trial and error.  Same for the stochs (stochastics).  The 21,4,4 setting is "fast" but it is what I like.  And on the RSI, I am using a setting of 5.  This is fairly fast, but not so fast that it is like a heart monitor.

    As I mentioned, during the day I use a different screen, it is one where I can keep an eye on multiple stocks at once.

    I have this screen set up with the 60min chart on top, and the 15min chart on the bottom for each stock that I am watching.  And with this setup I can fit multiple stocks on one screen.  Due to size constraints, I had to leave the rsi off of these charts, but I do have another chart available on that screen that is set up like the charts on the analysis screen, so it only takes a moment to view it and see what the rsi is doing.  On this relationship of PROX, we have the 60min chart that shows a sharp drop to 10, and a very quick rebound from there.  It paused on the 50ema and at the very right edge is making a nice move to break above this consolidation.  The volume and the macd moving up are good indications its likely to move up.  On the 15min chart you can see the nice saucer it made on that dip, and the increasing volume on the move to test the resistance at 11.  the macd is crossing to the upside on the 0 line, and the stochs are showing strength.  This is shaping up for a nice breakout on the 15min chart.  On the daily chart, this is coming from a nice consolidation on the daily 50ema, and showing the potential for a nice breakout of the recent resistance of 12.  The weekly chart is showing a real nice base and double bottom, so this is one that has some real good potential of turning into a longer term hold.

    Both of these are stocks that I highlighted in the members area during the week of Sept 4 - 7 on the "Stocks To Watch" (STW) page.  And on the "Trades" account I entered a position in both of them.  For PROX my entry was at 11.10 and on PWAV it was at 11.30.  At this time, these are still open positions, so I have to wait to see what the outcome of them will be.  But at this time, the close on Fri. was above my entry on both of them, so that is a good sign.

    This fall the new rules will take effect.  Those with over $25,000 will still be able to place intraday trades, and not have to worry about how many of them they place.  Margin accounts will have potential of using the increased margin, IF your broker offers it.  But this increase of margin will have to be used very carefully, the consequences of misusing will be quite severe.  For those that have less than $25,000, it will take work to make sure that you don't get designated as a Patter Day Trader.  I have found that options offer a real good avenue to accomplish this.  Options offer real good leverage, and the rewards from them can be quite substantial.  But as with anything, they can also be misused, and one of the biggest mistakes is the "lottery syndrome".  Options are also a real good tool for traders that have over $25,000 to use.  What is most important for every trader is to make a good entry, and concentrate on placing a good trade.  This means a position size that is not too large for your account, and by honoring your stops.  It is so important to keep your losses small.  Once you start letting the losses run, you are just tearing your account apart.  Yes losses hurt, mostly they hurt the ego.  Until you can overcome that, you won't be a successful trader.  Also we have brokers that are starting to react to the new rules, and are setting up their guidelines for this fall.  One broker has sent out an email shows they are going to crack down on the cash accounts to prevent "Free Riding".  They are going to make their customers wait until the sell is settled before those funds are available for the next purchase.

    I have also presented a way to use the charts to find the best entries, and you can also use this relationship to find the best exits.  I have never believed in trying to find the exact bottom and top, that is just something that can't be done accurately and consistently.  But by using the relationships, you can get closer to it, and be able to capture moves that generate some good returns.

    For those of you that purchased this report, and are not IITC (ItsInTheCharts) members, I would like to take this opportunity to offer you a discount on your first months subscription.  I will let you apply the cost of this report towards the price of the first months subscription.  As a member, you will have access to the commentaries on the NASDAQ.  I write a weekly commentary that looks for the longer term trend, and what to expect on Mon.  And each day of the week (Mon. - Thurs.) I write a daily commentary to look for the short term movements that we can look forward to.  During the trading day, I send out emails to the members when I see something worth bringing up.  Each day I present some Stocks for the Members to Watch.  These are stocks that have come up on a scan, and ones that I feel the charts are showing a potential for a move in a certain direction, or are showing a pivot, and could break either way.  By using the lessons in the members area, you would know how to prepare a plan, and to be ready to react when the stock does make a move.  Also in the members area is a message board that has different forums in it so the messages can be grouped by topic.  There is a forum for "Upcoming Events" this is where members can discuss news events, and expected news events.  There is a forum where the members can post stocks that they are interested in.  If you have a good scan and want to share the results with the other members, this is the place for it.  We have a forum where you can ask questions about options.  And a forum for questions about TA.  If you have a stock you like, but are unsure of what the charts are saying about it, this is where you can ask.  One really nice feature about the message board, is that it has a feature where you can search thru all of the messages for a specific word or phrase.

    And, when issues such as this come up, the members of IITC are not charged extra for it.  This report is part of the subscription.

So Sign Up today, and start enjoying the benefits of being a member of ItsInTheCharts!

Jim.

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