Intraday Trading High-Quality Stocks, Part 2

In my last article, Intraday Trading High-Quality Stocks, I presented a setup (CCI(35) less than -150 and RSI(2) less than 10 on 2-minute charts) and trigger (close above its 10-period moving average) that defined an oversold market condition ripe for trading the downtrend reversal. I called the strategy trading “wiggles” because its goal was to make as many 15 to 40 cent gain trades as possible utilizing 1,000 shares at a time to catch the stock as it fluctuated (or wiggled) around its rebounding trend.

Each stock has its own natural volatility or wiggle, if you will, and it’s these small fluctuations that are captured with this strategy. In this article, I’ll introduce the covered-call hedge as my natural finish to this sequence of intraday trades. It’s my preferred exit as the trade becomes tired and price turns over. This day-trading strategy really is a disguised income strategy that can conservatively produce greater than 20 percent annual yields even in today’s erratic market.

My goal is to deploy money in quality stocks to earn 20 percent annual gains with minimal risk. Granted, we’ll still be exposed to the extreme whims of the market. For me, that means limiting my trading to fundamentally sound stocks and hedging my bets whenever I can. Writing in-the-money naked puts (the subject of an earlier article, Trading Options for Income) is an example of such an income strategy. This one is a little more complicated and probably best described by an example.

Visa Inc
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is a quality stock. Among other criteria, its Zacks’ #1 ranking reflects earnings stability and growth for this large cap company, while the next two-year PEG ratios at 0.90 and 1.06 (using one year growth rates) show value remains in its current price. Because of this quality, institutions provide support for price and that’s comforting. Too, V is very liquid: currently averaging more than 9 million shares traded daily. Small moves and volume are key ingredients for any day trading vehicle.

Visa Chart

A portion of V’s 2-min chart from 6/10/09 is shown. Note, time is Central Standard Time so at 9:30 V was already an hour into its trading during which it had reversed its opening down trend at the half-hour mark (an often seen intraday reversal point). At 9:30, as it began trending down, it was time to watch for a reversal. As seen on the chart, I’ve defined eight steps in the ensuing series of wiggles’ trades.

Step 1: V steadily trends down for an hour bouncing several times off the resistance of its 10-period moving average;

Step 2: at 10:30, it approaches its 1st-hour’s lowest close (yellow dotted line) so I begin to look for the reversal; note, other types of support would be applicable as well, e.g., the prior days high, low or close or a Fibonacci level;

Step 3: shortly thereafter, the CCI(35) makes a series of bars falling below -150 (blue) indicating our rubber band is being stretched to its limits, i.e., V is extremely oversold here;

Step 4: the RSI(2) falls below 10 confirming the extreme oversold nature of the market;

Step 5: price closes above its 10-period moving average and begins trending up; the trade’s trigger is hit and 1,000 shares are purchased then sold for a 34 cent gain (+$320 profit after two $10 commissions) over the next 30 minutes;

Step 6: price pulls back to its 10-period moving average; RSI(2) reaches a minimum below 30; and the second trade is taken; it plays out over the next 30 minutes for a 24 cent gain (+$220 after two $10 commissions);

Step 7: price pulls back again, and RS(2) makes another minimum; this third trade goes long 1,000 shares at $68.80, but shortly thereafter, it meets resistance near its 1st-hour’s highest close and falls back;

Step 8: the long position is hedged by developing long play into a covered call; 10 June $65 calls, expiring in nine days, are sold for their $4.20 per share premium; an advantage of this option play is that its value changes slower than does that of the underlying stock, so one has a little extra time to make a judgment about the stock and implement the call or look for the rebound higher.

Bearing in mind that my high-level goal is to deploy money at a 20 percent plus return annually, let’s look at the profit consequences of the above sequence of trades nine days later at the option position’s expiration. Note, options expire effectively on a Friday, though officially on a Sunday, but my money remains tied up until Monday morning (11 days). The two wiggle trade returned $540 after commission:

Wiggle Trade 1 profit: +$320 Wiggle Trade 2 profit: +$220 Total: $540

Assume V’s price remains above $65 for the next nine days, which should hold true since that’s well below its 20-day moving average which has closely supported price over the last few months. The 1,000 V shares will be called away at option expiration for $65 a share. That’s what I want to happen, since my goal isn’t stock ownership (not to say that won’t happen occasionally). It’s a benefit resulting from writing in-the-money calls. So let’s calculate the profit of trade 3, the total return of this sequence of trades and the percent downside risk.

Risk/Reward Calculations for the Wiggles Trade

Trade 3 Profit = $370 = 1,000 x ($65 – $68.80 + $4.20) – $30 [3 $10 commissions] Total Profit from entire trading sequence = $910 = $540 + $370 Cash Invested = $64,080 = $68,800 – $4,200 – $540 + $20 for 11 days % Return (11 days) = $910/$64,080 = 1.42% % Return (annualized) = 1.42% x (365/11) = 47.1% % Downside Protection = 6.9% = ($0.54 +$4.20)/$68.80

This 11-day trade allowed me to deploy $64,080 at 47.1 percent annualized rate of return in a fundamentally sound stock.

The next day, V set up again, and I was able to complete two round-trip wiggles trades before the market turned down leaving me holding 800 shares of V at $67.53 a share. I then sold eight Jun $65 calls for $2.90 and deployed $51,728.

Wiggles’ Trade Profit: $160 = ($104 + $88 – 4x$16 round-trip commission) Trade 3 Profit = $272 = 800 x ($65 – $67.53 + $2.90) – $24 [3 $8 commissions] Cash Invested = $51,560 = 800 x ($67.53 – 2.90) + $16 – $160 % Return (10 days) = $432/$51,560 = 0.84% % Return (annualized) = 0.84% x (365/10) = 30.5% % Downside Protection = 4.6% = ($160/800 +$2.90)/$67.53

This 10-day trade allowed me to deploy another $51,728 at 30.5 percent annualized rate of return.

So there you have it, the wiggles strategy allows one to deploy money at high rates of return by day trading a bit first. I’ve executed as many as nine wiggles trades, earning $1,353 before ending the sequence. One word of caution though, trading wiggles in quality stocks at 1,000 shares at a time requires a large capital stake that may be entirely committed to one stock through the end trade’s covered call. For me, this approach offers an efficient way to deploy cash into about 10 quality stocks. Something I usually only need to do once a month.

Richard Miller, Ph.D. – Statistics Professional, is the president of and