This Week’s Battle Plan

Yesterday was Kentucky Derby Day, which in my home carries equal
importance with birthdays and religious holidays. I’m less interested
in the betting aspect of the race (though it certainly is nice when I
win) as I am in the chase to figure it out. The race is a major puzzle
that requires months of work to figure out and I find it to be
challenging, frustrating and exciting all at the same time. The horses
that make it to the race are athletes that defy the odds. Three years
ago more than 35,000 horses were “bred” to be race horses.
Yesterday, only 16 were good enough to make it to the greatest race of
the year. And by the end of the day, there was only one winner, a
semi-longshot named Funny Cide, who broke the heart of the favorite
and his larger-than-life trainer.

Here’s How To Lose Money…Just Think That If It Happened Last Time,
It Will Happen Again

Here’s the thought process that caused millions of dollars to be lost
yesterday, and it’s the same thought process that causes millions of
dollars to be lost in the markets every day.

Ten Most Wanted won the Illinois Derby by a healthy four lengths in
early April. This race is viewed as a prep race for the Derby. Never
mind the fact that he had only won one other race in his career. He
won the Illinois Derby. Why is that significant? Because it was the
same race that War Emblem, last year’s Kentucky Derby winner, won. And
War Emblem then went on to win the Preakness and came very close to
winning the Triple Crown, horse racing’s most illustrious achievement.

Everything. Many traders, especially less experienced traders, will
make decisions based upon one or two events that recently happened.
“Last week and the week before we opened higher off the news and
reversed. Today we opened higher again off the news, What should I do?
I’ll of course play the reversal. IF IT HAPPENED TWICE BEFORE IT WILL
OF COURSE HAPPEN AGAIN.” Or, they will change the rules of a very
good methodology because on the trade before had they just done one
thing differently, the small profit would have been a large profit. Because
it happened once before it will HAVE TO happen again! Because last
year’s winner of the Kentucky Derby won the Illinois Derby, this year’s
Kentucky Derby winner will come from the winner of the Illinois Derby.
Wrong! Life is never, never, never that simple. Just because it
happened once it ABSOLUTELY DOES NOT MEAN it will happen again. And
yesterday, that was never more true, when Ten Most Wanted crossed the
finish line with eight horses in front of him.

3 Great Ways To Use The VIX…(and you won’t
find this information on other Web sites!)

As I mentioned last week, I’ve taken portions of this information and
placed it in a
book, in a
video course and into my
seminar. There is not enough space here to cover everything. But,
let me give you three concepts, a few of which will likely be new to
you:

Concept One – When the VIX pulls too far from
its 10 period moving average, the market has a high likelihood of
reversing.

First, re-read last
week’s piece if you need to understand the basis of this. Second,
here are the rules I use in my own trading to take advantage of this:
The CVR III uses moving averages to measure extreme VIX readings. When
the VIX moves 10% from its 10-day moving average, it has been pulled
to an extreme and is likely to snap back. I first published this in
1997 and it still holds true today. For the past decade it has correctly
predicted market direction within a few days a little better than 65%
of the time, a very healthy edge. You can use this information many
different ways, including to trade the SPY’s, e-minis, options and
more. Just make sure you understand the drawdowns inherent in it, the
risks involved, and proper stop placement. But, when the rubber band
gets pulled too far, meaning the VIX moves more than 10% away from its
moving average, the market is getting closer and closer to reversing.

Concept Two – If the VIX moves too far away
from its moving average, you should not be looking to take new
positions in the direction of the recent trend!

Think about this: If the VIX is running away to the upside, it means
the market is selling off and likely oversold. And it means a reversal
is near (see Concept One again). Why the heck would you be putting on
new short positions at this time? You are setting yourself up to get
hit. A reversal and likely a sharp reversal is near. DON’T ADD NEW
SHORT POSITIONS WHEN THE MARKET IS IN THIS CONDITION! The impending
rally will likely hit you hard and you will potentially lose very
quickly. The same goes for adding to long positions when the VIX moves
too far under its mean.

Concept Three – When the VIX pulls too far
from its 10-period moving average, you should be “more
aggressive” with locking profits in.

Same scenario as above. The VIX is running away to the upside. That
means the market has sold off sharply. It also means you probably have
very good profits on your short position. You can do one of two things
here. You can be delusional and believe the market is going to zero
(something that has yet to ever happen but is discussed every time we
sell off sharply), or you can be wise and start locking in profits
aggressively. The market is oversold, it’s likely to reverse, why risk
it all? You need to lock things in and tighten your stops. Put the
money in the bank. Maybe the market will sell off a bit further, maybe
you would have made another 32 cents in the position had you hung
around, but who cares? The profits are there and more importantly, the
market is going to eventually reverse! It always has and likely always
will. Lock in the gains and put the money in the bank. Do this enough
times year after year and you will likely own one of the horses
in the Kentucky Derby instead of betting on them (just hope
that the horse you own is not Ten Most Wanted).

Have a great week trading (and don’t tell my wife I hit the Derby
yesterday. We don’t need any more new furniture in the house)!