Jenga and the Physics of Trading

 

Date: 10/29/2021
Author: Chris Hood

 


Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.


This game had gone on for some time, and I was getting nervous.

My wife had just completed her turn at Jenga, successfully placing a block atop a tower of wood that seemed to defy gravity.

This miniature tower had reached such heights that my palms were sweating.

Could it even get any higher?

It was my go, and I could see the disaster coming, but rules are rules. So no passing, I had to keep going.

So I took a deep breath and started to slide out a block…

 

 

As a professional trader, I always weigh my potential gains versus my downside risk. So that turn in Jenga that had me sweating was like entering a long options trade on a stock that had just made a 5-day bull run.

It’s far more likely to fall hard than keep climbing.

Profitable traders know that profit-taking WILL happen. It’s basic market psychology…and if you’re going to make money, you can’t ignore this any more than an engineer can disregard the laws of physics.

This is a critical concept that I emphasize with all my subscribers. It’s why we made 70% on GOOGL and 69% on PI just this week.

With options, you want to get in at the lowest price possible and ride the trend up.

So how do you do it?

One technique is to use Keltner channels and avoid entering trades that have moved too far from the mean.

Take a look at this graph.

 

 

The white center line represents the 20-day moving average of SPY. The bands above and below show the one, two, and three ATR Keltner channels.

I won’t get into the overly technical details, but the principle is simple.

The further price moves from the moving average, the more likely it will be to revert to the mean rather than continuing to climb.

With just a glance you can see this in action.

On Tuesday, we saw it bump the top channel after a 9-day rally…then a pullback.

I don’t pretend to know what SPY will actually do over the next few days. But, honestly, no one does.

Traders don’t work in certainties but probabilities. And what I can say is that a significant pullback is more likely than an unchecked rally to the moon.

In my 20 years of trading, I’ve seen some stocks just keep climbing to insanely high prices. But this is the rare exception, not the rule.

I’m perfectly comfortable getting out early with a solid win that ‘letting it ride.’ I never want to see my profits evaporate because of greed.

This is why planning your profit-taking levels BEFORE you place the trade is absolutely critical.

Based on your technical analysis, you have to decide how far you expect the stock to climb. Set an alert on your broker platform and follow your rules.

Exit when you say you will.

…when I finally placed the final block atop the wobbly Jenga tower, I held my breath.

Sure enough, it came crashing down.

And while I did have to listen to my wife’s teasing, I was just glad I’d only taken a blow to my pride and not my trading account.

Cheers,
Chris Hood

 

P.S. This is precisely what my colleague Dr. Kent Moors did on his recent 106.3% gain on NTTF. In before the pop and out before the drop. Get more details on his system by clicking the link here.

 

 

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