The stock options market in Singapore has been growing over the years, and so has the sophistication of professional and novice traders. However, these traders always face new challenges as the markets evolve. The number one challenge is usually finding an edge that can give them an advantage over other market participants.
What are techniques?
Several techniques are used to identify such an edge and give you those critical few extra percentage points that could mean profit or loss for your trade. The effectiveness will vary depending on how well they fit your trading plan and personality. Still, it provides another data point that you can factor into your decision-making process. No trader works off pure logic alone – we all take our emotional baggage out of the closet at some point.
These techniques are based on technical analysis of price patterns and indicators, but this is just one component. Fundamental analysis needs to be applied because it is still possible to find good opportunities in stocks trading below their intrinsic value (you can check here for more info).
One of the more popular methods, especially with newer traders, is SMA crossovers which have shown to be a reliable indicator of buying and selling pressure for both momentum type stocks but can show false signals on more stable stocks. The crossover consists of two SMAs (Simple Moving Averages), one longer than the other (e.g. 20/50), which you can imagine as an area where there has been resistance previously that price needs to break through before moving up.
Once price breaks above the resistance, it signals that selling pressure has been overcome and buyers have taken control of the market. Likewise, when the shorter SMA crosses below the longer-term average, this signals that selling pressure has increased. Perhaps more new sellers have entered the market, indicating a top might be forming. The applications are obvious – if you see across where you expect it to go one way or another, buy/sell while factoring in your option pricing model on whether being long or short is better for your risk-reward profile.
The key to using SMAs is understanding how they work and their limitations. While many traders will tell you that they can predict prices, this is not true. They are doing to identify potential areas where the market could go but certainly not say which direction it will take. Secondly, these are lagging indicators – by the time you see a crossover on your chart, it is already too late to act on it. It means that if there were selling pressure around that SMA, the price would have dropped off before reaching the area where the short-selling trigger occurred, even though it might look like a good entry point now.
Another familiar technique traders use to identify extremes in buying or selling pressure is using an overbought/oversold indicator that tells them when either of them is stretched. One that is commonly used is the Relative Strength Index. The RSI gives a numerical value from 0 to 100, which shows how fast or slow a stock is trading relative to recent price swings.
If you see an RSI value of 80, it means that for the last 20 days, there have been four or more consecutive days where the stock has moved up by at least 3%. If this happens after weeks of going down, it means that the market makers who often set prices for stocks are starting to lose control and can no longer push it lower. They compensate by widening the spread (difference between the bid and ask), but too many people will be watching this indicator and waiting for an opportunity to jump in at what they think is a good price level.