When Trading Futures and Commodities which carry explosive Leverage, it is critical to identify High Probability Trade setups with potential reward that is many multiples of your risk. Today, Silver is offering such a setup.
In order to measure probabilities of a setup, we first must understand baseline movement - i.e. How does price behave over a given time frame.
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This is a Baseline statistical data table. What it shows for a given Future, in this case Silver, is the Historical price distribution over a given Trading Interval. We want to know the Average movement Higher or Lower, as well as the Statistical probability of advancing and declining price moves.
If you look at the columns you will see we are measuring price movement Up and Down over a 5/10/15/20/40 + 60 trading day interval. We've circled the 20 Day Max/Min column as this is the preferred time interval we focus on for swing trading. What we see is the following:
1) The Average price move over any rolling 20 Day period over the past 2 + years is 65.8 cents up vs 71 cents down from any random close.
2) The percentile table shows us the probability of prices advancing or declining. The Blue rows tell us where price has moved 80% of time, while the grey rows show us the 70% level. This helps quantify expected adverse price movement from a risk management perspective. We also have some targets for profit capture.
You can see that Price advanced 24.6 cents 80% of the time and 34.3 cents 70% of the time over 20 trading days. Further, price declined 17.8 cents 80% of the time and 28.8 cents 70% of the time. So the expected 70th percentile move on random entry is 34.3 up by (28.8) down for Bull/Bear odds of 7-6. Now that we know the expected random Silver price distribution, we are able to measure distribution of particular setups vs the baseline to locate High Probability Trades.
We analyze the CFTC COT reports to measure participant activity and positioning, looking for extremes that can be measured.
Using Data Analytics we created a Relative Strength score for Commercial and Fund Positioning and Weekly activity. We factor in the COT activity relative to Price/Open Interest and Volume action for a 18month and 5year score. We then look for extremes and measure price distribution.
When viewing the COT, many market participants mistakenly believe that any time there is "Heavy" Commercial buying, that it is "Bullish". But how do you measure Heavy or Light? How do you discern what is meaningful vs what is noise?
I can assure you that in many cases, bullish Commercial positioning leads to negative subsequent price dispersion. Each Future, must be viewed separately - There is no 1 size fits all for COT analysis.
Lets look at the latest COT report from 04/03/08
Here, we can see that Silver Net Commercial 18m + 5yr Relative Strength Scores a Maximum 100%, while Funds are at Zero. So we definitely have a case of extreme positioning, but what is price distribution given this setup?
Utilizing our application, we can query all instances in history where Net Commercial 18m RS score was greater than 98% as is the case today. What we see is quite compelling. Since 2006, we have only seen this occur 29 times or about 2-3 times per year. The 80th Percentile price distribution over 20 days is 46.4 up vs 11.2 down, and 72.5 cents up vs 16.6 down in the 70th Percentile.
So we are now seeing Bull Bear odds of 4.4-1 given this High NetComm position score, while the baseline distribution was only 7-6. This provides us a significant statistical edge.
In any successful trading operation you have 3 key attributes that must be addressed. 1) Setup - Which we have Discussed 2) Signal Mechanism or entry. 3) Risk Mgmt or proper betting.
Lets address Signal now by looking at this weekly chart.
They say that "The Trend is your Friend... except at the end!" Silver has clearly been in a Downtrend since the July 2016 High of $21. We have seen steadily lower lows & lower highs, and our adaptive 23 week moving channel has been trending lower and pressuring prices.
One of our favorite Tried and true trend reversal signals is the "1-2-3 Reversal" made famous by Trader Vic. It goes as follows:
1 - When a trend is in force, the first reversal signal is a break in trend-line. We can see this occurred at point one back in Jan.
2 - Price will then reverse and re-test the preceding low. In this case Silver did retest, and has currently made a higher low at # 2.
3 - Confirmation is breakout above #1 High.
Significant returns can be generated by anticipating step 3, at the point of Step 2. And this is where we are at today. The risk by going in at step 2 is that you are early in the trade, so there is a trade-off here.
For entry signal, you can use your preferred method such as 4 day High, Pivot breakout, or for example we will use a 2day close above our 23 day adaptive channel. This has been triggered today.
Final step is Proper betting.
Your ability to trade profitably all comes down to how you bet. You can trade high probability setups, but you must bet in a controlled manner to ensure you are able to handle losses professionally. Even if you have great setups with a 75% win rate, (unrealistic but possible - Our studies show price movement is random and your win % will be closer to 50/50) this still means 25% losers. This means over 100 trades, there will be at least 25 losses, and it's possible it may be 25 losses in a row!
So each time you bet, you have to ensure R/R is at least 2-1 or better, and make sure you give yourself enough opportunities to realize the statistical edge your system is providing. Our trade entry today is as follows:
1) You can buy Jul SI fut @ 16.93. Hedge for 76days w/ 17by15.75 put Spread - cost 50cts.
2) If/when price moves to 17.50 - sell a 18.50 covered Call which should net you approx 30 cents. Cost of hedge is now 20cents, with profit potential of 1.27 for R/R of 6-1.
3) If SI reverses + closes below 16.25 - sell a $17 covered call for approx 34 cts, and cover the 15.75 short put for approx loss of 15cts. This would lock in a loss @ approx 30cts. But remember your profit target was $1.20 here, so this is still R/R of 4-1.
If you target trades with a Risk/Reward of 2-1 or better, and are able to identify trades w/ probabilities of 50% or better, you will generate outstanding returns.
Hedge Funds, and many Buy and Sell Side firms are utilizing Big Data and Alternative Data Analytics to gain a trading edge. As this is who you are competing against, why aren't you adding this valuable tool to your trading arsenal?
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