I always say that one of the best things about options is the ability to profit no matter which way the market moves.
Red or green — it doesn’t matter if you know what you’re doing and how to play both sides.
But how do you get to that level?
Well, for starters, many options traders have a few key technical patterns they rely on.
There are plenty to choose from, and most of those patterns have their own variations. The key is finding the ones that work for you and becoming an expert at spotting them.
That’s what I’ve done with my Trade Of The Day.
I deliver it to traders 30 minutes before the market opens each day, and the goal is to get in and get out quickly, usually within a few minutes to a few hours after making the trade.
There’s a lot that goes into each trade (and you can get the specifics here), but in a nutshell, I am doing three things:
- Analyzing overseas markets, particularly in Asia and Europe
- Analyzing market-moving data, such as Fed minutes, economic releases, etc.
- Analyzing the chart of SPY, the ETF that tracks the S&P 500 and my No. 1 ticker to trade
When analyzing SPY’s chart in the premarket, one of the key things I’m determining is what pattern I will look at for that day.
Predominantly, I rely on two key patterns:
- The head and shoulders for timing bearish trades
- The inverse head and shoulders for timing bullish trades.
Today, I want to take a closer look at the one that I’ve relied on the most in recent weeks…
Head and Shoulders: A Simple Pattern For Timing Bearish Trades
A head and shoulders (H&S) is a bullish-to-bearish reversal pattern, and it is my favorite setup for buying put options.
The head and shoulders is made up of three peaks, with the highest peak (the head) between two outside peaks (the shoulders), which are typically lower than the head.
The line connecting the first and second troughs is called the neckline. Once a security’s price breaks below that line, the pattern is considered triggered.
Source: Charles Schwab & Co.
As I said above, the head and shoulders is a reversal pattern — from a bullish trend to a bearish one. This means that it shows the power of changing hands from the bulls to the bears.
After the first peak in price (left shoulder), the security declines, which shows waning momentum for the bulls. Then, in a push to regain that momentum, the bulls drive the price higher and past the initial peak to a higher high (the head).
To complete the pattern, the bulls must attempt one more push higher that does not exceed the previous peak, but rather lands somewhere in the area of the left shoulder, thus forming the right shoulder. Because the bulls failed to make a new higher high, the bears are now in charge.
Once the price falls below that neckline, that is a good place for traders to look to buy put options.
For instance, in the chart below, I’ve highlighted a clear example of the pattern:
You can see that once the pattern triggered, SPY fell dramatically. And those who followed my Trade Of The Day had a chance to make up to 61% in 60 minutes. That’s like earning 1% a minute.
Below is another example of head and shoulders patterns. You can see the two initial pushes higher (green candles) followed by the right shoulder in red.
Now, keep in mind that technical analysis is really more of an art than a science. The two shoulders might not line up perfectly, for instance. You can see above that the left shoulder is higher than the right shoulder.
And in the first chart, it was the right shoulder that was higher. But the essence of the pattern is still there, and we can see the bears wrestling control away from the bulls in both instances.
But the more comfortable you get with the pattern — and the meaning of what the price action is telling you — the easier it will be to spot and trade it.
If you could use a little help in this department, I do the heavy lifting for you with my Trade Of The Day. Not only do I tell you what pattern to look for each day, but I also provide the exact strike and expiration of the option I think you can use to take advantage of it.
And I send a followup email once the pattern has triggered so you know when to get in. If you’re interested in trying it out, there’s even time to get in on today’s trade.