Implied Volatility – Trading Options Video 14 part 3

There are all kinds of ways that you can use
this. Here is something a little bit different. This is the gold/silver ratio. We’re taking
the GLD and the SLV. In this case, gold was outperforming silver. As soon as the market
started to drop, you can see the topping process here. You would take your trend line again. In this case, I would set up a channel. But
it’s the same thing. You start to see a topping process going on, and the market is starting
to decline. That means silver is now outperforming gold. You want to find out who the outperformer
is. In this case, from August of 2010 to April of 2011, silver outperformed gold. You can
see that it’s in a dramatic decline here, on the ratio. You would go long silver. It just means that
silver is outperforming gold. When the market started to go up, right here – what you want
to do is put a trend line in, and you can see a dramatic turnaround. Now, all of a sudden,
gold is starting to outperform silver. What you want to do is, as soon as it broke
that trend line is, you want to get out of silver, and go long gold. You want to continue
to follow that, until it breaks this trend line. That’s what makes ratio trading so much
simpler than trying to actually pick an individual stock and determine support and resistance
areas, and when to get in and when to get out, using Fibonacci ratios and all kinds
of complicated formulas, in order to determine when to go long an individual stock or ETF. Ratio trading makes it very easy. If you’re
taking two similar issues, issues that normally relate to each other, and finding out which
one is strong and which one is weak. Simple trend lines do the trick. You don’t need anything
else. That’s why it makes it extremely simple to use, and extremely powerful in the signals
that it gives you. The only thing you really need to do is identify
new trends. As soon as it starts going into a new trend, you say, “Okay, silver is now
outperforming gold. I’m going long silver. As soon as it makes this dramatic turnaround
here, and it looks like we’re in a new uptrend for gold, then I’m out of silver, and I’m
into gold.” That’s what makes this type of trading so
exciting. This is the way professionals trade. The top 1% of all the traders who are making
tons of money are doing this on a regular basis. They are simply doing ratios. They
want to find what issue is stronger than the other, and they want to go long that. If the
other issue starts to come on strong, then they’re going to go long that. Some of the most consistently reliable ratio
trades are the gold/silver trade. The gold/silver ratio is consistently reliable, and it trends
extremely well. Just remember that when the chart is going up, it means the first issue
is outperforming the second issue, and you want to go long that. When it starts to go
into a topping process, and you’re into a new trend downward, you know that the second
issue is outperforming the first. You want to go long the second issue. Then, of course, what you can do is measure
just about any issue that you want against an index. For example, here’s AT&T, vs. the
S&P 500. i want to see if AT&T is going to outperform the S&P 500. As you can see, it
wasn’t really a clearly defined trend, so I’m not going to get involved. Here’s U.S Steel, compared to the S&P 500.
You can see that not only did it not perform very well against the S&P 500, it was in a
consistent downtrend to the S&P 500. Because it is in a defined trend, and that’s what
you’re looking for. You’re looking for a defined trend. If it’s not outperforming the S&P 500,
you might want to go short U.S. Steel here. It is so deeply underperforming, so vastly
underperforming the S&P 500 that you might want to go short that issue. Here’s AXP against the S&P 500. You can see
that for the most part, it stayed pretty much the same. There’s no clearly defined trend
there, so I would stay out of that issue. Here’s Alchoa against the S&P 500. You can
see that it did outperform for a little while. You can see the clearly defined trends here.
They’re really nice. Of course, as soon as it broke that trend, you want to get out.
Then it went into another trend here, and it’s still in that downtrend now. You want
to stay involved in that to the downside, if you want to short Alchoa. As soon as it
breaks that trend line, you’re out. It’s very simple to trade these. Here is the
Emerging Market ETF. You can see that the S&P 500, for the most part, from October of
2010, has outperformed it. It’s a little bit more volatile. It’s not a clearly defined
trend, so I would stay away from it. Here’s the XLB. Again, it’s not a really clearly
defined trend here, but you can see the huge volatility at the top here. You may have thought
about going short, right in this area here. That’s not a bad trade. Here’s the XLF, the financial ETF, against
the S&P 500. You can see how terrible it has performed against the S&P 500. It’s been in
a consistent downtrend since April of 2010. That’s a pretty well-defined downtrend here.
It looks like it may be starting to create a little bit of a bottom here, but it’s still
too early to tell.

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