Playing with DIAmonds

In Friday's newsletter I highlighted the cyclical nature of the S&P 500 and how it may be heading towards another short-term cycle low. The recent cycles are even more apparent in the Dow Jones Industrial Average. Looking at the chart of DIA, the ETF based on the DJIA, and the Stochastics indicator, it seems another low may be just days away (not taking external events into consideration).

In mid August, DIA fell with resolve going into the end of the month. Selling quickly died off, the ETF meandered sideways for a few days and then rebounded on increasing volume. During that time, the stochastic indicator fell smoothly, turned upwards, and generated a buy signal as it rebounded above the 20 level.

Once again we see DIA falling with resolve and Stochastics smoothly falling. If the same pattern is repeated, DIA, and the Stochastics indicator, may form a low within the next few days and begin to work on a rebound.

Short-term traders can watch for this and buy the ETF to play the rebound once there is confirmation a rebound may have started, such as a strong reversal day or a Stochastics buy signal. The safest way to trade that would be with a stop-loss just below recent lows and closing out the trade with the profit if DIA returns to recent highs.

What if a trader likes using options, looking to benefit from the increased leverage they can give. First, we need to think about time periods.

Checking the seasonal track record of DIA trades over the next few months I see an overall upward bias. Many of the time periods have had gains in 12 or 13 out of DIA's 15 years:

To raise my chances of success on a bullish DIA option trade, I want to give the trade enough time to work, not have time value decay be that big of a factor, and I want to target closing the trade at a reasonable profit. So I think in terms of December calls, which are 94 days to expiration. Most time decay is in the last 30 days, therefore December calls would give me 60 or so days to stay in a trade with less concern about time decay.

With DIA cycling within a trading range in recent months, I want to pick strikes that roughly correspond to the edges of the trading range – December 145 and 155 strikes should work, and they have good Open Interest levels.

Finally, I want to pick a profit target and stop-loss that are reasonable and have worked before.

Since I think there's a good chance the upcoming current cycle low will work out similar to the August rebound, I'll back-test a similar trade during that time period. I'll also do the two other previous lows just to make sure. I'm going to look to enter a 2-3 month bull call spread at the open AFTER a strong up-close day after a clear reversal, OR on a traditional Stochastics ‘buy signal' (%D rises above 20).

With a 2-3 month period to work with, to raise the odds of trade success, I'm thinking of using a 30% profit target and a 35% stop-loss. I back-test using these values.  The results are:

Even though this is not a statistically large sample, it shows this approach can work. It can work on other major-index ETFs like SPY as well.

The setup for this trade strategy is not currently present in DIA, and external events have the potential to really change the game this time. But you can watch DIA over the next week or two for a short-term cycle low, and if you feel comfortable with the external-events picture, the two trade strategies above hold attractive potential.

Of course, there's much more you need to know and many more stocks you can capitalize upon each and every day.  To find out more, type in

By Gregg Harris, MarketTamer Chief Technical Strategist

Copyright (C) 2013 Stock & Options Training LLC

Unless indicated otherwise, at the time of this writing, the author has no positions in any of the above-mentioned securities.

Gregg Harris is the Chief Technical Strategist at with extensive experience in the financial sector.

Gregg started out as an Engineer and brings a rigorous thinking to his financial research. Gregg's passion for finance resulted in the creation of a real-time quote system and his work has been featured nationally in publications, such as the Investment Guide magazine.

As an avid researcher, Gregg concentrates on leveraging what institutional and big money players are doing to move the market and create seasonal trend patterns. Using custom research tools, Gregg identifies stocks that are optimal for stock and options traders to exploit these trends and find the tailwinds that can propel stocks to levels that are hidden to the average trader.


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