Trade secrets: How to find new trade ideas by reading market movements

February 16, 2022

Trade secrets: How to find new trade ideas by reading market movements

One of the most fundamental skills traders must develop is the ability to find new trade ideas – a good trader can view the market from every angle and make assessments on how they believe the chips will fall.

One of the most fundamental skills traders must develop is the ability to find new trade ideas – a good trader can view the market from every angle and make assessments on how they believe the chips will fall.

While this may sound easy on the surface, selecting the right stock to trade is a deeply involved process that requires traders to look at everything from macroeconomic factors to company fundamentals to identify the business that best suits their personal philosophy and represents an opportunity for returns.

To get a better understanding of how to do this, Reach Markets’ Tim Gilderdale, CAIA, compiled this basic guide to help traders get started.

1 – Macro

Look at the developing macroeconomic and geopolitical themes in the market. Which stock valuations are most exposed / susceptible? Current themes include:

  • inflation and interest rate increases
  • leisure stocks and the reopening of the economy
  • commodity and energy price pressures
  • geopolitical tensions in Ukraine and Taiwan

Recent themes include:

  • COVID-19 and panic selling
  • supply chain disruptions
  • warehousing and technology
  • interest rate decreases to record lows

2 – Finding a stock

The stock screener lists all the optionable stocks in the Aussie market.

  • You can start by sorting the optionable stocks by today’s largest ‘price change %’ which can highlight a potential misvaluation, overshoot or breakout move.
  • You can also look at IV rank to see which stocks have their options series priced relatively high/low compared with the previous 52 weeks. Unusually high or low IV can present an opportunity, because if you expect IV to return to normal levels you can sell or buy options (respectively) that align with your directional view.
  • You could also sort by liquidity and cycle through the most liquid stock options to look for opportunities. Many Implied Volatility users save the most liquid optionable stocks in their ‘watchlists’.

You can also look at the market map located in the trading dashboard to see how each stock is faring compared with its sector and the market overall.

3 – Micro / fundamental

Develop an understanding for the stock and what drives its value so you can react quickly to developments.

If you have the time, you could run a Porter’s Five Forces analysis on the stock to see how the suppliers, buyers, competitors and substitutes affect the negotiating position and market power of the business, highlighting key competitive resources, important metrics and the threat of new entrants as the environment changes.

Where there is scope for a stock to benefit from M&A activity due to economies of scale, or as a strategic acquisition, a significant ‘control premium’ may be applied in the event of a takeover bid. 

Identifying these stocks could deliver a quick boost to your options portfolio, however attempting to time the market can be expensive so takeover potential is something to consider in your overall view of the stock.

It may be beneficial to investigate the Earnings Per Share (EPS) multiples in a sector and identify why they differ within their industry.

4 – Technical analysis

Look for major support and resistance levels in the charts. These are where there is significant buying or selling pressure. These levels are critical to both range trading and breakout strategies. 

If a long period of time has passed since the market has tested a major support or resistance level, there may be many buyers or sellers lining up their orders at that level. This could result in a quick bounce or rebound.

Determine whether the stock exhibits price behaviour with certain indicators – e.g. 50/200-day Moving Averages (MAs), fibonacci levels, Relative Strength Index (RSI), Moving Average Convergence/Divergence (MACD), Commodity Channel Index, etc.

When multiple indicators line up, there may be a strong signal to enter a trade. When more traders share the same view of a stock, it can become a self-fulfilling prophecy. (Just be careful not to go overboard with excessive indicators.)

Take note of the candles. Hammer and dragonfly dojis may be hinting at the return of strong buying pressure after hitting a support level. Inverted hammers and gravestones may be hinting at the return of strong selling pressure after hitting a resistance level.

Candlestick patterns and trends – If traders believe a stock is going to behave according to their recent candlestick patterns, then traders may trade based on these recent candlestick patterns, creating yet another self-fulfilling prophecy.

Traders may view higher highs and higher lows as a bullish signal, along with consecutive days of green candles.

Traders may see a ‘cup and saucepan’ pattern forming and collectively increase their buying pressure to deliver the final boost to break through resistance.

5 – Order depth

You can view important short-term trading information here. Large volumes on the buyers side represents a strong support level, while large volumes on the sellers side represents a strong resistance level. 

There may be a significant gap between the support and resistance levels with very little order volume at the price points in between. When this is the case it wouldn’t take much buying pressure to lift the stock price off support, or much selling pressure to drop the stock price down from resistance.

Keep in mind that order depth volumes are not 100% reliable for several reasons, including:

  • Conditional orders that have not been triggered are not listed
  • Traders may quickly change their minds and cancel orders
  • Designated Trading Representatives (DTRs) might drip larger orders into the market slowly so they do not throw off the market price in order to abide by ASX Market Integrity rules
  • Institutional block trades are also not reflected in the ‘order depth’

6 – Pick your strategy

The Implied Volatility options cookbook is a great tool for filtering between strategies. You can filter the strategies based on your view and preference for:

  • price direction
  • implied volatility levels
  • time decay
  • complexity

If you want a simple bullish trade, you may choose a long call option. If you want a bullish trade that also will benefit from falling implied volatility levels, you may select a bull put spread.

If you are more bearish on the market and want a simple strategy, you may choose a long put option. If you are bearish and expect implied volatility to fall from current levels, you may choose a bull call spread. 

If you expect sideways price action and a decrease in implied volatility, you may choose an iron condor trade.

Alternatively, you can use Implied Volatility’s trade scanners to generate trade ideas for you.

If you would like to try the best options trading technology in the Aussie market, with the nation’s lowest options brokerage fees, click here for a trial of our Implied Volatility options trading platform.

General Advice Warning

Any advice provided by Reach Markets including on its website and by its representatives is general advice only and does not consider your objectives, financial situation or needs, and you should consider whether it is appropriate for you. This might mean that you need to seek personal advice from a representative authorised to provide personal advice. If you are thinking about acquiring a financial product, you should consider our Financial Services Guide (FSG) including the Privacy Statement and any relevant Product Disclosure Statement or Prospectus (if one is available) to understand the features, risks and returns associated with the investment.

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