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The “OOPS signal” trade


Have you been taken by surprise by movement of your stock? Options traders who find themselves on the wrong side of a trade have experienced this dilemma, but as often as not, it occurs as part of a move and retracement.

 

The “OOPS signal” was developed by trader and author Larry Williams. It was named for the experience among traders, upon discovering, “Oops, we lost.”


When the market opens lower than the previous day’s close, a trader places a buy-stop order above the previous day’s low price. When the market opens higher than the previous close, a sell-stop[ order is placed below the previous day’s high.


Most traders recognize that gaps from one day’s close to the next day’s open occur for any number of reasons: news, rumor, earnings, etc. However, the move often exaggerates the impact of news. You see this all the time with earnings surprises. A big gap in the price (upward for positive surprises, downward for negative) is next offset by a move back to the previous trading level. This reversal is the “Oops moment.”

 

Trading on this system is contrarian. You recognize that “the market” overall tends to follow the news, and often acts inefficiently. Rather than buying after many others have bought, or selling after others have sold, the “Oops trader” is a true contrarian, who sees the exaggerated movement and times trades to exploit the likely retracement and closing of the gap.
 

The expected retracement not only closes gaps and  corrects exaggerated price movement. With a well-timed trade, the Oops trader is able to anticipate profit-taking or loss cutting, not in response to smart market timing and moves, but to the gut reaction among “the crowd” to the gap in price.


Larry Williams himself referred to this condition as a market “mistake,”a reference to the tendency for price to react to surprises in an exaggerated manner and then to quickly correct. In this respect, the market is extremely inefficient. The efficient market hypothesis is misunderstood; it points out that price discounts information efficiently, but it does not claim that price movement is efficient. And every options trader knows that in fact,  markets are inefficient, irrational, reactive, prone to greed and panic, and overall neurotic.

For example, look at the six-month chart for Tesla. It has been erratic and volatile throughout this period, moving between $260 on the low side and $390 on the high side. That’s an extreme range of 130 points. You can find numerous examples of an “Oops moment” on this chart. A few have been highlighted.

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For example, in May, price opened at about $305 and dropped the same day to under $295; then gapped lower to $285. As all of this occurred, price also moved below the t-line (in blue). Recall that this is an 8-day exponential moving average and price crossover indicates a change in sentiment. Even so, within a moment price had recovered and quickly moved up to $370  -- quite a lot of back and forth in a single month.


A second example occurred in August. Price again fell below the t-line and this time remained there for a month before a partial recovery.


The third and fourth examples, both in September, were the most interesting. Both were island clusters, single sessions gapping below price levels with gaps on both sides. Both of these patterns were bullish abandoned baby patterns.


Here’s the dilemma for options traders: The signals were clear and all represented bullish reversal predictions. The first Oops did reverse, but the other three did not. This reveals that the usual signals options traders seek are less reliable in volatile times. Tesla was so volatile that the Oops signal did not provide the guidance you normally find with strong retracement patterns.


In “normal” circumstances (low to moderate volatility) the Oops signal is one form of retracement timing, allowing a swing trader to exploit market behavior. This also points to the maximum timing for leverage through opening of options trades. As such moments, single long calls or puts are likely to perform better than elsewhere on the chart. Short options may also be used as long as the price move is dramatic enough, and confirmed by other signals, to raise confidence as high as possible. To hedge risks, traders may also exploit the Oops signal with vertical spreads, synthetic stock positions, or collars.
 

In the case of volatility, everything is less predictable, including even the strongest of reversal signals. So for options trading, the “Oops” might refer not to the initial signal for timing purposes, but to the entire pattern. It’s not just a matter of “Oops, we lost” but perhaps one of “Oops, the reversal was not reliable.”

Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.

 

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