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November brought an almost vertical rally with it. However, markets don’t usually go up and down in a straight line and often, such vertical moves are unsustainable. Common sense would indicate that a pullback or cooling off period is overdue for U.S. equity markets. Cracks are beginning to appear in the tech-heavy Nasdaq 100 index . I have shown a chart of Invesco QQQ Trust (QQQ) which is an ETF that tracks the Nasdaq 100. Notice that $400 is an area of strong resistance and the QQQ got rejected around $395 even before testing this resistance area. If this pullback starts materializing, the first downside target based on support/resistance zones is $378. That means we have more room to fall before we test the next support area. Now that I have a bearish bias on the tech sector, I need to pick out a stock which will allow me to take advantage of a possible pullback in Nasdaq 100. Finding a stock to put on a bearish trade The stock I have picked for a bearish trade is Netflix (NFLX) . As highlighted in the chart below, NFLX is showing a very aggressive downward price movement. I am using the following indicators to confirm my negative bias on NFLX. Price Action : The easiest way to gauge market direction is to observe price candles. Starting Nov. 29, NFLX price candles are forming lower highs and lower lows, which is the easiest way to spot a downtrend. RSI (Relative Strength Index): To provide further confirmation, I have added some indicators to my chart. Using the RSI indicator is straightforward. If it moves above 70 that means the stock is overbought. Once overbought, a trader needs to wait for the stock to drop below the 70 area for a bearish setup to form. NFLX was in overbought territory for almost 20 days and has now dropped below the 70 threshold which confirms a downtrend. DMI (Directional Movement Index): When the DI+ (green line) is above DI- (red line), the stock is in an uptrend. However, when the DI lines start changing direction, that indicates a possible change in the current trend. This is exactly what we are seeing in the chart below. The trade set-up: NFLX $455-$450 Bear Put Spread With a bearish directional bias in place, all I need to do is find a suitable options structure to take a bearish trade. The trade structure I am using here is called a “bear put spread” also known as a “put debit spread”. To construct my bear put spread, all I need to do is buy a $455 put and sell a $450 put as a single unit. Most trading platforms will offer a bear put spread (or long put spread) as a trade type and automatically construct the trade for you. All one needs to do is make sure that they pick the right strikes and expiration dates. Here is my exact trade setup: Buy $455 put, Dec. 29 expiry Sell $450 put, Dec. 29 expiry Cost: $2.50 Scaling up I am using 1 contract as an example. But scaling up this trade is as easy as adding more contracts. Eg. Adding 10 contracts would risk $2,500 to make $2,500 (i.e 100% ROI) on this trade. Profit target If NFLX is trading at $450 or below on expiration date, this trade will double my money and return a 100% ROI on money invested. Trade Management As soon as I get filled on this trade, I can place a GTC (good till canceled) closing order for $5 on this trade. That way, the trade will close on its own when it reaches its full profit target. Note that debit spreads will typically close on the last few days of expiration week. If the trade goes against me, I would want to get out of the trade if I lose 50% of my initial investment (i.e 1.25c). By simply doing this, every winner will cancel out two losing trades. -Nishant Pant Founder: https://tradingextremes.com Author: Mean Reversion Trading Youtube, Twitter: @TheMeanTrader DISCLOSURES: ( Nishant currently has a $455-$450 put spread on NFLX which expires on 12/29/23) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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