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| Pers Investment & Option Trading Stratig Option Trading Tips and Techniques | | by: | |
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Created: 3:22pm on 10-10-2005
Modified: 9:57am on 03-13-2010 | |
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The prudent selling of appreciated assets in order to buy undervalued ones is the essence of successful investing. No one has perfect timing.
James B. Stewart
Revised 03/13/10 by Paul G.Privitera
The following segment is from my option trading notes. It is a collective log of rules devised through years of trading and designed for the working person. Recognizing these rules will prevent many types of losses encountered when putting on positions and taking profits. This information is for the intermediate or advance trader only. Obviously this is not an exhaustive study; however I will keep this information in continual update as my research progresses.
Throughout this piece you will see many references even appeals concerning proper income and/or cash flow within your budget. Having adequate discritionary income and sufficient capital is critical to your success.
I recommend you keep to these trading patterns based on your available capital:
Remember always follow your money management parameters.Each level builds upon the last.
This will make more sence to you after reading through the entire piece.
>5k
Long Term (1 year +) Bull Call & Bear Put spreads, Strangles, Ratio back spreads, Iron butterflies on index options and Outright ETF ownership, mutual funds, CD's and bonds.
>15K
Short Term (< 6 months) Credit Calender spreads, strangles, straddles, butterflies on stocks.
>25k
Short Term (< 3 months) Credit Condor spreads, Naked puts, butterfly spreads on stocks and sectors,bull put and bear call spreads, direct stock ownership using collars.
>50k
Day trading ( <1 day), futures trading, commodity trading, sizzlers(<3day option trades)
Poorly funded accounts and/or negative cash flow in your budget will cause the following problems:
You will be unable to take advantage of opportunities when they happen .
You will not have enough funding to utilize multiple trades when necessary (I.E.) sizzlers.
You will not be able to meet margin calls when needed.
You will not be able to play in-money long or short positions with high volatility.
You will not be able to effectively play iron butfly, calenders when needed.
You will not be able to morph your trades in a timely fashion to gain advantage. You will not have enough play in your option positions to effectively utilize stops.
You will not be able to work with expensive stocks/options that offer greater risk/opportunity.
You will not be able to afford to squeeze out profits of a dieing position while putting on new positions, such as buying more on the way down.
You will trade too often and will take unnecessary risks out of need, fear & desperation.
Out of the money Bull put credit spreads as well as Bear Call credit spreads will not be feasible.
Many Option stratigies work well for trend trading. For tight range trading consider Collars (With stock ownership), calendars and butterfly techniques.
Exchange traded funds & Mutual funds
Before we continue I'd like to introduce Exchange Traded Funds. If you don't have the required outlay (5K -25K) for most option trading then ETF's are are a great way to take advantage of movements within the stock market with reduced risk. In addition, ETF ownership does not have issues of time errosion as options do -- this makes them good for strangle stratigies with indexes and sector funds that trade in a very short range. Although you don't have the leverage that option trading offers you still get the advantage of being able to concentrate your money on advancing sectors while eliminating the risk and expence of individual stock purchases. ETF's can be a good start up strategy for any portfolio. Unlike mutual funds with ETF's you can enter and exit the market during the trading day. In addition you can combine this type of trading with low cost short term option stratigies such as out-of-money strangles,sizzler trades and credit bull put spreads. As always Just be sure to do your research. ETF's come in the following catagories:
Equity
Sector
International
Bond
Bear Market
Currency
Commidity
Inflation Protected
Money management - Quite Franky, this is one of the most important parts of trading, if you don't play the statistics and work the odds you will never make money regardless of how well you pick your trades. Consider that winning traders are still wrong more than 60-70% of the time.- the trick is to make more money when your right. Keep track of risk/ reward ratios. Keep to 3-8% risk (margin requirement) per position. I Utilize only 1/2 of funds (trading account balance) --with each months profit I will reinvest ½ of of it and transfer the remaining 1/2 into a savings/checking acct. Utilize 3 up 1 down Reward/risk on directional trades if possible. Diversify by working with multiple stocks/sectors similtaniously as well as utilizing multiple strategies ( I.E. use a mixture of trades where some profit by time erosion, some profit with movement, some for last minute profit and some positions for LT profit.) When deciding what type of strategies to use consider the overall market environment as mentioned later in this article-Never rely on 1 or 2 limited positions. If you do have only 1 or 2 positions then engineer them as reverse neutral or bi-directional , be prepared for periods of no profit. Often times having more money on the table reduces risk and increases the chances of success however counter intuitive it may seem. Use professional recommendations and do your research to determine these positions. Have enough funds in your account to meet margin if you get called out or put to, otherwise you'll be faced with a margin call. Try to limit the entire portfolio's real losses at <5-8% and paper losses <8-15%. I cannot stress how important this is- -You must have your account funded appropriately or you will find yourself unable to simultaneously play both sides of the market causing missed profit opportunities. Think Balance and think skim (incremental profits) rather than expecting or relying on windfall profits for your gains. Expect to win only sporadically. Ideally, your account should be funded at a minimum of 15 - 20K for optimal advantage. In summary, 3-5% investment in individual stocks, 5-18% in ETF and sector positions and 20-30% for index positions. Once you go over these maximiums ( this usually will happen as you add to a winning position over time) you must use trade triggers and/or limit orders to get out of upside down positions.
For option buying stick to only long term positions unless your either very talented or very experienced.
When using triggers keep in mind that you must be willing to loose everything up to the trigger point. Obviously if you don't have a large enough position to account for normal standard deviation flucutations then you must be willing to get called out. DO NOT use triggers in a volitile market OR to change a positions orientation.
If a trade us going to go right it will usually do so from the start. Use the stomach test on all of your trades, if your anxious after placing the trade, no matter what strategy or techniques you use, your doing something wrong when designing it.
Buy way-out money options if you expect a relatively quick move into intrinsic value on the option. It is also a valuable strategy to get a piece of the action with minimial financial layout on expensive options. On the other hand if you expect a relatively small move and you have large cash reserves OR very little time left before expiration then purchase way-in-money options.
Puts hold their time value better when Out-of-The-Money. Calls hold their time value when in-the-money. Subsequently one can buy out-of-money puts on a reverse ETF fund to leverage your interest in an upward movement while maintaining the benefit of preserving time value that out-of-money puts offer.
Under normal circumstances buy Puts a little bit In-The-Money and buy Calls a little bit Out-Of-Money that way if the market reverses a little bit your capital will be preserved. LT trades only.
Because of the above characteristics of options- Bull Put spreads and straight calls tend to work best for Advancing markets while buying straight puts work best for Declining markets.
Contrarian Indicators Three very important contrarian indicators are:
1) Investors Intellegence.
2) CBOE Equity Put/Call Ratio
3) Rydex Nova/Ursa Ratio.
They can be found, among other places at the Schaffers Investment Research website.
Some other indicators
4) Baltic trade freight index
5) Advance Decline Index
6) VIX Index
Heat Maps Galore
7) FINVIZ.COM
NOTE: Keep in mind that at any given time the usefullness of indicators will change. Watch closely which indicators give you usefull information and those that don't.
Some possible indications of a trend change.
1) A major milestone is reached within the index. (I.E.) 10000 for the DOW.
2) Wide ranging day that stands out over a 6-12 month period.
3) Moving average crossovers.
4) A week over week trend of increasing "UP" days in the market.
5) A major socioeconomic event such as the start or finish of a great war.
6) A top official within a company or country is fired, hired, elected or imipeached.
7) A major lawsuit is filed against a company or a new product is introduced.
8) Selling by insiders (institutional selling)
9) P/E ratios become unusually low.
10) Lower dividend yields.
11) Interest rates get lower.
Market Tops
1) When all the bear market pudits dissappear.
2) When pundits all say buy, buy, buy.
3) A sector top can often be predicted when new compitation arises.
4)Over expansion and unmanagable
5) Massive acquisitions, especially in retail
6) New government regulation or action
Market Bottoms
1) Market sentiment is very high.
2) Bears exceed bulls in the investment intellegence survey. Less than 40% Bulls.
3) Mutual funds bailing out.
4) An uncommon Cresendo sell off.
5) A bottom in 1/3 of the sectors in short <1week time frame.
6) VIX reading above 40 indicates pure panic.
7) extreme instability in the markets.
Individual stock bottoms
1) All sponcership is lost. Multiple downgrades.
2) More and More bad news but the stock no longer decreases.
3) Consistent large insider bottoms.
4) Very bad rumers and alligations but stock remains stable with no decrease.
Individual stock Tops
1) New competition
2) Vagueness at conference calls
3) Blindsided by Government via new law or discount.
4) Accounting Mayhem
5) More than 50% bullish in market.
My way of using technical indicators:
1] Always monitor channels, pennants, flags and trendlines for your graph analysis.
MOVING AVERAGES
Using the 10, 35, 50 and 200 day averages.
1. Buy when the close is above the 50 period and the 10 period average is above both the 35 and 50 period averages.
2. If the close is above the 50 period average but the 10 period average is above the 35 period average, exit shorts but do not go long.
3. Trade only in the direction of the moving averages, when there is a crossover in the moving averages trade only in the direction of the crossover.
4. When the market is trending and you are looking for a place to get in, wait for it to retrace to one of the moving averages or trendlines.
5. Assume that the main trendline or moving average will hold and not be broken. If it is strong it should act as a support and resisstance when the market approaches it.
ADX
1. When above 30, consider the trend very strong.
2. Below 20, consider the trend weak.
3. Trade only in the direction of the trend.
4. The higher the ADX the less likely that a full pullback will occur.
5. Take profits if below 20.
6. Add to position if above 30.
7. If it dips to below 30 after being above 30 for a time consider the trend to become choppy.
OSCILLATORS (for trading within a range only)
STOCHASTICS
1. Buy when both lines are above the oversold level.
2. Buy when the fast line %K crosses over the slow line %D.
3. Be long when both lines are above the overbought area but not yet turning lower.
4. Buy when the indicator is strong and retests its extreme.
5. Look for a failed move.
6.Look for divergence. If you see the market making lower lows while the st indicator makes higher lows: this can indicate a trend change.
MCD
1. Buy when the dotted line is above the signal line and short only when it is below.
2. Buy when the crossover is below the zero line.
3. Buy when the moving averages cross above the signal line.
4. Look for divergence.
RSI
1. Buy when the RSI comes out of oversold territory.
2. Buy when the RSI stalls at the 50 line.
3. Buy when the RSI is above the 50 line.
4. Look for divergence between price action and the indicator,.
STANDARD DEVIATION
1. Can be used for stops and stop limit orders for hedging protection on your portfolio.
Timing - Getting in at the right time is crucial. The 3ed Friday of every month and especially triple witching Friday are good turning points. If the market had a huge run either up or down leading into that day you can usually expect it to reverse for the following week. Other attractive periods when you can enter: When a stock has a pullback from its annual high, When insiders buy at the annual high or when the stock exibits a short squeeze situtation.
Expect to make money in spurts, success may be a marathon but making money is in knowing when to run the sprint. Time value erodes very very quickly as expiration comes near therefore exit purchased Options no later than 1.5 months before expiration.
Don't ever Ignore Volatility -When placing a trade. You can loose money quick when using out-of-money options that are too expensive. Option or stockVolitility can be found on various financial web sites. Unusually high option prices or volume (3 to 5 x normal) for the near month can indicate that a move is brewing, especially if the underlying has been flat. Don't use trade triggers during volitile market periods In addition- It is safer to liquidate the short end of a spread to adjust your position rather than buying overpriced options on the long end. If implied volitality is far in excess (more than 1.5X) that of historical volitality then don't trade it.
Weekend Jeopardy–Prepare your portfolio for unexpected weekend events by ensuring your portfolio is completely balanced. I.E. The recent takeover of Fannie May and Freddi Mac by U.S. government on Sunday Setember 7 caused stock market futures to soar for Monday's opening.
Morning Mayhem- Wait until 8:30 ( Mountain time) for market to stabilize. You should use only limit orders to get into a position. If necessary It's O.K. to use market orders to get out of a position in a hurry.
Closing Bell Madness- Markets can be very volatile the last 20-30 minutes. Plan your trades accordingly.
Desperation & Fear -Have a reasonable living budget in place and live within your means. If you have to dip into your trading account to pay bills you will never get ahead.
Market conditions will change, don't let fear drive your trading decisions, look forward not backword.
Keep tabs on VIX readings Increasing VIX readings signal an impending move on the index's.
Watch your moving averages Sometimes you can find repeatable patterns in the 10 day cycle.
Earnings Releases -Don't do calendar spreads or butterflies on months when earnings are released. surprises can cause the stock to behave unpredictably ruining your calender spread profits
Always Scale Into your trades - Wait for trades to achieve profit before adding more contracts. As an example: Lets say your working with ETF index trades and the market is in an overall up movement and begins to turn down -- (currently you have worked your way up to say 50% risk on the positive side-will get to this later), lets also say that the maximium risk level you began with was 20%; you would begin setting up a negative ETF posture with -say- a 10% trade then as the market kept correcting you upped the position by adding another 5%, then 3% and would continue doing this up to 20% risk on that trade. Concurrently, on the other side of the position you would begin taking the profit and reducing the positive trade risk level. since as we said the position had been advancing for a while and you worked your way to the 50% or more of a risk You would begin taking your profit off the table in increments as that trade lost money. Begin this by taking 30%, then 10%, then 5% profit until the entire risk is back to 3% or lower on positive end.
When the position begins advancing again in the overall market direction you can then add to the positive end by starting with an additional 15% bringing you to 18% risk, then add an additional 10%, then 5% and so on utill your back up to 50% risk. In the meantime you would completely remove all the profit on the negative side and leave yourself with no more 3% risk on the negative end.
EXCEPTION: Cal spds, Btfly spds.- If you're buying on the way up then begin with more contracts and add less and less as position prospers. Do the reverse if your buying on the way down in an up market. If Time runs low simply buy (Same strike) out 2-3 months on the new contracts. (This is counter intuitive and is actually the opposite of what most people do.)
Set loss limits and Exit strategy - Have a plan in place in advance to either morph the trade or take profits before the trade is put on. Know what your going to do ahead of time if the market corrects. Emotions can kill your portfolio. Scale out slowly by 1st creating a neutral position if necessary. In volitile situtations you can engineer your trade to profit in more than one direction or at least profit in one direction while neutralizing itself in the other. Begin EVERY TRADE CAUTIOUSLY- remember , there is never a sure thing, if the position or the trade itself doesn't protect you from loss then use trade triggers and limit orders. Never go above your risk parameters unless your so far ahead that you can afford to loose it if the market goes against you.
Be Care full when listening to Analysts - Use proper judgment when following analysts. Remember their not fortune tellers. Track the success of the people you would like to follow. If someones name is not behind the recommendation watch out. A listing of some analysts and guru's who have excellent track records:
Market timer Bob Brinker
Options expert Bernie Schaffer
Economist Andrew Smithers
Bond investor El-Erian of Pimco
Stock Expert Jim Cramer of Mad Money
Trade Balancing- Keep your portfolio balanced albeit skewed in the overall market direction. Base all positions on overall market direction
Impatience -Impatience will loose you money every time. Wait for proper R/R ratio on your strategies, wait for account to achieve incremental profits, Wait for good prices on your options, Wait for technical indicators to come in line. I'll say it again: Success may be a marathon but making excellent returns can often happen in sprints.
Make use of option Expiration week by utilizing quick gain/ low risk trades. During the last 3 days before expiration you can make quite a bit with virtually no risk by selling options (using using bull put or bear call strategies but you must accurately predict if and by how much the underlying stock will move during that short time. I call these trades sizzlers. These trades work best in groups. Playing only 1 underlying at a time is too risky.
Have a repeatable plan and use it, its to much aggravation and work to try to profit from every single swing or opportunity. get comfortable with certain stocks, indexes and/or strategies and do regular study on them. Keep a basket of stocks on the back burner (so to speak) to pull up and use if necessary. 20 or more is a good number. But never work with more than 5-8 simultaneously.
Current Events - Don’t base trades on future market events. News is often already built into the stock price so be carefull. However, one can often use news as an indicator of market strength; when weak or lame positive news is given on a day to day basis to justify small positive moves in the market, especially during a correction a bear enviroment, it can be an indication of a faultering market. The reverse is also true.
Living under your means- This is the only way to get ahead financially especially if your trading. Afterall, how can you ever increase your nestegg if your consistently adding more bills and obligations as your means increase.
Trying new techniques-Although admirable-be prepared for unexpected surprises and possible losses- It seems to happen every time.
Play the right options - If you can't get a good price on your options then forgo the trade. They'll be other opportunities. Regardless of what the underlying stock is doing place your limit order between the bid and ask, in very volatile conditions you can even place your limit order up to 2% under the going price.
Get out of stagnant trades that are not making money -You be judge of how long your willing to wait. Ignoring opportunity costs will put a dent in your portfolio. If your utilizing options that expire way out into the future be prepared to wait, if necessary, for the trade to pan out, especially if its been morphed. In some cases you can even buy more of the position on the way down, that is- if your expecting it to start upward before the positions expiration. Reevaluate your portfolio strategy every 3-4 months, if you haven't been making a profit change your strategy.
Option Price ,Volume, Open interest and Spread Anomalies - Unusually high option price and/or volume for the near term AT-MONEY- options can be indicative of an impending move. Another indication of a potential market change of venue , so to speak, is if out-of-money options suddenly begin increasing in price with little if any changes in the underlying OR if the spread between the bid and ask increases more than usual, OR if the stock backtracks significantly but the out of the money options loose little if any value.; all of these conditions can be indicative of a fast moving stock. If open interest is twice the trading volume of the underlying stock (multiply OI by 100) don' trade it.
Always Consider the Market Trading Environment: During very high market volatility periods option prices will be very, very high. This can be an opportune time to play out-of-money strangles >6months. Trading periods need to be short and profits need to be taken quickly since the market will be bouncing but not trending.Trending strategies don't work well during these periods. Unfortunately making good returns with straddles/strangles requires a much higher portfolio balance, so if your short on funds its best to simply stay out during these times. One example of this is the sub-prime fallout period that begin 10/30/07 and is still playing out as of the time of this letter. 5 to 6 months later.
During strong market trending periods, especially upward, option prices will be on the low side. This is a good time to play bull put spreads and other long option positions. Calender spreads work especially well for big slow growth blue chip stocks in advancing markets - they can assure you of steady growth even in lag periods and give you excellent leverage on your money as well. A good example is the stock market between the years 2003 and 2004.
During very stable flat market periods you can either play calender spreads, butterfly type spreads and/or seek out up and coming new companies with cheap options that have very strong technicals,fundamentals and accompanying sector strength. An example would be the period between 2004 and mid 2005.
Recessions usually last between 6 - 8 months and are often "called" after they occur.
Once you become experienced shoot for no more than 10-20% per month on your money --this is the target the Pros's recommend. any more and you will be taking unnecessary risks and open yourself up to greater losses. If you can't live with those returns than you must either enrich your trading account or find alternate sources of income for yourself.
If you have a large enough portfolio to buy stocks outright then Collars work well to achieve downside protection on your holdings and enable you to make incremental profits using delta neutral strategies, especially if the stock is stable or making or slight increases. In this case think of puts as insurance.
Buy only as much time as you need (for the trade to work itself out). For very short periods <1 month, buy significantly in -the-money to insulate yourself from Time Value deterioration. For long period trades buy out-of-money to keep your costs low and increase your leverage.
You can measure profits from options liquidated. Close out as many of the positive options as necessary – you can sometimes liquidate negative legs when the position is positive. Try to get a collection of securities together that you get to know well and use them over and over.
Use multiple time frames and choose the strategies your most comfortable with.
Butterfly, Iron Btfly and Calender Spreads - S.T. for stagnant or tight ranging market periods. Must have large contract size to overcome commissions and the possibility of minuscule gains. If your working with stocks you must use multiple trades to increase success. If working with an index you must offset with directional trades on individual securities. 1 Month (Short leg)
In-Money Long or Short straight options - Used for tight S.T. range trading during very high volatility periods when the market or index is moving in a tight range area. 1 Month
Ratio Back spreads, Bull call, Bear put and leaps - Used for L.T. trend trading. Trade in market direction. Utilize trades in 4-8 sectors simultaneously to increase chances of success. 1 Year
Strangle/Straddle - Used for medium term trend trading during very high volatility periods when the stock or index is capable of large swings. When working with stocks use with multiple securities to increase chances of success. 3 Months.
Sizzler - used for very, very S.T. spike trading 3 days before option expiration. Must have multiple trades on simultaneously to increase success. 3 Days
Bull Put - Used for medium term trend trading for up periods. .Bear Call- Used for medium term trend trading for down periods. Must have multiple trades on simultaneously to increase success. 3 - 6 Months.
Embedded Trades - Put a calendar spread inside a long option position. 1yr long/1 month calendar. Put a short term Bull Put credit spread inside a Long Term Bear Call credit spread to make profit in the event of a stagnant underlying or visa versa. Bull Puts, Bear Call credit spreads can be designed to make money either thru time erosion (by staying out of a given range) or by movement ( by traveling thru a given range) It simply depends on how you design it. The latter can be used to buffer a Long Term spread by making money in the event the L.T. goes upside down while only limiting the gain in the event the Long Term trade goes in its planned direction
Prep Trades - Trades that are ripe for morphing in the event the market forms a direction. I.E. A strangle or straddle trade that is played at-the-money but can be easily morphed to a bull put or bear call spread. .
Index Sector Tracking stocks - You can work with specific sectors within the S&P index to take advantage of areas of strength in the economy without the added work and risk of working with individual stocks if you so choose. These Index groups are also available as ETF's.
The Following is a list of SPDR index sector tracking stocks that have options trading capability:
Consumer Staples XLP
Energy XLE
Financial XLF
Health care XLV
Industrial XLI
Materials XLB
Technology XLK
Utilities XLU
Consumer XLY
Oil & Gas Explor XOP
The following is a list of the major index Tracking Stocks: DIA QQQQ SPY
Note: There are various ways to create the same spread to accomplish different objectives, for example, a Bull Call spread can be designed to act as a TE (Time Erosion) trade or a long position.
Morphing Trades or Turning Loosers into Winers:
Long (Call or Put) -> Bear call, Bull Put
Strangle/Straddle -> RBS, Bull Put, Bear Call or Long
Calender -> Bull Put or Bear Call
Bull Put/Bear Call -> Calender
Bull Call or Bear Put -> RBS or long (Call or Put)
Iron Butterfly -> In-Money Bull put or Bear call
Straight Butterfly and Sizzler --> Let them burn out.
DO NOT MORPH Butterflies and Sizzler trades. Rather let them both burn out. As indicated, Iron Butterfly trades can be morphed. Have loss limit exit points for way-in-money options.
Butterflies, sizzlers and strangles/straddles must be done in groups and used simultaneously with other strategies. They must all be done in a 3up 1 down risk/reward ratio if possible. Index spreads can be done alone. 3 legged calender spreads can also be done alone as long as your playing them in groups.
DO not morph or skim L.T. >1.5 year trades, rather set 4-8 trades (with proper allocation) and leave them all on. In some cases you may want to have loss limit exit points.
SKIMMING profits on the other strategies is advantageous, but you must research or developer rules for doing this.
A good hierarchy of approach when setting stops, preparing and recgonizing reversals and breakouts as well as confirming trend or range changes.
Current events and seasonal considerations,
Overall market direction,
Specific Mutual fund performance can que you to hot sectors and stocks.
Specific sector performance,
Specific stock performance,
Original tenor of trade,
Distance in or out of the money,
Current trend or range conditions,
Chart patterns & reversals, technicals,
Remember to impliment a (money management) failsafe after considerable profits are made, especially if they are 2-3% and made within 1-3 days. Keep an eye on the VIX, this is a good predictor of future volatility. When using Moving Averages make sure you examine the 30minute denomonation for the 10 day graph and compare it with the 60 day and yearly graph. Before adjusting your position for a change make sure all the graphs are telling you the same thing.
Sometimes after a period of 1-2 months of tight range trading (in an upward market) you will see a breakout to the downside - don't hesitate to play this even though it is against the prevalent trend. Don't be afraid to play this trend - just slowly adjust your position. Dont't worry about liquidating loosing legs as the lost monies is more than made up for within the intact leg. Make sure you use all 5 of the above methods when gauging the direction of a trade.
A good Hirachy to keep in mind (in order of risk & funding requirements):
Day trading
Commidity Futures
Option Trading
Stock Ownership
Exchange Traded funds
Mutual funds
CD's
Money Markets
Corporate Bonds
Municipal Bonds
U.S. Treasury Bonds
There are varying philosophies
You can search for the big movers and put on 5 to six of those trades. With this method you may receive a negative income for a 4 to 6 month period or even longer. However if you are making good choices you will end up positive for the year.
You can restrict your choices to stable stocks in which you can earn a stable but restricted income using techniques such as calender spreads or time erosion bull or bear put spreads.
You can use a balanced strategy as I have described at the end of this paper.
You can work with the major sector or index options to take advantage of the overall market conditions without the work of searching individual stocks.
You can scalp using day trading techniques. This is where you go in and out on a daily basis. Usually requires a large account balance. >50K. You own the shares outright for very short periods.
.REMEMBER, Wait as long as necessary to make a good trade. Watch-Watch-Watch then Wait and wait some more. Only then should you place your trade..... Always Keep the big picture in mind then work out the details down the line. Although you may make money in the short run -- ignoring any of this information will open you up to serious losses in the long run. I.E. Wait for tops and bottoms, not just major ones but minor ones as well before putting on your trades. Always Get into your trades with limit orders and out with stop-loss orders.
Hedge VS. Diversification - A hedge is a position that helps when the rest of your portfolio does poorly. I.E. An oil sector hedge (positive play) can do well when the rest of your portfolio is tanking but can also do well ( in the case when your hedge is relatively overpriced and you position yourself negatively) when the rest of your portfolio is doing well. Diversification is when you have positions geared in the same direction but within different sectors of the economy OR within different companies within the same sector.
My Strategy -To begin with- subtract your age from 100. The remaining number is the percentage of total savings (capital) that you can use for speculative trading. Out of that amount I will utilize a total of 50% (margin requirement) and distribute that as evenly as possible in the following manner (this will-in effect- keep average potential risk to around 20% of total trading capital). In all trades but especially in ultra short term (<3days)try to keep on 1 up 3 down ratio of possible gains to losses- including commissions - try to use a combination of trades that collectively make money In either direction. For L.T trades I utilize 3 stocks for each of 5 sectors that I am interested in trading. (I try to put on new ones every month in order to have a steady supply of expiring L.T. trades to work with) For additional trades (I.E. Time Erosion) consider the behavior of the given stock and sector to decide on the type. For example, IF the market or sector posture is up then put on a PUT calendar spread for the stock. (If possible Try utilize both advancing and declining sectors simultaneously-PUT calendar spreads work well for declining sectors as well.). In the case of Bull put or Bear call Time erosion trades try to balance all the betas against a sector hedge. If you desire you can set stops when your minimum target profits are violated or simply leave them on. In some cases I will utilize a long term directional (contrary) index trade (as a hedge) and orientate all the other trades in the overall market direction or you can use a Long term index trade in the direction of the overall market, and hedge the sectors/stocks by working them against each other based on the health and direction of each sector.
Long term trades (excluding ETF index trades) do not need to be morphed (>1 year), nor do you need to worry about triggers since these trades should be put on only in a balanced fashion with hedges. Time Erosion trades, when designed properly either alone (Using multiple positions) or within other trades, should not normally need triggers, morphing or reallocating (barring Bull put or Bear call if you so desire)- nor should sizzlers. When working with funds in your 401K like large cap growth, mid cap growth and international remember that they are tied more to the S&P then the DOW.
If The other types of positions go upside down use automatic trade triggers to stop losses . In situations where the positions do well consider reallocating monies to those trades. Re-Evaluate your strategy every 3 months if your not making good profit. Use all of your knowledge to design and manage the proper trade for the conditions. Each situation can be different.
When considering when to take profits take into account the initial length of the trade and the quickness of the profit, if you obtain 20% in a very short time it's best to take it, you can afford to wait for profits if you have more than 6 months left on a trade. If its an index trade with a confirmed direction you can keep it on until a major top or bottom is reached, if it's a butterfly or TE trade then you simply let them all expire and keep the profits, if it's a straddle/strangle recommendation then wait until the target profit is reached. In general, for directional trades it is best to wait for a particular (minimum profit) then set stop-losses after that point, don't try to make money on the ebb and flow. I.E. Let your profits run but if you Reach 10% or more (profit) during the month you need to tighten your stop losses and liquidate any trades to reduce your loss exposure to 2-4% of the entire portfolio. Some other techniques can also be used like taking ¼ of your profits when the Standard deviation (based on 10 weekly closings)is breached then taking the remaining profits in quarter increments as the technical’s are breached.
. If you looking for L.T. investment then simply put on Ratio Back Spreads and keep them until the technical’s are violated. In all other cases follow your own rules for getting in and out of trades based on technical indicators.
During the course of a trade you can also liquidate some positions and reallocate the funds elsewhere; you can also morph the position to gain greater advantage of market changes. Do not, however, do any of these practices unless a position is expiring ( <1.5 months) or you find another position that is rallying.
To decide when to start a trade I use the following methods: For steady predictable range trading I like to reference the 2, 5 and 10 day graphs (7-14 day swings). For trend trading I like to use the 3, 6 and 12 month graphs. Within these graphs I like to reference the 10, 30, 50 and 200 day moving averages as to when they cross each other. When positions go upside-down try to preserve your gains only by morphing the position (don't try to profit on minor trend or range corrections), then when it reverts back to the original overall direction cash out the positive options thus leaving the position with an enhanced positive bias as it was initially. Utilize limit orders and/or trade triggers to get in and out in all but in the most extreme situtations, (let the market make the final decision - not you). This is especially true if you have either a lot of intrinsic profit in the position or if you have more than 18% of the position at stake in a mutual fund, ETF or index trade or 5% of a position at stake in an individual stock/option trade. Start your stock/option trades with only 1-2% of account and work your way up as the position progresses.
Exceptions to the above rules are LT plays where the market is definitively trending in one direction. Although a given stock can move wildly index's or index tracking stocks are oftn more predictable. Credit spreads can be used like calender spreads (to make regular monthly income.)
If (during that month) and/or when all of your trades become liquidated do not begin trading again until the next month.
PLEASE - PLEASE - PLEASE -----Make sure your properly capitilized!
Make sure you have enough cash to make trade adjustments when/where necessary.
Make sure you have enough cash to put on a balance of trades.
Make sure you have adequate monthly cash flow to meet all monthly obligations without any trade income.
Make sure you have adequate discipline to follow all of your trade rules even after continued success or failure.
If your working with limited capital then concentrate on LT trades and don’t expect any windfalls.
If at all possible adjust your loss potential to no more than the monthly cash infusion of your account.
You can usually expect 5% - 10% annually if your holding a generalized portfolio of stocks and mutual funds.
10% - 15% with ETF holdings.
36% - 100% and up with successful option trading.
?? with day trading
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