Last updated on April 18th, 2020
Do you ever get the feeling that markets are rigged against you?
Does it always seem like the market makes the exact opposite move that you are looking for?
Why does it seem like the market reverses the very moment you put a trade on?
While it can see like markets are determined to take your money, there are other issues at hand that hold most traders back from seeing the big profits in their accounts.
It always baffles me when I see how aggressive many traders are with with their trading when they are so cautious with their money in other areas of life. I have a trading friend that refuses to spend $100 on a pair of new golf shoes but will then go and risk 50% of his account on one options trade.
How does the market get us so twisted around with how we manage risk?
In many cases, the lack of profits can be boiled down to a few common mistakes.
These 5 questions can provide an instant turn around in your performance and can lead to the the big profits that we are all looking for from our trading.
Does this options position meet the rules of my system?
We are all hit with new trade ideas on a daily basis whether from financial media, a newsletter service, or a colleague at the office.
None of these are good sources for trade ideas.
It’s crucial to have a defined system in place that will guide your trades from start to finish.
It doesn’t matter if it’s a set of indicators or looking for different chart patterns. You have to know beforehand what you are looking for in every trade.
If you take a look at the chart below, I have an exact sequence that I look for when getting into a trade. When this sequence plays out, I know that it produces a +70% win rate over time with the winners 2 X the size of the losing trades
From the moment I put a position on, I know exactly how to manage that trade. I am targeting 100% returns on the winning trades while risking 50% of what I pay to put the position on. This takes a good amount of emotion out of my trading. I’m not overreacting to every move back and forth in the markets.
I’m executing my trade plan which I know will place the odds in my favor over time.
Before you put another dime of your hard earned money on the line, make sure you are able to define your trade plan from start to finish. Doing so will reduce the headaches and stress from the daily grind of the markets.
If you don’t have a system in place to guide your trading decisions make sure you check out our Nasdaq Options Superstars program. It provides a program that will put the odds in your favor on every trade and will help produce the consistent profits that we are all pursuing.
Which options expiration cycle best matches your outlook for the stock?
Having the ability to trade both weekly and monthly options can lead to exciting returns. The weekly options can provide amazing returns from being in a trade for just a few days. However, your success or failure from trading options can be greatly influenced by selecting the right expiration cycle.
In my opinion, most retail traders should trade options with between 20-60 days left to expiration.
Trading the short term weekly options exclusively can lead to very inconsistent results especially if they don’t match up with your outlook for the stock that you are trading.
We are big believers in trading the same stocks consistently over time and I look at the same 40 stocks on a daily basis. I don’t get distracted by any other markets outside of my universe of products.
This allows me to get to know the markets that I’m trading.
I have traded Apple for years now and have taken hundreds of trades during that time. As a result, I know that my average holding time on an Apple trade is between 5-20 days. This can be valuable information to me because it can help me select the best expiration cycle for my next Apple trade.
If you plan on staying in the trade for a few weeks at a time, then it makes no sense to trade the weekly options.
On the other hand if you plan on getting in and out of a trade in 1-3 days then it makes no sense trading an option with 3 months left to expiration.
Knowing what an average holding time is on a trade will make your trading so much easier and you will see much more consistent growth in your account.
Looking for between 20-60 days left to expiration on the options that you are trading will allow to be patient on trades without the time decay hurting too badly. You will eliminate the stress that can come from trading the weekly options.
Which options strategy will best maximize your profit and keep the risk to a minimum?
I hear from so many traders on a weekly basis that get so locked in to trading one type of options strategy.
- Some traders are only willing to buy individual calls and puts
- Others only want to sell credit spreads.
I find that in both cases that thought process comes from a lack of understanding of how options trade.
Trading long calls and puts only can lead to big returns and can also feel like a safe way of trading since you can’t lose more than what you pay for the option.
What many retail traders don’t realize is this approach is by far the most aggressive approach you can take. It will tie up the most capital and only give you 1 way of making money.
Trading vertical spreads can give you multiple ways of making money on a trade and still leaves you with a defined risk trade. I know what my maximum loss is right up front when taking a trade.
Using our criteria for a vertical spread can actually reduce the cost of a trade by 50% or more when compared to buying an outright call or put option.
Trading credit spreads will give you 5 ways of making money on every trade and most importantly will put the time decay in your favor on a trade. They can be a great way of producing a consistent source of income.
If used incorrectly, you can find yourself spinning your wheels with no profit to show for your hard work
If you are going to be successful trading options, you absolutely need to have a mix of options strategies as part of your toolbox. Market conditions will change and you need to be flexible with how you are trading.
There are times when trading long calls and puts makes sense. In a volatile market they can produce great results.
There are other cases where using vertical spreads will allow you to better control your risk and be able to make money in a wide range of different markets.
Don’t lock yourself into one type of strategy out of fear or greed. If you can expand your toolbox to include vertical spreads as well you will see far better results long term.
Is there enough liquidity in the options?
There is no worse feeling than finding yourself stuck in an options trade without being able to get out at a good price. This can happen when you are trading products that don’t have good liquidity.
What makes an option liquid?
We want to see good volume and open interest in the options that we are trading. A good rule of thumb is to look for open interest of 30-50 X the number of contracts that you are looking to trade.
If you are trading 10 contracts you will want to look for 300-500 contracts of open interest.
The more volume and open interest that an option has, the tighter the bid/ask spreads will be. This will allow you to get in and out of your trades faster and at better pricing.
Just saving a few pennies on each trade can lead to a big cost savings at the end of the year
Ideally we would love to see good volume and open interest in the options we are trading but open interest does trump volume. You will find that 9 times out of 10 the monthly options will have better liquidity in the options which will make them much easier to trade.
This is why we do a bulk of our trading with the monthly options.
Do you have an exit plan?
This is similar to the first question but it’s such an important question that it justifies being on our list twice. Getting out of trades early or staying in too long can lead to leaving profit on the table or taking larger losses than necessary.
If you don’t have an exit plan in place from the get go, you will find yourself trading off emotion.
You will over react to every move up or down and will often times lead to you getting out of trades at the wrong time.
Knowing where you plan on getting out of a trade before you ever enter the position will help limit the emotional aspect of trading.
It will give you a rule that you can stay disciplined to. If you structure the rule to put the odds in your favor long term you will see much better consistency from your trading.
For example, any time I buy a call or a put or a debit spread I know I will limit my losses to 50% of what I pay to put the position on. When you combine this with the fact that we are targeting 100% returns on the winning trades it takes a tremendous amount of pressure off my winning %.
I don’t need to win 80% of the time to make money.
Learning how to take a loss is a big step in becoming a successful trader. Making sure your winners are larger than the losers is also an important formula to have in place.
Always Ask These Questions
While the answers to these 5 questions won’t guarantee success on every trade, they will start to stack the deck in your favor. You will be able to back up your trading decisions through numbers and statistics.
If you take these steps, you will start to outperform most traders out there that overlook these areas.