Hello again, in the article this week there is some outstanding information on how to trade options successfully. Earlier we covered the technical aspects of options trading and now it is time begin putting it together in a workable trading plan.
It is imperative you trade with a plan. No trader has ever successfully prospered without a trading plan or with a plan that they didn't stick to. The main aspects of a good trading plan include, but are not limited to:
1. Money management rules, i.e. acceptable profits and losses per trade, how much capital you will commit to any one trade and to the market at any one time. It is important you identify what your stop loss margin is (as discussed last week) and even more important you stick to it. Writing this sort of information into your trading plan will help cement it in your mind. We will discuss more on money management in week eight.
2. Stock and option identification rules, i.e. how you will decide which stocks to trade options on and which options you will trade. You should figure out if you like technical analysis, fundamental anlysis or a combination of both. How big will your watch list be? Will you trade lower priced stocks or higher priced stocks? Do you like trading in the money or out of the money options? What Greeks will you consider?
3. Entry and exit rules, i.e. how you will decide to enter and exit a trade, how long you will stay in a trade and how often you will trade. Entry and exit rules will depend largely on technical analysis, write down the patterns and indicators you will look for. Deciding how often to trade will be a big factor in your success. Most people over trade, if you have a fixed profit target then once you have met it you should stop trading. Going for an extra profit over and above what you planned for can possibly lead to a loss, which is very difficult to handle if were showing a profit originally!
4. Your own strategy rules, i.e. which trading strategies you will use primarily and which strategies suit your risk profile. "Know thyself" as the ancient Greek saying goes is critical when formulating a stock options trading plan. You will tend to trade options and you do anything else in life, for example, if you are cautious by nature you will trade cautiously, if you are impatient in everyday life you will trade impatiently. Therefore consider your unique traits and formulate your plan around them.
Once you have practiced trading options you will discover your own style of trading, and from that you will develop a plan that suits you. Once you have your plan, and you know it works, stick to it through thick and thin. That doesn't mean that a plan can't be changed but you must ensure that you give your plan a chance to work and that you don't change it the first time you take a loss.
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