How To Make Money in the Market

Here’s a simple framework for you to use to hopefully help you make money in the options market.  Although making money in the market is accomplished in only two ways – buy low and sell high; sell high and buy low – we all know it can prove far more complicated than that on a day-to-day or month-to-month basis.  How does one actually go about the process of trading?

Since I’m asked just about every week “How do you find opportunities in the market?”, I thought I would distill down a three-step method that can help you get organized and keep you on a path (hopefully) to successful trading.  Please keep in mind that there is no Holy Grail to trading other than, perhaps, to consistently cut your losses and let your winners run.  Easier said, than done, right?  Well, at least trying to do this within a framework might give you some structure.

So now, start considering that each part of your trading is probably going to fall into one of the following three steps:

1.  Find your opportunity (stock, ETF or index)

2.  Find the trade (option)

3.  Manage the option trade (trade plan)

For this blog I’ll summarize some of the most important factors for each step.  But I will also write a full-blown article covering these steps in more detail.  I’ll add this article to my list of action items today, so check back here later today and I’ll hopefully have it ready to go.  Check back if you don’t see it.

1.  Find your opportunity (stock, ETF or index)

I’ve heard from several of my newsletter recipients and free members that they have problems finding opportunities, or at least have problems finding the opportunities very quickly.  With more than 3,000 optionable products it certainly can seem overwhelming just getting started.

So consider following just a handful of stocks, ETF’s or indexes that you know.  Choose companies that you are familiar with or are in the news, or sectors that you already follow.  Don’t bother trying to find the diamond in the rough, the next GOOG or AAPL.  Why?  Because you may only need a 5-10% move in the stock to produce an option profit of 100%.

Now that you have a few stocks you’ll watch, take a look at the first stock on your list and decide on either of the following:

If you think you can pick direction with your technical or fundamental analysis, then select a directional trade in step 2.

If you can’t pick a direction, then choose a non-directional trade in step 2 (iron condor, butterfly, calendar, straddle, etc).  There you go.  Step one is finished.  Remember, I’ll have more on this later.

2.  Find the trade (option)

I see a lot of people start here.  If you think of the option trade – the strategy, that is – as a tool, then you’ll want to use the right tool for the job.  A carpenter for example will say “I need to cut this piece of wood.  Which is the correct saw for me to use?”  What you probably don’t want to do is say “I have this saw, let me go find something to cut with it.”  Is that the carpenter you want working on your house?  Probably not.

Once you’ve determined whether you think the stock will move, then you can start to focus on the correct strategy.  Believe me, choosing the right strategy is far more important than most people believe.  For instance, if you’re bullish, should you choose to buy a call?  Or buy a call spread?

Let’s assume you’re bullish on the stock you’re watching.  When considering strategies the first question to answer involves the implied volatility.  If the volatility is high and you think it could fall, then you would most likely want to buy the vertical spread instead of buying a call because the former strategy can largely protect you from a drop in the volatility.

Not worried about the volatility dropping?  Then the second item you might consider would be to choose the strategy, with the correct strikes of course, that can return a 100% profit with the least amount of stock movement.  Celebrating a 100% profit while your trading buddies only made 50% on their option trades during the same stock movement is truly priceless.

3.  Manage the option trade (trade plan)

You should never have to ask yourself, or anyone else for that matter, “OK, what do I do now?”  You should know how you’re going to handle an option trade BEFORE you even get into the trade.  Know when to take profits, cut losses, or make adjustments.  As an example, consider cutting losses at 50% of the risk in the trade and taking profits at 100%.

This of course begs the question of how much you might consider putting into the trade in the first place, and that will differ from trader to trader and strategy to strategy, but I’ll give you some more ideas of how that can work when I finish the bigger article on this topic.

As I said above, this is merely a summation of some of the bigger aspects to consider, and you’ll of course need to consider many other things e.g., the global macro-economic environment, individual company news, volatility skews, etc.  But everything can fit within this three step framework and help you to maintain a handle on your trading, and hopefully improve your profitability.

Trade safe!

Submitted by Greg Loehr at Optionsbuzz


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