Simplifying Your Trading

Some traders like structure. The more hard and fast rules you can give them, the better they like it. On the other hand, there are creative thinkers – traders who take concepts and experiment until they find a method that fits their personality.

Since we're still a little wet behind the ears in the experience department, let's leave creativity for a future discussion. Today, let's focus on the questions you need to answer that will help determine whether or not a trade is viable.

We've all heard Jim Cramer or some other analyst (notice the first four letters of analyst) howling about the next "hot" stock that's about to move. In the excitement of getting what people think is "inside" information, new traders tend to rush over to the computer and start hitting the buy button. Think about it. If the trade goes bad and they lose money, they can blame Jim Cramer instead of themselves (where it belongs) – an easy out. Their money is still gone, but it wasn't their fault.

Why should a trader bother to think for himself when someone else has already done it for them? It's uncanny how many people spend countless thousands of dollars in search of the Holy Grail. They typically end up with charting software full of little green arrows and red arrows pointing hither and yon as buy and sell signals. If that stuff really worked, we wouldn't need teachers to explain the "whys" and "hows" of trading. We'd only need people to sit and help us count the massive profits we'd all be making while we're out shopping for more swampland in Florida.

In this week's column I've enclosed a checklist (see below) of sorts. This checklist is for those who are considering the purchase or sale of an option. It may take a few minutes to fill out the checklist, but, once you do, you'll know if you have a viable trade.


It should be a simple matter to copy and paste the checklist into a MS Word file. Then, you can print out as many copies as you need to help you with your decision making. Punch three holes and keep them in a loose-leaf and you'll have a convenient way to track your trades.

It's often recommended that traders keep a journal of their trades. That's an excellent idea, but writing your notes and thoughts onto the checklist will is an organized and efficient way of accomplishing the same thing. As we progress, I will publish a new checklist for most of the strategies we will discuss.

Option Purchase or Sale Checklist
Stock / Index:
Current Price:

Option (Put or Call)
Option Symbol:
Action: (Purchase or Sale)
Expiration Month / Strike Price:
Option Price: (Bid & Ask)
Option Undervalued or Overvalued
Delta / Implied Volatility:

Number of Contracts:
Purchase / Sale Price (Bid or Ask):
Total Investment:

Stock Target Price:
Option Target Price:

EXIT PLAN:
Support Levels 1 & 2
10 Day EMA / 50 Day EMA
Cut Loss Exit Price:
Stop Loss Order @:
Actual Exit Price:
Profit / Loss:
Reason for Entering Trade:

Notes:

Your Assignment

In the next week, come up with some trades. Fill out the checklist and see what trades you can generate. Use the day's closing prices. It's a little easier to calculate when the market isn't bouncing around. It's OK to use puts, too. Some of the best trades you'll ever make are to the downside. Remember, just because you would like to make a trade, you may not find one that meets the criteria you've established for a viable trade.

Don't compromise!! That's when you can get into big trouble. Make sure that you maintain the standards you've set. It's very easy to rationalize a few points here and there – and using an overpriced option, etc. It's like rationalizing that extra piece of cake – pretending that those extra calories don't exist.

Follow Up

In our July 20, 2006 column, we went, step-by-step, through the trade selection process. We ended up with an August $25 long call position on EBAY. The trade was hypothetical, but it was based on current prices. At the time, EBAY was trading at $25.93. The call cost $2.40.

We had an exit strategy to sell our option if/when EBAY closed below $25. The very next day, EBAY closed at $24.66. It's been inching down steadily ever since. We would have been stopped out and our option would have been sold for about $1.25. That's an estimate, but it's close enough.

What did we accomplish? Hypothetically, when EBAY's support level didn't hold, we admitted that we were wrong, closed the position and conserved our trading capital. That's the name of the game. We're going to have losses, but keeping them under control will allow us to continue trading and to possibly become profitable in the future.

Could EBAY rebound before August expiration? Sure, it's possible. But the odds are against it. You don't want to get caught puffing on that hopium. It's dangerous. If you want to bet on a long-shot, go to the track. The odds are better.

Picking directions when trading options is a difficult task, to say the least. You have to be right about three things: 1) the direction; 2) the size of the move; and 3) how long it will take for it to get there. The rewards can be substantial -- if you guess right. Use the checklist above. It will help.

Missed Any Columns?

Hey, this is good stuff – especially if you're serious about learning options. The Pulitzer people won't likely be knocking at my door soon, but I've taught a lot of people how to conservatively and consistently make money – and they're still making money to this day. I hope you'll become one of them.

So, if you missed any of my previous columns, click on the following link and, hopefully, they will magically appear. http://forexworlduk.blogspot.com

Who Is This Guy? --

Mike Parnos has "been there and done that" – plenty! Known as "Online Trading Academy's Options Therapist," Mike has been trading, consulting and teaching option strategies for over 12 years. Both individually, and through his writings, Mike specializes in teaching conservative and non-directional option strategies while providing therapeutic guidance to thousands of individuals, brokers and institutional traders. Over the years, he has learned from his mistakes, and the mistakes of others, and he's here to share his wisdom with you. "Trading is as much psychological as it is skill," says Mike. "Keep an open mind. You never know what might find its way in there."

Disclaimer: Mike Parnos is an options instructor and mentor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.