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Options Trading Rules
Level One: 6 of 11
Let's discuss some of the most important options-trading rules for successful investors.
There are 27 market sectors, (the Banking and Technology sectors for example) comprised of 247 Industry Groups as determined by Standard & Poor's. Every publicly traded company falls into one of these industry groups. It's incredible to see just how much industry group performance can influence the price movement of a stock. Companies are lumped together into a given industry group based upon the products or services they offer. Often each of the companies in a given industry group sell to the same client base. This is the reason that bad news from one company will tend to drive down the price of other stocks in the same group.
An example of this was the Enron fiasco a few years ago. There were a number of healthy utility companies that shared industry group placement with Enron prior to the discovery of questionable practices within the company. Once word of the scandal reached the public, the entire group dropped like a rock. Investors didn't know whom to trust within the group. As a result, even the "good" companies were punished.
Before we enter the trade, check the trend of the general markets, the specific market sector, industry group, and the trend of the stock.
When should you be happy with the profits? If you answered, "Never!" you may have a problem. Try this: When you're ready to enter a trade, instead of buying one contract, buy two. That way, when you first feel excitement over a great trade, you can think, "Should I be happy with this profit?" If so, then consider selling one of the contracts, leaving the other contract to run until you see sell signals. The secret here is to remind yourself: "I'll never go broke taking profits off of the table."
Another strategy is to analyze the stock chart for patterns of support and resistance. Try and identify the average move when the stock rises. If the stock tends to rally 20 percent each time it has a breakout, expect this run to be no different. Plan to exit near the 20 percent level.
Ask yourself when "good enough" should really be considered "good enough." Set exit points relative to the average move in the price of the stock, and exit in a timely manner. Consider selling half when you're happy and let the other half ride until your exit point is met, or until you receive sell signals.
Watch for patterns in other relevant news. For example, whenever the Chairman of the Federal Reserve speaks, reverberations are felt in the markets. If he were to hint at an increase in interest rates, ask yourself if the stocks or options that you are currently trading would feel the influence of his comments. Watch the reactions of the market. This is one of those times when running with the herd may be a good thing. If your holdings drop in value on his comments, protect yourself. Consider exiting the trade. Make sure that you have stop-losses in place prior to the announcement. An appropriately placed stop-loss is the next best thing to knowing the future.
Schedules for reports and events from the Federal Reserve are available on the Web at http://www.federalreserve.gov/calendar.htm.
Check to see when the stock reports its quarterly earnings. Look for an announcement three months later on the same day. This may not give you the exact date, but you can fine-tune the date by following the news. Check to see when key economic reports are due for release.
Conducting a nightly review of your holdings is imperative to investing success. If you would like to build your wealth, you simply cannot afford to ignore your investments. As part of your nightly routine, you should check the stock charts for each of your holdings, as well as the market news for each. Review the information. See if the charts or news items would direct you to sell your positions. This is also a great time to review the placement of your stop-losses. Conducting this analysis should take you no longer than 15 minutes each night. Armed with information regarding your positions, you can submit orders for action the next morning.
There is no excuse for being uninformed with the events of your stocks. If you begin to notice weakness in the chart patterns for your holdings, consider exiting your trades, unless of course you're using Bearish strategies! Review the placement of your stop-losses. Consider adjusting them in order to protect yourself from unexpected news.
Rule #1 - Trade with the Market, Sector and Stock
This sounds like a simple rule, but it's an easy one to forget. Most of the time, when we're ready to enter an option trade, we're familiar with the trend for the stock. This is usually what attracted us to the trade in the first place. Checking the trend of the stock isn't enough. Before placing an order for the stock or its options you must clearly understand the direction of the general market, and market sector for the stock. Be sure that the market and sector trends are moving in a direction appropriate to your strategy.There are 27 market sectors, (the Banking and Technology sectors for example) comprised of 247 Industry Groups as determined by Standard & Poor's. Every publicly traded company falls into one of these industry groups. It's incredible to see just how much industry group performance can influence the price movement of a stock. Companies are lumped together into a given industry group based upon the products or services they offer. Often each of the companies in a given industry group sell to the same client base. This is the reason that bad news from one company will tend to drive down the price of other stocks in the same group.
An example of this was the Enron fiasco a few years ago. There were a number of healthy utility companies that shared industry group placement with Enron prior to the discovery of questionable practices within the company. Once word of the scandal reached the public, the entire group dropped like a rock. Investors didn't know whom to trust within the group. As a result, even the "good" companies were punished.
Before we enter the trade, check the trend of the general markets, the specific market sector, industry group, and the trend of the stock.
Rule #2 - Have an Exit Strategy Prior To Entering the Trade
Before you ever enter a trade, you should prepare an exit. Not only will this prevent you from being paralyzed into inaction in the event the trade begins to go against you, it will also help you to recognize when you should be happy with the profits.When should you be happy with the profits? If you answered, "Never!" you may have a problem. Try this: When you're ready to enter a trade, instead of buying one contract, buy two. That way, when you first feel excitement over a great trade, you can think, "Should I be happy with this profit?" If so, then consider selling one of the contracts, leaving the other contract to run until you see sell signals. The secret here is to remind yourself: "I'll never go broke taking profits off of the table."
Another strategy is to analyze the stock chart for patterns of support and resistance. Try and identify the average move when the stock rises. If the stock tends to rally 20 percent each time it has a breakout, expect this run to be no different. Plan to exit near the 20 percent level.
Ask yourself when "good enough" should really be considered "good enough." Set exit points relative to the average move in the price of the stock, and exit in a timely manner. Consider selling half when you're happy and let the other half ride until your exit point is met, or until you receive sell signals.
Rule #3 - Beware of Upcoming Announcements
Life is full of surprises. Hopefully, your investments are as free as possible from the sorts of surprises that tend to lose money. Fortunately, there are specific announcements that are easy to plan for, such as quarterly and annual reports. Watch the news items for your stocks, and mark your calendars to expect announcements. If you know that the last earnings announcement for a given company was May 20th, plan that the next announcement will be three months later on August 20th. It may not actually fall on that day, but you will know roughly when to expect it. A quick bit of research to identify the fiscal year-end and reporting periods for a stock will go a long way towards preparing you for the unexpected. You can find the Fiscal Year-End and quarterly reporting periods for your stocks by clicking on the "Company Profile" link on the left side of the page from the Corporate Snapshot page. This information will show you when the stock closes its books for the year, but it doesn't tell you exactly when the results for that year or quarter will be announced. Check the news for that information. Most companies will let investors know when to expect the actual announcement.Watch for patterns in other relevant news. For example, whenever the Chairman of the Federal Reserve speaks, reverberations are felt in the markets. If he were to hint at an increase in interest rates, ask yourself if the stocks or options that you are currently trading would feel the influence of his comments. Watch the reactions of the market. This is one of those times when running with the herd may be a good thing. If your holdings drop in value on his comments, protect yourself. Consider exiting the trade. Make sure that you have stop-losses in place prior to the announcement. An appropriately placed stop-loss is the next best thing to knowing the future.
Schedules for reports and events from the Federal Reserve are available on the Web at http://www.federalreserve.gov/calendar.htm.
Check to see when the stock reports its quarterly earnings. Look for an announcement three months later on the same day. This may not give you the exact date, but you can fine-tune the date by following the news. Check to see when key economic reports are due for release.
Conducting a nightly review of your holdings is imperative to investing success. If you would like to build your wealth, you simply cannot afford to ignore your investments. As part of your nightly routine, you should check the stock charts for each of your holdings, as well as the market news for each. Review the information. See if the charts or news items would direct you to sell your positions. This is also a great time to review the placement of your stop-losses. Conducting this analysis should take you no longer than 15 minutes each night. Armed with information regarding your positions, you can submit orders for action the next morning.
There is no excuse for being uninformed with the events of your stocks. If you begin to notice weakness in the chart patterns for your holdings, consider exiting your trades, unless of course you're using Bearish strategies! Review the placement of your stop-losses. Consider adjusting them in order to protect yourself from unexpected news.
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