Trading options is like fishing. You use your bait in order to catch a fish. Once you catch a fish you have to reel it in. The worse thing that can happen is your fish gets away with your bait. One of the best ways to prevent this from happening is by having a stop loss order. Once you’re positive in your option trade make sure to lock in profits. You must know your entries and your exits and your stop loss is one of your exits.
The entry is the most important part of trading. You should spend the majority of your time scanning the market and looking for your set up in order to identify the best entries. The best entries limits drawdowns and maximizes upside potential. This is an art and not an exact science. The majority of your time should not be spent in trades or jumping in and out of trades. The majority of your time should be spent watching the market. You have to first identify what you want to trade and then get to know it by watching the market.
The Trend Is Your Friend
It doesn’t matter if you’re swing trading or day trading when you trade you have to move with the trend of the market and you must have a stop loss in place. If you get stopped out of the trade after being in the trade for 1 min with day trading or for 1 day with swing trading then you’ve got the trend wrong. That’s why when you are positive in your trade you should take profits. There are a couple of ways to take profits. You can either move your stop loss to secure profit or exit the trade all together while you are in profit. That’s a successful option trade. Once you move your stop loss to secure profits you have won. Once you sell some contracts in profit you have won. Wining is not making 10,000% on a trade. Winning is not losing. The funny thing is if you don’t lose and only grow your account 3% a day you will double your account in 30 days. One of my mentors greatest quote is never turn a winning trade into a losing trade.
The best trades have great entries that allow you to have minimum drawdowns and maximum upside potential. One of the ways to force yourself into great trades is to place your stop loss at your entry or in profit once you’re in profit. What this does is automatically limits your drawdown and one of the criteria for a great trade will be met. Then all you have to do is focus on your exit. You can take profits at 5%, 10%, 25% or 50%, but make sure to always adjust your stop loss to secure profits. For example if you’re up 5% then move your stop loss to secure a profit of 1 %. If you’re up 10% move the stop loss to 5%, up 20% move your stop loss to 10% ect. When you reach your take profit you just take profit. This is what always take profit means.
Let’s discuss for a moment about the few that are able to make 10,000% on a trade. 1st they know the trend of the market and usually have a 50 to 80% stop loss if they have one at all. They have no risk management and are willing to lose it all in order to make that 10K percent return. If the market reveres on them close to the expiration of their contract then they are done. These risker bets are better made with LEAP call options from the “bottom” of the market. They are best done with swing trades to the upside, because the market always trends up overtime. Now you may have years of sideways movement, but the trend will be up after that period of consolidation.
The two statements I have heard repeatedly regarding trading are 1. always take profits and 2. cut your losers short and let your winners ride. I never truly understood those statements until recently. If you enter into a trade and it becomes negative and continues to fall and hit your stop loss then that’s called cutting your losers short. Always take profits means always adjust your stop loss to a point that will allow you to be in profit. Let your winner ride means that once you’re positive in your trade you take profit and then let a couple contracts/ winners ride to see how high they will fly, but of course with a stop loss order in place that will secure a profit no matter how minimal.
Before you enter a trade you must use technical analysis to determine the trend of the market. Getting this right is of utmost importance and you must get this right 70 to 80% of the time in order to be a consistently profitable trader. Some people spend years practice trading in order to get this right 70% of the time. Once you have this right your trade will be in profit, but you must have a plan. For swing trading my stop loss ranges from 25 to 50% depending on how tight I want to play it. For day trading my stop loss is usually 10 to 15%. You must know when you’re going to take profits and know where your stop loss will be. This is the only way to reel in your fish, otherwise you will have to cut your bait.