Lessons from the Option Battlefield
I’m coming up on my 2 year anniversary with Investools and trading options. As part of that, I’ve been reviewing all of my trades, trading rules, success rates, and operations. Some very interesting (OK, not ‘that’ interesting but interesting in a ‘Dorky’ kind of way) patterns have emerge from obvious to insightful. For instance:
1) Paper trading did very little for me. My patterns of trading completely changed from paper trading to real trading. What works better for me is to trade a small number of contracts. The pricing on Think or Swim is a huge help and would have saved me thousands of dollars in commissions.
2) The search for the perfect system is a fools errand. It matters very little what system you use, only that you use a system without fail or exception. This is particularly important for me.
3) If I follow my rules I make money. Almost without exception, the only time I ever lost money was when I didn’t follow my rules. Try this yourself…. Sort your trades by largest loss to smallest loss and deconstruct your trade to see in how many of those trades you followed your rules. I bet its less than 10% (mine was less than 5%).
4) Technical analysis gives you an advantage, but is not perfect. In the beginning I was so convinced of the advantage of certain technical indicators (think MACD, STOCH, RSI, candles, etc) that I ignored other less important indicators like price (DOH!). Put it another way, price trumps everything else. In order of importance from price, I would say support and resistance, volume, industry / sector, and overall market. I have my studies divided in two; one set of studies for trending stocks and another set of studies for non-trending stocks. When in doubt I drop to price and volume only.
5) News does not help. Almost all of the great traders are not on Wall Street and maintain a respectful disconnect with news. So I greatly reduced my exposure to news, market reports, and commentary and my trading improved instantly. Even if I got the news right and early, that didn’t mean that it was a reliable predictor of the market’s response.
6) Don’t try to master everything at once. Pick one technique such as conservative credit spreads, iron condors, strangles / straddles, diagonals, etc. and master it. Work it until you are consistently making money month to month and then and only then start mastering a second technique. Today I only use 3 techniques; credit spreads, iron condors, and diagonals. I don’t feel any need to add additional techniques.
7) Be careful of how you treat your winnings. I noticed that I would use my normal techniques to create winnings and then use those winnings to put on higher risk trades that I would never put on with my normal capital. Then if those trades moved against me I would rationalize that I “was using winnings anyway” and it was OK if I lost those funds. Don’t do that. Treat all winnings as capital and hold to it with everything you’ve got.
8) Trading is not entertainment. Be careful not to trade because you are bored. When you are board get up, go for a walk, read the message boards etc, but don’t trade for entertainment. Good trading is a boring activity akin to working in a factory. (Albeit a high paying factory!!)
9) Its easy to put on a trade, its much harder to exit. Spend at least 70% of your time defending your trades. In times of sudden shifts, trade defensively only.
10) Strive to ride a trade for only 60% of a movement. A great trader is never the first in and never the last out. In a 100% move, trade to capture the move from 20% to 80%.
11)Remember, the holy grail in trading is to become a consistent trader. It’s a lot more important to make 3% a month consistently than to shoot for 10 -15% a month and fail too often. Make your money hitting singles and doubles and you will eventually see occasional home runs.
12) It doesn’t take a lot of time. Once the initial learning is complete (about a year for me) I spend about 10-15 hours a week trading. Any more or less than this and my performance suffers.
I hope this helps others out there!
Good luck and good trading,
Mojo
September 12th, 2007 at 5:07 pm
Thanks, again, Mojo,
Reading this, I can certainly see my mistake in taking on too many different approaches. I am up about 15% for my first nine months but I can’t say it is because of skill and cunning on my part. A more disciplined approach is my new mantra.
Mark Matthews
February 6th, 2008 at 2:36 am
This is a very interesting blog! You have some excellent material to help me expand past my simple option trades (selling covered calls and buying some naked calls years ago)
One minor typo you may want to edit is “board” in rule #8 above. I believe the correct usage is “bored” Not a big deal though.
Thanks!
February 6th, 2008 at 3:59 pm
Dan S -
Thanks for the compliment and pointing out the spelling. I fixed it but I’m sure there are many more!
Feel free to trade along and to post and trades or questions you might have. We are installing forum software soon.
Regards,
Mojo
February 9th, 2008 at 5:05 pm
Mojo-
Absolutely fantastic site! I have been trading options on ThinkorSwim for a few months now and think I have found my calling. ToS sures makes it retail trader friendly.
My question is in regards to Iron Condors. I don’t usually worry about commissions much, however, in placing Iron Condors on the liquid ETF’s like SPY, QQQQ and IWM I find a lot of my potential gain is eaten up by commissions. Any suggestion? Tips?
I am sure I will have many more questions along the way. Keep up the good work.
Woodward
February 9th, 2008 at 11:21 pm
Woodward,
Thanks man, that means a lot to me and I love Think or Swim as well!
In order to save commisions on QQQQ and IWM you could go to larger versions such as NDX and RUT. Its the same cost per contract but these contracts are much larger in size for the same commission. The SPYs bigger cousin is the SPX but I don’t recommend trading those because the fills are horrible especially when the market is moving quickly.
Feel free to post away your questions,
Mojo
February 10th, 2008 at 2:44 am
Have you had much success with NDX and RUT? I have had a really hard time getting filled on the Iron Condor and I have to give up .10 or .15 just to get filled. Is it worth it? What ETF or Indexes do you place you Iron Condors on?
I love the 60/40 long term/short term capital gains tax rules on the major indexes too!
February 10th, 2008 at 11:53 am
I’ve had very good luck getting filled on the RUT using GTC orders and being patient. The NDX isn’t quite as good.
What are your Iron Condor rules? How far out do you initiate under what conditions?
Mojo
February 15th, 2008 at 3:22 am
Hello Mojo:
I got introduced to your site when you posted a reply on Investools forum about a Short Straddle for BIDU a couple days ago.
I am so happy that I “stumbled” upon your site. I am hoping to learn and contribute when I can as I go along.
I used to trade stocks and long calls “randomly” in the 90s. After the tech bubble burst, I didn’t do much trading (So I lost out completely on the last bull run).
When someone said buy this or sell that, I never understood the why. I also read Peter Lynch’s book - and a few others - well it didn’t help much becuase he preached buying what you “knew and liked” and “buy and hold”.
Finally, I took the Investools course in early January and it has been a great help. I have immersed myself into the learning process. Hope to learn more from you. More about me later…
Here is a quick question : What do you mean when say “Put it another way, price trumps everything else.” I am missing something here.
Thanks and hope to keep in touch,
Kanti
February 15th, 2008 at 5:04 pm
Kanti,
I’m glad to see you here. We have lots of Investools students and others here as well so you are in good company.
“Price trumps everything” - After taking my technical analysis classes I was so convinced by the power of the MACD / STOCH that I was trading to those indicators first and not to the stock price. So, what I remind myself of is that all indicators except price are trailing indicators and that price trumps everything. If I could make money trading the MACD/STOCH I would have killed it!!!
Be sure to head over to our message board. Its still in beta but we are getting the kinks out and will be announcing it in the next few weeks. Goto http://www.insanemoney.com/forums/ or click the ‘forums’ tab at the top of this page.
Thanks,
Mojo