Whoever told you trading is "easy", is likely inexperienced and lazy; or has become experienced but remains lazy, looking to dupe an even more inexperienced and lazier person. You need more than "Believe and Achieve" mantras.
Sustaining profitable trading results requires cultivating daily trade discipline. Like any other demanding profession, online options trading from home is no different. Choose one tenet to practise each month. There are 12, so you have a year to build your skill progressively.
1. Become a price puritan. The ONLY reason for price to exist and change is because of Supply and Demand. Where there are more buyers with reasons to buy than sellers with reasons to sell, price must rise. If there are more sellers with reasons to sell than buyers have reasons to buy, price must fall. If buyers and sellers have equal reasons or none to engage each other, price remains unchanged. Pure price trading techniques are true to this inescapable economic law.
2. Dilute concentration risk. S&P 500 accounts for slightly over 3/4 of the market capitalization in the entire universe of mutual funds. The top 100 stocks in the S&P500 (with minimal changes in inclusion/exclusion) accounts for ~43% of what mutual funds use in constructing their funds, i.e. the overwhelming majority of mutual funds gravitate to the same stocks in their holdings. As the top 100 stocks are large–cap oriented, two thirds of these funds are into large caps with only one third of these funds choosing to include only small and/or mid caps exclusively. Large caps tend to have weaker relative strength compared to small and mid caps. You were sold “Sector Diversification” – printed on the marketing prospectus. But you are actually intensifying exposure to weaker relative strength, given the cap-weighted concentration, even if the large caps you have holdings in, are distributed across sectors.
3. Being “trendy” but missing the Trend – the style junkie. Fund managers typically stay within their style. An equity fund is not going to become a fixed income fund. Their company’s charter is pre–defined in the type of fund house they operate as. A large growth fund remains a large growth fund, even when large growth funds underperform, while small and mid–cap funds are outperforming in relative terms. It’s not the fund manager’s fault, you funded the fund with your money to manage. This also partly explains why the high turnover of fund managers can affect the fund’s performance, as the fund manager wants to change styles but is constrained. Diversify outside what the news tells you is "Trendy". Replace reliance on funds with the use of optionable Indexes/ETFs.
4. Limit the Fundamentals – the Paper Poker Game. The psyche of investors behind Supply and Demand is expressed in price, beyond fundamentals alone. Investors sold off fundamentally sound stocks, after the unfortunate 9-11 incident and it was repeated with the financial pandemic of 2008, going into 2009. Benjamin F. King: Market and Industry Factors; Journal of Business, January 1966: “ Of a stock’s move ... 20% is peculiar to the one stock.” A Fundamental Analyst fusses with paper (Balance Sheet, Income Statement & Cash Flow Statement), only to explain 20% of price behaviour. As valid as all the FA work is, would you gamble against the house armed with only 20% of the odds with paperwork done by Analysts?
5. Divorce the underlying. You may think you are intimate (be it "love" or "lust") with the traded product. So, you go looking for patterns, setups, indicators that simply do not exist. Love is indeed blind. It’s more sensible to understand the cyclical/seasonal behavior of the asset class the underlying is in; and, how the underlying behaves near support/resistance levels with changes in supply/demand. You really do not know the underlying. Marrying one underlying imposes opportunity costs of not trading other more valid candidates. The stock isn’t going to “love” you back.
6. Define losses first, before profits. Manage risk ABOVE and BEFORE profits AND as finite. However well planned a trade is, it may never reach its profit target. Some choose to use a 1% absolute loss rule of the original trading capital, to define the absolute risk per trade. E.g. if your trading capital is USD $50’000, 1% is equal to USD $500 maximum loss per trade to incur; versus, accepting a 50% loss on the P/L of that specific position.
7. Doubling down accelerates losses. Doubling down only accelerates the average cost towards the losses – known as – “catching a falling knife”. The breakeven will keep moving away, as you chase the price. Trade for profit. Do not trade for breakeven with odds against you. Only add to a winner, if the entry criteria and Reward to Risk Ratio repeats the setup of the original winning trade. Limit adjustments – ever tried to "adjust" the sharpness of a knife?
8. Keep the learning real and thematically consistent. Counter the fixation with “magic” tricks of “technical analysis wizards” by learning from trades you have lived through. Price signals tend to be the strongest. Add depth to your insights into the dimensions of price. Set aside 1%-2% of your portfolio for continual self-education. With whatever you learn, if you struggle to relate it to some field or function in the trading platform, unlearn it if you cannot relate what is taught to what you can price in the platform. You will have to drop the “L” plates from “L”-earn, to earn.
9. Ditch the software crutches. Software is not a substitute for critical thinking. Break down the logic in the software (how, what and why). Black box software cultivates an addiction for repeatedly mindless subscriptions. Break the habit, trust your logic to reason – you have profitable trades that you thought through yourself. As you “outsource” the administrative tasks associated with trading (e.g. record keeping of trades), do not outsource your brain.
10. Plan trades with business discipline. Most plans cover Entries, Exits, Stops and Profit Targets. Still, no one enters a business with a few bullet points. Your trading plan must address the very defining reason of “Why trade?” What is your motivation (each day, month and quarter)? E.g. build up the children’s education fund, pay for household expenses or self-directed retirement? How robust do you want your home business to be? It’s reflected in the construction of your portfolio and trade plan.
11. Unrealistic expectations. Build wealth slowly and consistently. Forget dream chasing home runs. Trading is a life endeavour. The markets will outlive all of us.
12. Scrooge – cheap is not smart. Volatility dominates price-performance. Do not make option decisions simply on cost alone. Options are not fairly priced on bid-ask alone. Options perform based on what you pay for them. E.g. buying High(er) Deltas may not be the cheapest but may give the required directional bias. Rethink for a set amount of Theta decay, what that buys you. Like in real life, bargain shopping can lead to more junk than you've got room to store. Don’t end up with an inventory of junk Calls and Puts in your portfolio. Get savvy, seek value.
In adopting these practices as part of the daily trade discipline for online options trading, what can I expect to achieve? See Trading Profit | Consistent Results to view a retail option trader’s portfolio that exercises the discipline of the tenets.
As you exercise stricter daily trade discipline, you should see these characteristics of a more stable portfolio performance:
- Profits should step up gradually, depending on the size of your account. If it’s in the tens of thousands, the profits should step up consistently like a ladder from the low hundreds, to the higher hundreds; then, move up from the higher hundreds into the thousands. If your account is above $100K, profits should step up from the high hundreds into the thousands.
- Profits that jump from low hundreds into the thousands signal an over-reliance on gapping plays, which fail to help you step up consistently profitable results.
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