Let’s get right into the philosophies those successful options traders have sworn by since the beginning. A lot of people hear the words options trading and their immediate response is that of horror. Their face will contort. Their body will recoil. They’ll look right at you and say, “Oh options trading, I know about that — it’s very risky”. Or, “options trading, that’s a sure way to lose all your money.” When the people who talk to you like this are friends and family — people who you know, like and trust — you start to doubt yourself and what you know. In my experience, it’s simply a matter of subscribing to three key philosophies or disciplines that many of the most successful options traders out there have already internalized. In subscribing to these philosophies, we turn options trading from being what others see it as — a high stakes gamble — into what is really is — a limited risk investment vehicle with astronomical profits. The first philosophy is that there is no place for emotion in options trading. We set rules for our trading practice. Whether the rules we set dictate how close to an expiration date options must automatically be sold or how low should the bid price get before we automatically sell, whatever the trading rules we set up for ourselves are, those are the ones we follow. This is not a case where rules were meant to be broken. Our trading rules are our foundation of web hosting based trading. Too many times, I have seen traders get emotionally involved with one option or another. When its value reverses — and in the case of options, that can be fairly quickly — instead of selling, they hold on to that option in hopes that it will reverse again, and they will recover their losses. There is no place for emotion in options trading Soon, a bad situation becomes worse. I’ve seen $5 options drop to 50 cents — a tenth of their value. While I was automatically stopped out at $4 for a 20% loss and already into a second trade where I had doubled my money in three days, my trader friend was still hoping, wishing and praying that his options would recover. In almost all cases, those trader friends who allow emotions to override their trading rules lose — and they lose big. They usually don’t stay trading for long. As a corollary to this philosophy, you have to realize that you will have many losing trades. Out of every 10 trades I make, two to four of them lose. My trading rules, however, protect me from big losses, and on the flip side, they maximize my profit gains. So, let’s qualitatively do the math here. In the worst case, five are losers and five are winners out of 10 trades. For the five losers, I have followed my money management trading rules and automatically sold when the loss is at 20%. For the five winners, I have doubled my investment. I hope that makes sense to you. The second philosophy is to follow the institutional traders — do what they do. Who are they? Institutional traders are pension fund managers, 401K fund managers and mutual fund managers. They control massive amounts of money. When they make a move they have the power to disturb the balance between supply and demand. The first aspect of this philosophy is to trade options whose underlying stocks are those that the institutional traders trade. See, the institutional traders use a basic set of fundamental metrics — things like earnings per share, relative price strength and industry group strength to get an idea of how the companies that a given stock represents are doing. Follow the institutional traders’ footsteps and filter the thousands of stocks out there by Follow the footsteps of the institutional traders their fundamental metrics. By doing this, you will have put yourself in a good position to take advantage of the wakes left by their moves. The second aspect is to follow the institutional traders’ moves. When an institutional trader makes a trade — whether it is to buy, sell, short or buy to cover a particular stock — just due to the sheer size of the trades an institutional trader makes, they can immediately change the balance between supply and demand, which is a big component of price. When we determine that we should enter an options trade whose underlying stock we’ve already determined through fundamental metric filtering is in the sights of an institutional trader, we’ll watch closely to make sure that the underlying stock’s price is moving in the direction of our trade. For example, if we are thinking of buying call options, we are going to be looking to see that the underlying stock is appreciating. Secondly, we’ll watch closely to see that a large amount of the stock is trading, which means that our institutional traders are confirming our move. We even look at the macro movements of the institutional traders throughout the course of a day. If the institutional traders are sitting on the sidelines just watching, you can tell because the amount of trading done in a day will register light. When the institutional traders get in there and are buying and selling, you can tell because the volume of trades going on is very heavy. The second philosophy summarized is that we want to be aware that there are institutional traders out there. If we simply ride on their coat tails and make similar trades on similar stocks, we can take advantage of the disturbances they make in the supply and demand balance and the related change in price. The third and, probably, most important philosophy is that successful options traders keep things very simple. Complication equals confusion. Successful options traders keep things very simple — complication equals confusion The simpler the trading strategy, the less chance for mistakes. The simpler, the less expertise required. The simpler, the less time that is required. The simpler, the fewer tools that is required. Successful options traders use simple terminology. Successful options traders have simple criteria they follow to determine which stocks they should be watching. Successful options traders believe in simple technical analysis. Technical analysis, after all, is made up of only two core variables — price and volume. Every other indicator is some mathematical manipulation of price and volume. Over-complicating technical analysis is a recipe for disaster. Finally, successful options traders believe in simple money management rules, such as, “If this happens, then buy. If this happens, then sell.” You have to decide, “I will not spend any more than 10% of my account on any one options trade.” Successful options traders spend no more than 20 minutes an evening and no more than two hours over their weekend trading. Successful options traders can show you their whole strategy on a piece of paper. There is no need for complex computer algorithms and such. So, our second strategy is to internalize and subscribe to the philosophies and disciplines that successful options trader’s follow.

In review:

1. Pull the emotion out of your options trading. Use your trading rules to minimize losses while taking full advantage of possible profits, and fully expect that you will have losing trades.

2. Respect the fact that there are a few traders out there that control large sums of money and leave behind large wakes when they trade. The simpler the trading strategy, the less chance for mistakes Be aware of these institutional traders and ride their coat tails. Trade the stocks that they trade in the directions they trade at the times they trade.

3. Keep every thing very simple. When in doubt, simplify. A simplified trading practice equals a reliable, limited-risk, easy trading practice that won’t have you glued to the trading screen. These are the philosophies of successful options trading. Again, go back through the chapter and review it to make sure it all makes sense. Move on when you are sure you understand everything.

trading strategies developed by AJ Brown -- tradingtrainer.com

To read and learn options trading visit optionsoutlet.org.

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