John Lansing, April 10, 2009
Let's face it, no one ever went broke taking a profit, and in a fast-moving, volatile market like this, you can make HUGE profits in a short amount of time ... even (and especially) when it's going down! And by keeping your "core" positions in place, you won't miss out on the bigger moves that you expect.
Think of all the bear market rallies you can play via calls, and think of all the puts you can buy when the rallies fade and stocks/indices tank back to new lows. But remember, when you approach a volatile market without bias, you will win much more often than you lose.
Good Money-Management Strategies
I recommend using solid money-management strategies with your active trading portfolio in a difficult and volatile market. When it comes to trading options, that means buying contracts on dips and closing out positions on rips.
Speaking of getting good prices, when you get in cheap, it only makes sense to close out your position on a nice pop in the options. (For more on when to close out a trade, see Closing Out Option Trades for Triple-Digit Profits.)
We Learn Valuable Lessons From Losing Trades
Where a lot of once-successful traders go wrong is that they start to believe their own hype. That is, they get on a roll and bank a handful of winning trades, but not only do they not stop and take a look at what they did right, but they also neglect to look back at the trades that didn't turn out so well.
Whether it's a bull or a bear market, the more trades you make, the more losers you're going to encounter. It's a fact. But that's why we stay in this game, to go after that growing number of winners that are going to put us within closer reach of our financial goals.
Bottom line, we learn more from our mistakes because we tend to make less of them when we sit back and review what went wrong, versus just focusing on everything that went right.
One That Got Away
Profiting from bearish trades in a bear market sounds simpler than it is. Unfortunately, sometimes options don't work even when the stock does what it's supposed to do.
For example, here is a recent trade I made. Goodrich Petroleum (GDP) made it all the way to target price and then dropped 50% in a matter of 10 trading days. Those puts should have jumped in value, but they didn't.
What Went Wrong?
My analysis of stock and the direction it would take were 100% correct, but the option I picked to take advantage of the stock's move was 100% incorrect because not enough time was allowed.
In options trading, you can get everything right, but if the strike and month are off just a tad, it's 100% wrong. That is where speed comes in.
All the Right Ingredients
Think of options trading in a volatile market like a good soup or a stew, and these are the ingredients you will need to be right more often than you're wrong:
1. One cup of direction
2. One cup of distance
3. One cup of speed (or the duration of time it will take to hit target)
Put all those ingredients into a trading portfolio and — shazzam! — you have a healthy meal for a lifetime!
But what else do you need to actually pull all this off?
The Right Ingredients are Only Half the Battle
Now that you know the recipe for a successful options trade, what else do you need to pull all this off?
Just like with any good recipe, the quality of ingredients doesn't matter if you don't know how to cook with them!
So, whether you're trying to whip up some short-term gains or you're letting longer-term profits simmer, I'll tell you what you need to do to craft a portfolio you can not only digest, but also enjoy.
Keeping Your Powder Dry
You must be capitalized. Yes, you actually need money to make money.
That means keeping some powder dry and being on the lookout for the freshest investment opportunities, so when the price pulls back, you can add to your position.
Don't get into trading, at least not in this kind of market, unless you have the money to build on your good trades.
For more on trading in a volatile market check out 10 Tip to Mangage Risk in a Volatile Market
You Need to Exercise Discipline
This is something that most people only want to talk about when things go wrong.
For example, overleveraged and undercapitalized options traders may score big because they backed up the truck on one or two plays and they both worked. They aren't actually practicing sound judgment; they simply got lucky — and luck runs out.
Scale In and Scale Out
Money management is a form of discipline, and I have found that just following "buy up to" a certain price does not always help less-experienced traders. In this crazy, unpredictable market we've been in for the last year, you have to continue to review your open positions every day to be ready to add or lighten up as volatility builds.
But, no matter how good the advice is from a guru you might follow or the trading technology you have at your disposal, you still have to come to the table with some money-management skills. If you fail in this area, then you will find yourself going from trading idea to trading idea, seeking a Holy Grail that just doesn't exist.
The Will to Come Back From a String of Losses
How does a trader get through tough times without allowing his or her bad habits to take over what sits between the keyboard and chair?
If the trader does not have a proven and well-tested plan, he or she is throwing money at the stock market in much the same way that gamblers put coins into slot machines. They could hit or miss — but the house knows the odds, and we all know what happens in these situations.
If a trader wants to get to the point where he or she is winning more than losing, the trader must take the time and do the work to get a solid trading strategy and plan.
It's More Than Just Good Picks
A plan isn't just good picks; it's following the rules that I keep pounding the table about.
This is why you should keep your positions small and spread them out into all different plays. This way, when you're wrong, it won't kill your portfolio.
You can't win every single trade, so you have to take the necessary measures to ensure you manage profits and losses, because we are in a market like none of us have ever seen before.
Following these guidelines will keep the bear from eating you alive.
Be a better trader.
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