Just because the markets are getting bounced round doesn’t mean that you have to be. Following a disciplined approach to trading will go a long way to keeping you out of trouble.
Let’s review the three main factors to maintaining a sound trading discipline and see how you can use this information to keep your trading plan on track.
Disciplined Trading . Having a disciplined approach every time you place a trade will go a long way to building a successful trading career. Not only will you be trading the best strategies in mostly highly liquid options, but you can rest assured the trade probabilities are in line with your risk and reward parameters.
Three Key Factors to help strengthen your trading discipline
The first consideration is whether or a not the options are LIQUID. Do the options have tight bid/ ask spreads, is there a good amount of open interest, and are there many strikes. Closing an illiquid options position can be difficult. If you have sold an option for a credit you want to buy it back for less than you received in order to profit from the trade. This can be difficult, if not imposible if you trade options with wide bid/ask spreads ( illiquid options). Always remember to trade liquid options regardless of market gyrations. You’ll thank yourself in the long run. Here is a good discussion about liquidity (click here) from Investopedia
If you’re going to try to trade illiquid options, you should be aware of the pitfalls of doing so. First of all, because there is a very low level of liquidity, the bid-ask spread will be much wider. That means you’ll be relying on people in the market who want to hedge their bets in an environment that isn’t highly liquid.
Chances are, you may have a difficult time trying to sell an option that is illiquid. If you’re lucky enough to do so—if at all—there is a good likelihood that you’ll be selling it at a discount instead of the market price—or the price at which you’re willing to sell.
It isn’t uncommon to see volatility (click here)contract as a stock rises in price. For some reason traders feel more comfortable knowing that a stock is going up. They get very nervous when stocks go down. When prices fall, volatility can get to extreme levels. For premium sellers that is the time to sell options and collect rich credits. With prices climbing and exceeding technical resistance levels, premiums are getting crushed along with volatility. Be careful if you are trying to sell options with very low volatility.
The third factor we have considered is probability (click here) The probability of profit is a calculation telling the probability of making at least $0.01 on your trade. This may not seem like a large number, but it is not an upward bound limit of profit. You can see this calculation on your trading platform. By checking these stats you can readily see if the potential reward is worth the risk you are taking on the trade.
If you would like a more thorough discussion of these three metrics, check out this You Tube video with Tom Preston.
it’s a good one…
The fundamental rules of trading haven’t changed just because the market is waiting with bated breath to hear what J Powell has to say tomorrow.
The markets are random. No one knows what is going to happen with any degree of certainty.
The best advice in times like is to only trade highly liquid options, be aware of the volatility environment to know whether selling premium or paying a debit and know the probability of making a profit and your max loss if the trade doesn’t go your way.
Please share your thoughts and suggestions in the comment section below