As an instructor, I get asked all the time about my favorite strategies in the market. Someone will say, "Do you have a favorite strategy?" and I will reply "yes" and I won't say anything else. This is a less than exciting answer, I know, but it is given because it doesn't matter what strategies I like, or use, what matters is that the individual trader finds a strategy that they like and then really learn that strategy inside and out.
Emotional trading is dangerous at best and can set a pattern of failure within the market. One student once said, "I have my favorites listed on a chart hanging on the wall - when I want to find a stock to trade, I throw a dart." This kind of trading would make a freight train take a dirt road. You might as well sign up for "Psychic Quarterly" or just ask your neighbor for the good "hot stock tip." It would be just as effective. There is no Holy Grail or Crystal Ball.
Take the emotion out of the trade. Develop a Master Strategy Playbook and live by your rules and guidelines. Yes, you will have to tweak them once in a while and when you do, tweak them carefully and with small increments not a gigantic swath.
Virtual trading is excellent as you try new strategies in the market. However, don't let this become your trading instead of the real thing. Virtual traders don't make a dime but it is a great learning experience. So if your goal is to make monthly cash flow, then virtual trade for a set time and then get into the real market. No great swimmer just sat at the side of the pool and did the backstroke for 10 hours a day and then won a gold medal.
Last but not least - keep positive. Even with all the craziness in the market and the government and our social climate, I believe that things will get better. I believe the words of Ronald Reagan as he said, "I know in my heart that man is good, that what is right will always eventually triumph and there is purpose and worth to each and every life."
If you get thrown from the horse - you get back on. If you miss a step in trading, then re-frame and re-boot and get back to basics and try again. As traders we must never give up.
Friday, March 26, 2010
Wednesday, March 24, 2010
Intermediate Trading Lab
Notes for the March 24, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
Friday, March 19, 2010
Volatility - Part II
In the last post we discussed Historical and Implied Volatility. It's time now to see how these two important indicators can be used to help increase our probabilities of a successful trade.
For this discussion, we are going to treat HV and IV as the surrogate projection of the stock and option price respectively. We are also going to use a website that is well known for volatility information - www.ivolatility.com.
After going into www.ivolatility.com and entering the underlying symbol of the stock, two choices of graphs appear on the right hand side and the bottom graph is the Volatility graph. The blue line is the 30 Day HV and the yellow line is the IV. We read the chart on the right and it becomes important to understand where the lines should be to be in a "sweet spot" for various trading strategies.
If, for example, the IV is at 68%, we read this as that the Option is priced for a 68% move, up or down, in the underlying stock.
Now, we look at the position of the HV and IV on the right hand side of the chart. The following graphic illustrates how for a Call Option, the HV should be below the mid-point and the IV should be below the midpoint. If the stock is undervalued, then the probabilities of it going up are greater, and if the option is undervalued, then the price is right for the Call Option that is purchased.
So, in this particular chart, volatility is acceptable for a Call Option. In the next post, we will look at the volatility requirements for both the Put Option and the Covered Call.
For this discussion, we are going to treat HV and IV as the surrogate projection of the stock and option price respectively. We are also going to use a website that is well known for volatility information - www.ivolatility.com.
After going into www.ivolatility.com and entering the underlying symbol of the stock, two choices of graphs appear on the right hand side and the bottom graph is the Volatility graph. The blue line is the 30 Day HV and the yellow line is the IV. We read the chart on the right and it becomes important to understand where the lines should be to be in a "sweet spot" for various trading strategies.
If, for example, the IV is at 68%, we read this as that the Option is priced for a 68% move, up or down, in the underlying stock.
Now, we look at the position of the HV and IV on the right hand side of the chart. The following graphic illustrates how for a Call Option, the HV should be below the mid-point and the IV should be below the midpoint. If the stock is undervalued, then the probabilities of it going up are greater, and if the option is undervalued, then the price is right for the Call Option that is purchased.
So, in this particular chart, volatility is acceptable for a Call Option. In the next post, we will look at the volatility requirements for both the Put Option and the Covered Call.
Wednesday, March 17, 2010
Intermediate Trading Lab
Notes for the March 17, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
Monday, March 15, 2010
Volatility - Part I
One of the most important aspects of the trading process is understanding and using Volatility. There are two types of Volatility that we will explore over the next few posts: Historical Volatility (HV) and Implied Volatility (IV).
Historical Volatility (HV) is the realized volatility of a financial instrument over a given time period. Generally, this measure is calculated by determining the average deviation from the average price of a financial instrument in the given time period. Standard deviation is the most common but not the only way to calculate historical volatility. Also known as "statistical volatility," this measure is frequently compared with implied volatility to determine if options prices are over- or undervalued.
Now, with the legal definition out of the way, let's take a look at a simplified view of HV. HV is simply how much the underlying (Stock) changes in price. It is usually calculated by taking the daily closing prices and averaging how much change is occurring over a given period of time.
The Option Chain within MachTrader has the HV and IV information at the top (as shown by the red box). For the HV, this gives the Historical Volatility within that specific time frame.
Implied Volatility (IV) is the estimated volatility of a security's price. In general, implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets.
In addition to known factors such as market price, interest rate, expiration date, and strike price, implied volatility is used in calculating an option's premium. IV can be derived from a model such as the Black-Scholes Model.
Now - the simplified version: Implied Volatility of an option represents what traders expect to happen in the future of the stock and how volatile they expect it to become. In other words, it is the volatility of the future. The IV is the surrogate projection of an Option's price.
Next post we will explore how to use the HV and IV to determine if the Volatility is in a "sweet spot" to trade Calls, Puts or Covered Calls.
Historical Volatility (HV) is the realized volatility of a financial instrument over a given time period. Generally, this measure is calculated by determining the average deviation from the average price of a financial instrument in the given time period. Standard deviation is the most common but not the only way to calculate historical volatility. Also known as "statistical volatility," this measure is frequently compared with implied volatility to determine if options prices are over- or undervalued.
Now, with the legal definition out of the way, let's take a look at a simplified view of HV. HV is simply how much the underlying (Stock) changes in price. It is usually calculated by taking the daily closing prices and averaging how much change is occurring over a given period of time.
The Option Chain within MachTrader has the HV and IV information at the top (as shown by the red box). For the HV, this gives the Historical Volatility within that specific time frame.
Implied Volatility (IV) is the estimated volatility of a security's price. In general, implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets.
In addition to known factors such as market price, interest rate, expiration date, and strike price, implied volatility is used in calculating an option's premium. IV can be derived from a model such as the Black-Scholes Model.
Now - the simplified version: Implied Volatility of an option represents what traders expect to happen in the future of the stock and how volatile they expect it to become. In other words, it is the volatility of the future. The IV is the surrogate projection of an Option's price.
Next post we will explore how to use the HV and IV to determine if the Volatility is in a "sweet spot" to trade Calls, Puts or Covered Calls.
Thursday, March 11, 2010
Risk Graphs
The Risk Graph may be one of the most under-utilized tools available to the active trader. Available in MachTrader, the risk graph, when understood, is a powerful compliment to the traders toolkit.
The Risk Graph solicits stock information as well as option information and then builds the corresponding risk graph. The example risk graph shown is for a Bull Put Spread. As the risk graph is produced, current stock price information is given within the black box and updates "real time" throughout the trading day. The trader can watch the price of the stock move and the impact upon his/her position.
The blue dotted horizontal line in the middle of the risk graph is the 0.00 (zero) line. If the risk graph is above the zero line, then the position will yield a net profit, if it is below, then the net will be negative. The black line is the risk graph of the position at expiration.
When the stock is in such a position that the stock price vertical line intersects the risk graph, then the corresponding net profit or loss is shown at the right. The risk graph uses the black scholes formula to determine the net profit or loss.
The blue line comes on as a default whenever a risk graph is created. The blue line (selected in the lower left) is the risk graph of the position now (in other words - today). Notice that the number of calendar days that remain prior to expiration is listed. The default colors of red, green and magenta and corresponding entry boxes are available to enter up to four different risk graph lines with four different time frames prior to expiration.
If the trader wants to compare the current chart with the risk graph, he/she presses the "Show Chart" button on the lower right. This is especially helpful to determine support and/or resistance levels as part of the criteria for spread trades.
As an options trader, the risk graph is a very valuable tool in assessing the current state of the options position and the stock.
The Risk Graph solicits stock information as well as option information and then builds the corresponding risk graph. The example risk graph shown is for a Bull Put Spread. As the risk graph is produced, current stock price information is given within the black box and updates "real time" throughout the trading day. The trader can watch the price of the stock move and the impact upon his/her position.
The blue dotted horizontal line in the middle of the risk graph is the 0.00 (zero) line. If the risk graph is above the zero line, then the position will yield a net profit, if it is below, then the net will be negative. The black line is the risk graph of the position at expiration.
When the stock is in such a position that the stock price vertical line intersects the risk graph, then the corresponding net profit or loss is shown at the right. The risk graph uses the black scholes formula to determine the net profit or loss.
The blue line comes on as a default whenever a risk graph is created. The blue line (selected in the lower left) is the risk graph of the position now (in other words - today). Notice that the number of calendar days that remain prior to expiration is listed. The default colors of red, green and magenta and corresponding entry boxes are available to enter up to four different risk graph lines with four different time frames prior to expiration.
If the trader wants to compare the current chart with the risk graph, he/she presses the "Show Chart" button on the lower right. This is especially helpful to determine support and/or resistance levels as part of the criteria for spread trades.
As an options trader, the risk graph is a very valuable tool in assessing the current state of the options position and the stock.
Intermediate Trading Lab
Notes for the March 10, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.
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