You’ve spent vast amounts of time, money, and effort to become options trading experts. You know the difference between bids and offers, puts and calls, exercise prices, and expiration days.
And you still can’t make any money.
Now what?
Where do you apply your newfound expertise? How do you maximize your reward versus your risk?
It is all very simple. Stick to five simple disciplines that I am about to teach you and you will suddenly find that the number of your new trades that are winners takes a quantum leap, and the money will start pouring into your trading account.
It’s really not all that hard to do. So here we go!
1) Know the Macro Picture
If you have a handle on whether the economy is growing or shrinking, you have a major advantage in the options market.
In a growing economy, you only want to employ bullish strategies, such as calls, call spreads, and short volatility plays.
In a shrinking economy, you want to execute bearish plays, such as puts, put spreads, and long volatility plays.
Remember the only thing that is useful is a view on what the economy is going to do NEXT. The government only publishes historical economic data, which is for the most part useless in predicting what is going to happen in the future.
Remember, the options market is all about discounting what is going to happen next.
And how do you find that out? Well, you could hire your own in-house staff economist. Or you could rely on economic research from the largest brokerage houses that all have their own economist.
Even the Federal Reserve puts out its own forecasts for economic growth prospects. However, all of these sources have notoriously poor track records. Listening to them and placing bets on their advice CAN get you into a world of trouble.
For the best possible read on the future of the U.S. and the global economy, there is no better place to go than Global Trading Dispatch, published by me, John Thomas, the Mad Hedge Fund Trader.
This is where the largest hedge funds, brokers, and yes, even the U.S. government go to find out what really is going to happen to the economy.
2) Looking for Great Industry Fundamentals
Do you want to give yourself another edge?
There are more than 100 different industries listed on the U.S. stock markets. However, only about five or 10 are really growing decisively at any particular time. The rest are either going nowhere or are shrinking.
In fact, you can find a handful of sectors that are booming while others are in outright recession.
If you are a major hedge fund, institution, or government, you may want to cover all 100 of those industries. Good luck with that.
If you are a small hedge fund, or an individual working from home, you will want to conserve your time and resources, skip most of the U.S. industry, and only focus on a handful.
Some traders take this a step further and only concentrate on a single high-growing, volatile industry, such as technology or biotech, or a single name, such as Netflix (NFLX), Tesla (TSLA), or Amazon (AMZN).
How do you decide which industry to trade?
Brokerage houses pump out more free research than you could ever read in a lifetime. Government reports tend to be stodgy, boring, and out of date. Big hedge funds keep their in-house research confidential (although some of it leaks out to me).
The Mad Hedge Fund Trader solves this problem for you by limiting its scope to a small number of benchmark, pathfinder industries, such as technology, banks, energy, consumer cyclicals, biotech, and cybersecurity.
In this way, we gain a handle on what is happening in the economy as a whole, while lining up rifle shots on the best options trades out there.
We want to direct you where the action is, and where we have a good handle on future earnings prospects.
It doesn’t hurt that we live on the edge of Silicon Valley and get invited to test out many technologies before they are made public.
3) The Micro Picture is Ideal
Once you have a handle on the economy and the best industries, it’s time to zero in on the best company to trade in, or the “MICRO” selection.
It’s always great to find a good target to trade in because positions in single companies deliver double or triple the returns compared to stock indexes.
That’s because the market will pay a far higher implied volatility for a single company than a large basket of companies.
Remember also that you are taking greater risks in trading individual companies. One single stock is subject to far greater even risk and a basket.
If the earnings come through as expected, everything is hunky-dory. If they don’t, the shares can drop by half in a heartbeat. Large indexes buffer this effect.
Of course, there are gobs of market research out there from brokers about individual companies. Some of it is right, some of it is wrong, but all of it is conflicted. Recommendations are either “BUY” or “HOLD.”
Brokers are loath to issue a “SELL” recommendation for a stock because it will eliminate any chance of that firm obtaining new issue business. Who wants to hire a broker to sell new stock with a “SELL” recommendation on their stock?
And brokerage firms don’t make their bread and butter on those piddling little discount commissions you have been paying them. They make it on new issues business. In fact, a new issue can earn as much as $100 million from a new issue for one firm.
I have been following about 100 companies in the leading market sectors for nearly half a century. Some of the managements of these firms have become close friends over the decades. So, I get some really first-class information.
When markets rotate to sectors and companies that I already know, I have a huge advantage. Needless to say, this gives me a massive head start when selecting individual names for options Trade Alerts.
4) The Technicals Line Up
I have never been a huge fan of technical analysis.
Most technical advice boils down to “If it’s gone up, it will go up more” or “If it’s gone down, it will go down more.”
Over time, the recommendations are accurate 50% of the time or are about equal to a coin toss.
However, the shorter the time frame, the more useful technical analysis becomes. If you analyze intraday trading, almost all very short-term movements can be explained in technical terms. This is entirely how day traders make their livings.
It’s a classic case of if enough people believe something, it becomes true, no matter how dubious the underlying facts may be.
So, it does behoove us to pay some attention to the charts when executing our trades.
Talk to old-time investors and you will find that they use fundamentals for long-term stock selection and technicals for short-term order execution.
Talk to them some more and you find the best fundamentalists sound like technicians, while savvy technicians refer to underlying fundamentals.
Get the technicals right, and you can provide one additional reason for your trade to work.
5) The calendar is favorable
There is one more means of assuring your trades turn into winners.
According to the data in the Stock Trader’s Almanac, $10,000 invested at the beginning of May and sold at the end of October every year since 1950 would be showing a loss today.
Amazingly, $10,000 invested on every November 1 and sold at the end of April would today be worth $702,000, giving you a compound annual return of 7.10%.
Of the 62 years under study, the market was down in 25 May-October periods, but negative in only 13 of the November-April periods, and down only three times in the past 20 years!
There have been just three times when the "good six months" have lost more than 10% (1969, 1973 and 2008), but with the "bad six months" time period there have been 11 losing efforts of 10% or more.
Yes, it may be disturbing to learn that we ardent stock market practitioners might in fact be the high priests of a strange set of beliefs. But hey, some people will do anything to outperform the market.
It is important to remember that this cyclicality is not 100% accurate, and you know the one time you bet the ranch, it won’t work.
So, there we have it.
Adopt these five simple disciplines and you will find your success rate on trades jumps from a coin toss to 70%, 80%, or even 90%.
In other words, you convert your trading from an endless series of frustrations to a reliable source of income.
If a potential trade meets only four of these five criteria, please do it with your money and not mine. Your chances of making money have just declined.
And I bet a lot of you poor souls execute trades all the time that meet NONE of these criteria.
Get the tailwinds of the economy, your industrial call, your company picks, the technicals, and the calendar working for you, and all of a sudden you’re a trading genius.
It only took me half a century to pull all this together. Hopefully, you can learn a little bit faster than that.
I hope it all works for you.
This is John Thomas signing off saying good luck and good trading.
