A “stop loss” is exactly what it sounds like; it’s a “good ‘til canceled” order which dictates an exit from your position if it’s reached your maximum risk limit. Seems like a reasonable thing to use, yes?
Well, yes and no. And I suppose “it depends” as well. There are some applications of using Stop Loss orders that are non-negotiable. Futures trading is a great example of a non-negotiable use of stops. Typically when you are trading futures contracts in a directional manner, you will use a “bracket order” which defines your “take profit” exits as well as your “stop loss” exits. Done correctly, it’s a simple, linear relationship which allows you to define your maximum trade risk before entry. They are “set it and forget it” simple. So far, so good. Futures contracts don’t have any variability to them (like implied volatility) thus they are the perfect linear trading instrument. Where we get into complications is when we’re trading options, and especially spreads. It’s not hard to set up a “take profit” limit order to close down your trade when the result is positive. In fact, we recommend using them. Where it all goes awry is when we try to dictate a “stop loss” exit using options. I certainly found this out the hard way many years ago when I just casually added some “max debit” stop orders on some credit spread positions. I was horrified to see that they filled for max debit with the price of the index HUNDREDS of points away! There was no way that they should have filled, but they did. Remember that a stop order is a “MARKET” order and the “market” for an option or a spread can vary by an unbelievable amount depending on what is happening in that exact second in the market. And also understand that each option is its own little “micro-market” with supply and demand constraints, and a bid/ask spread which can move an unbelievable amount. If you decide to use stop market orders on your credit spreads, it’s only a matter of time before you too will endure a “rite of passage” and be stopped out prematurely on a trade, possibly at a much greater debit than you expected. So what is the answer? There are three different ways that you can solve this dilemma: Mental Stops, Conditional/Stop Limits, and Trade Structure. Mental Stops are exactly what they sound like; YOU make the decision when to exit, based on whatever criteria that you pre-determined at the onset of the trade. This requires TIME and ACCESS to be effective. As an example, I sell naked puts on the Micro Emini S&P500 futures contract on TastyTrade. They do not allow me to set a stop loss order, although they do allow me to set a profit-target limit order. I just have to keep tabs on the desired max debit limit, and execute an exit if it hits that level. It’s a bit of a challenge with an instrument that trades 24 x 5, but one that I’m willing to undertake. For those of you using spreads, you can consider a STOP/LIMIT order if you broker allows it. You will define the STOP price at which the online broker is triggered into a “stop” condition, where it then passes the ability to exit the trade into a LIMIT order. The STOP fires, and then the broker will close down the trade at NO MORE than the LIMIT order specifies. This prevents an inflated exit, however there is the risk that you might not exit at all if IV spikes and exits immediately inflate. These types of exits are necessary for traders who might have primary responsibilities OTHER than trading during the day, like a stay at home Mom or an office worker. My favorite solution is Trade Structure to enact risk management. Set the reward-to-risk of the trade such that even a full loss is within your limits, and let the price do what it will. No stop required. Whatever solution that you choose, remember the First Rule of Risk Management: set your exit BEFORE you enter the position, not after. In your corner……..Doc Severson If you are looking for a consistent daily system done LIVE with you from the best mentor in the business, check out Doc's Daily Live Trading Room Markets change seasons like the weather; clearly we’re in a different type of market “character” than we were a year ago. And just like how you have to wear different clothing in the different seasons of weather (flip-flops in January is a risk), you need to be able to match your strategies to match the current Market.
So what is the weather like today in the Market? Even after dropping 100 points off of the recent highs on the S&P500, the character has not changed…yet. We’re still seeing “quiet/trending” behavior with relatively docile intraday volatility, and very low IMPLIED volatility. Because of this, we generally want to establish a LONG VEGA position. Is this a reference to a really bad Chevrolet from the 1970’s? Nope…”vega” means the sensitivity to changes in implied volatility. With implied volatility being low, the odds favor it RISING at some point, so we want to be trading positions that gain value if implied volatility rises. This is why we’re trading time spreads like Campaign Diagonals right now. In fact, we’ve been trading them since late August, and it’s been our simplest, most successful strategy in the live trading room since that point. The other thing that I like about them is the “don’t care” mentality towards day-to-day price movement. I really don’t care what happens overnight, because the position is self-hedged to a degree, whether the price goes up or down. So no more worrying about an overnight black swan event. Now certainly, if this little pullback turns into a bigger one and we see implied volatility spiking again, we’ll look to place SHORT VEGA trades like iron condors and credit spreads. Until that point, the weather is just fine for our campaign diagonals! Make sure that you’re adjusting your strategies to work with the current market. In your corner……..Doc Severson If you are interested in learning more about these strategies, Go LIVE with Doc every day trading them in the 12 Minute Trading Live Trading Room or Get the Campaign Cashflow Masterclass! The 2023 Year in Review Event was the best we've ever done. The engagement was fantastic with such great questions and comments, and we really hit the mark with what we shared on how to win and make money in 2024. Doc's strategy overview and breakdown was awesome!
We also announced multiple new Masterclasses, new strategies, and some very special offers including a Masterclass for FREE - but you will need to act quickly because it all goes away on Sunday, January 28th at Midnight! Here are answers the questions we received about the specials and offers at the event.
Have you heard of the term “Random Walk” as it relates to trading strategies?
The author Burton Malkiel wrote the book “A Random Walk Down Wall Street” in 1973, and has served to be kind of a bible to those in the investment community that believe that predicting forward price movement is impossible. This, of course, flies directly in the face of those that use technical charting studies to analyze price behavior and predict future movement. So you have two religious “camps” in the investing community:
Which camp do I ascribe to? Actually, both. I DO believe that price can do whatever it wants, WHENEVER it wants to. Actually predicting the forward movement of price action is a fool’s errand. But I also believe in the power of analyzing price movement and patterns, and some things repeat over and over again. Range Expansion leads to Range Contraction. Exhaustion leads to Consolidation. Those don’t change. Instead of forecasting future price movement, I will go so far as to give the benefit of the doubt to one direction or another. Strong convictions, loosely held. I use a somewhat hybrid approach that allows me to see and react to what’s actually happening, instead of forming a bias based on what I think SHOULD happen. The longer that I have been trading, the more that I admit to myself that I don’t know what’s going to happen in the next five minutes, let alone in the next month. That affords me a sort of freedom in a way, but only if I’m using a strategy designed to work with this “Random Walk” approach. In general, strategies designed to work with a Random Walk approach are generally better reward-to-risk, and exchange a decreased probability of success for better reward-to-risk. They also have more mechanical entry conditions, instead of waiting for a specific technical signal. Learning about and using them might make a difference in your trading. Ask us how you can get started. In your corner……..Doc Severson In the realm of options trading, selling covered calls stands out as a strategy that can potentially boost your income while holding onto stocks. Whether you're new to trading or looking for an additional income stream, let's break down the concept and explore some actionable steps to get started.
Understanding Covered Calls What Are Covered Calls? Covered calls involve selling call options on stocks you already own. This strategy is great for those who want to generate extra income while keeping their stock positions. Why Covered Calls?
Selecting the Right Stocks Choosing the right stocks is crucial for successful covered call strategies. Here are some recommended stocks, each priced under $15, that align well with covered call opportunities:
Step-by-Step Guide to Selling Covered Calls
Managing Your Covered Call Positions Once your covered call positions are in play, it's essential to manage them effectively:
Risks and Considerations While covered calls can be lucrative, it's crucial to be aware of potential risks:
Congratulations! You now have a simplified guide to start selling covered calls and potentially boost your income. Remember, like any investment strategy, it's important to stay informed, adapt as needed, and enjoy the potential benefits of this income-generating approach. Happy trading! |
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