Picking the Perfect Trade: A Trading Guide for Beginners
The great thing — and daunting thing — about the stock market is its sheer vastness. There is no holy grail; there is no perfect market, sector, industry or stock to trade. It’s full of opportunity, yet full of pitfalls should you lose your way. When it comes to options trading, it simply comes down to preference. No matter what your preference is though, the setup behind those trades can have a lot of similarities.
Some very successful traders build and constantly modify a watchlist, keeping a close eye on several dozen stocks that fit their trading style at the current time. Swing traders may be more interested in daily or weekly charts, looking to see if they can squeeze several percentage points out of a stock over a few days’ or weeks’ time. Others look to scalp “cash flow” trades, leveraging fast price action and healthy liquidity in short-term moves. There are a near-endless amount of trading styles and hybrid combinations.
So what’s the first move?
First, find a trading style that works for you. Are you looking for a stock or option to buy after the open and sell before the close? Many refer to these as “cash flow” trades, scalping and “hitting singles” rather than doubles, triples and homers. If that’s a little too fast paced, consider swing trading. This flexible style allows investors to trade a stock for just a few days, a few weeks or even several months.
In both scenarios — be it a one hour trade or a one week trade — traders need to determine their entry. Are they looking for a reversal? A breakout? In either case, we’re looking for a stock to begin a new trend and riding that for our desired amount of time. In its simplest form, this is picking a directional bias. It allows traders to determine whether they are bullish, bearish or neutral on a particular stock, sector or the market in general.
- Step One: Determine Your Time Frame and Bias
Putting Together a Trade
All of this sounds painfully obvious, right? Getting to this point though — maximizing consistency and utilizing discipline — is harder than many imagine when they first start trading. It’s a skill that takes many traders years to hone. But everyone starts somewhere.
So after you’ve determined a directional bias, then what? Now we have to come up with a strategy and that’s where Option Party can help. When looking for direction in the stock market, it’s pretty straight-forward. If we’re bullish we buy, if we’re bearish we sell and if we’re neutral we sit on our hands.
It’s much different in the options world, though. Those who are bullish can consider the following strategies: Long calls, short puts (cash-secured), bull call spreads and bull put spreads. Bears can consider plays such as the bear call spread, bear put spread, short calls and of course, long puts.
If an investor isn’t outright bearish or bullish, there are other strategies to consider as well. For instance, a bear call spread doesn’t necessarily require the stock to fall considerably, depending on what strike prices are used. Likewise, a bull put spread doesn’t need a stock to rally necessarily, so long as the position expires out-of-the-money. In fact, with both of these scenarios, the underlying stock can actually move in the opposite direction than what’s intended and still turn out profitably. (The link above in “bear call spread” explains how).
- Step Two: Determine Your Strategy
Trading With Option Party
Once traders know their time frame, their direction and their strategy, Option Party can really help them kick it into high gear. For our example, let’s say we’re bullish on stocks over the next month. As you can see below, several of those criteria are instantly satisfied by a quick and simple click of the “Bullish” button.
By telling the system we’re bullish, it will automatically include every bullish option strategy the system scans for. The image above only includes Level 1 strategies, but by clicking on the “Bullish” option, it also includes the Level 2 strategies. In this case (again not pictured), that includes bull put spreads and bull call spreads. For what it’s worth, should users see a strategy they do not prefer to use, all they need to do is simply uncheck that particular box. In this case, I unselected “Long Straddle” from my results.
You may also notice that we’ve titled this scan (in the upper left hand corner) “Bullish Trade Setups.” With Option Party, traders can utilize as many different scans as they’d like. It allows investors to be ready for a number of different scenarios without having to re-enter all the trade criteria. But enough about that, let’s get back to the trade at hand.
Using options can alter one’s time frame. For instance, very short-term traders are unlikely to use options that expire six months from now. They want the quick movement and deep liquidity to get in and out of their position in hurry. Even swing traders may not find much use in options that expire many months from now. Instead, the short-term trader may use options that expire this week or next. A swing trader may find it most useful to trade options expiring in the next 25 to 50 days.
No matter what the strategy is though, Option Party users can apply a filter to any given time frame. As you’ll see below, we can pinpoint exactly how far away we want our option expiration to occur. This is found, fittingly, under “Option Expiration.” In this scenario we used the minimum/maximum range we cited above, 25 days to 50 days.
In reality, investors will have to determine how long they believe it will take for their trade to pan out and plan accordingly. That will allow them to choose an expiration date with plenty of cushion for their plan. The next step is filtering, and we’ll get into that in our next installment.
But our takeaway from Part One is simple: Decide on a direction, a time frame and a strategy.