Trading strategies
I often sit back and view the market, consider how various trades are performing, and more importantly how the trading strategies themselves are holding up in response to an ongoing and frequently changing economic backdrop. Running a busy trading floor provides a real life, real time laboratory for creating opportunity. And harnessing literally decades of experience from my trading team and then sharing that with our clients.
Most retail investors and traders, often to their financial detriment. Have just one trading strategy which they almost always use – forcing it on the market. This often works for a period of time, helping their confidence grow. Position sizes increase and equity curve balloon and then bam!!! stop out after stop out. Despite the trader doing nothing different – how can this be? This may sound a familiar story, and if it does, read on!
Why use multiple trading strategies?
For a moment, I would like you to think of markets as a golf course. Sometimes you need to hit long, other times short. And then of course, there is the green! Ultimately, just like trading, the goal is simple. To move closer to the hole/make money. At our disposal on the golf course. We have a bag of clubs. Some are designed to hit long, others to chip short, and still more, like a sand wedge, for example, for very specific shots out of the bunker. If you tried to play a round of golf using one club, well, even if you were Tiger Woods. The chances are you would struggle! Not convinced? Try using a putter to get out of a bunker!
Yet all too often, this is how the less skilled or less educated trader approaches the market. With just one strategy that they use all the time. Irrespective of market conditions and this can lead to problems. I have seen this first hand, not only amongst clients. But even briefly on my trading floor. A good few years back. I had one particular trader, who we walked out. Simply because he was unwilling to break out of one strategy and view – one which was not working, I might add. Adamant he was right (even a broken watch is right twice a day). The difficulty for him related to ego. One simple question to ask is do you want to be right, or do you want to be rich? Because they are not the same thing. And trading can highlight this quicker than most businesses.
So how many trading strategies should you use?
Trading Strategies can be grouped into families. For example, based on the direction of the market, special situations or from aggressive to lower risk, to give you a few alternative ideas.
Right now, and this has been the case for a while now, one of my core strategies is in the covered call space. Why? Because it ticks many of my boxes, in terms of investment objectives, and what’s more, it works!
- The strategy generates cash flow
- The cashflow is up front
- It provides regularity of income – pretty much monthly,
- And it can profit from an upward or sideways move in the share price ie it’s not speculative
- It is largely passive requiring a handful of minutes per month.
In terms of allocation, given this requires the purchase of shares – either in the US or Australia, it needs a bit of working capital. But this is more than offset by the consistency of the trading strategy with most investors. After a couple of trades, keen to allocate more funding to the strategy.
What if you have a small account balance?
For those that love the attributes of this strategy. But are coming in with less working capital, calendar spreads also provide the above attributes. But require far less cash in the market. Returns are, therefore considerably higher, on a percentage basis, reflecting the use of a long dated call option, instead of shares. As the underlying asset on the strategy.
Where market conditions are more bearish, and share prices falling, the newer investor may shy away from using covered calls. Based on the view that the market is falling. However, by mastering what really is the foundation of options trading strategies. And building your expertise, this strategy can still be profitable even with a falling market.
How so, I hear you ask?
Instead of shares, we buy exchange traded funds (ETFs) traded on the US exchange. Which give us the ability to zone in on very specific opportunities. Let’s use an example of Europe, where the view may be that share prices are declining. Instead of shares, how about buying the Ultra Short European ETF. As European share prices fall. The value of that ETF goes up. We also sell covered calls over the ETF, providing a clear opportunity to generate up front cashflow and income, while using the strategy in a falling market. More on that sort of expert trading later.
Do you own shares worth less than what you paid for them?
How about using a really specialist strategy for a certain trading situation, such as the one here, where the share price has dropped. One of our Golden 4 Rules is to always have a stop loss on EVERY TRADE.
The specialist strategy to help dig you out of the hole formed by holding shares that are under your entry price is called stock repair.now this is a highly specialist strategy that saves you from the danger of “averaging down” ie buying more stock at a lower price to bring the average share price down – after all that is simply tying up more good money in a bad position and increasing your risk! Instead, stock repair can provide a better outcome – the potential to actually get out for a small profit or break even, without using a cent more of your money. This is one of the most powerful trading strategies that so very few people have ever heard of. We don’t use it often – but when we do, the results can come as such a relief to the trader who has gotten into problems, and was looking down the barrel of a loss.
What if you want more “colourful” trading?
For more aggressive and speculative trading strategies, we can tap into the spread family. These are combination strategies involving the buying and selling, simultaneously of call or put options. Like covered calls, spreads can be used to generate income, again paid upfront. What’s more the returns can often be quite substantial, on a percentage basis. However, with that comes a higher level of risk than with the, shall we say, plain vanilla, of covered calls.
Spreads can be set up for a credit, for those looking for income, or a debit, for those looking for a lower cost way of having a directional view (compared to simply buying a call or put). They also provide the opportunity for profit from an assortment of market conditions – after all spreads can yield profits in rising, sideways and falling markets, providing not only great opportunity but also genuine flexibility as well as defined levels of risk.
For those that are looking for even greater variety of strategy, spreads can be used in combination, with say a bull put and bear call spread used simultaneously to create an iron condor!
How about if you have no idea which direction its going to move?
This is not uncommon so let’s say you have no idea which was the price is going to move, but you do expect it to move sharply one way or the other. On all trades, the first step is to develop a view and here your view is really a “bet each way”. An example of when this may be the case, could be when a company is due to provide a trading update or some guidance. The news may be good or bad, and the share price will likely move up or down sharply, in response to that news. How can you possibly trade this? By reaching into our “bag of options clubs”, we can retrieve our straddle strategy. Not a tool to use too often, but under the right circumstances, it can be a cracker!
Typically, the straddle is set up by buying a call and a put, with the same strike price. If the price moves up, then the call will move higher giving you a profit, while the put will fall away. Based on options mechanics,primarily “delta”‘ the call will move higher than the put will fall, giving you a profit. Same if the price falls, the put will go up in value more than what the call falls, giving a profit. This is, again, more advanced but demonstrates the opportunity for profit that comes from knowing your trading strategies and selecting the best one for the job, at any given time.
So how many trading strategies do we use?
We teach, coach, mentor and recommend based on 13 different options strategies – those that are core, we use almost daily, others, in the more special situations camp, less frequently and some maybe only once or twice a year. However, we know and understand them intuitively based on decades of using them all.
Just like the golf course, when you know what all of your clubs are for, but more importantly actually know how and when to use them, your score improves dramatically.
This is what the professionals do every time they play, and they make BIG money. Just like golf, in trading, the professionals get paid, the amateurs don’t.
Unlike golf, where anyone can hack around a golf course, and enjoy the experience, the goal of trading is different. Losing money through the wrong strategy at the wrong time hurts, and is not fun – you won’t do it for long, before you quit.
And that is what happens for too many people.
By completing this article, which we hope you found useful, you should now have a clearer idea on what you could be doing with your investments. What we do, is empower people just like you to gain the knowledge, skills and confidence to generate an immediate and upfront income through applying these trading strategies and more.
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