You have your finger on the mouse and are ready to click “Send”. . .
But, are you 100% sure that you’ve made the right decision? Is there something you are missing or did you cover all the bases? Remember that once the trade gets filled you are committed and have real money at stake. I believe that you have to have a plan in advance. A little preparation now goes a long way when making trades, so ask yourself these 10 questions before making another trade.
Trade size is an extremely important aspect and ultimately the reason I list this as #1 on our list. Trading small and trading often leads to a lot of occurrences that overtime will give you that high probability of success you’ve been targeting. If you trade too large or too infrequent, then you don’t have enough data points to correctly give you the probabilities you’ve been looking for. I see this all the time with new traders that make 1 to 2 trades per month and are trading 25 to 30% of their capital per trade! Sound like somebody you know? Possibly sitting in your chair right now? And while it could work for a couple of months, in the long run this is not a sustainable strategy.
#2 What’s My Percentage Profit Target?
Going into a trade without a clearly defined profit objective is both risky and careless. We’ve all heard that you should “let your winners run and cut your losers short” right? Well that’s a load of crap! The most successful traders out there manage their winners and take profits. So before you go into your next trade try to figure out at what points you’ll exit the trade. I like to target around 50-75% of the max potential profit as a good starting point.
#3 What’s My Underlying Market Assumption?
Market direction plays less of a role today than ever before. You can trade the wrong side of the market and still profit with options —amazing, right?
Still you have to have some basis for making your directional assumption bullish, bearish or neutral. I suggest using a few simple but powerful technical analysis indicators like MACD, RSI, and Stochastics. These will help you more easily spot overbought and oversold ranges.
#4 Is There Enough Volume/Activity?
Volume should be a big consideration when making a trade. The reason is that without enough volume you run the risk of either becoming the only person in the market OR the data behind the probability indicators aren’t sufficient to give convincing percentages. Make sure that the contracts you are trading have significant volume. This will make entry/exit easier and also narrow your bid/ask spread significantly (saving money).
#5 Have I Checked Earnings Dates?
Bet at some point you’ve been “surprised” by earnings huh? We all have don’t worry. So take that market lesson and just double check any important earnings or announcements that are scheduled to come out while you have a position working.
It’s not that you shouldn’t trade near earnings (I actually make a lot of money trading around earnings) but rather that you know they are on the horizon. If you know it’s coming you won’t get caught with your pants . . . well, down.
#6 Where Is Implied Volatility Currently?
Possibly #2 on rank of importance for options trading is understanding where implied volatility is in the range. Are we at the high or low end of the range? This one factor can determine what strategy you use or don’t use and can cripple your success right from the start if you don’t get it right. And remember it’s not the number (15% IV) but rather its ranking in the current range history (top/bottom of the range etc.).
#7 Does This Fit Within My Overall Positions?
As traders we don’t want to be one-sided all the time. It’s just not smart knowing that the markets are cyclical in nature. Therefore, if you are looking at another bullish strategy ask yourself if this fits within your overall positions and portfolio. Do you really need another bullish position or could you use a bearish position instead to help smooth out the Deltas.
#8 Should I Look To Adjust At Some Point?
Generally I’m not a fan of adjusting defined risk trade since we should be keeping our trade size small from the start (see #1). However, at times with undefined risk trades you’ll need to pre-plan adjustments. Focus on the pain points in your strategy where you would need to adjust the trade should the market test you. Then figure out what you’ll do to adjust the trade in advance so you can act quickly if needed.
#9 Does The Strategy Fit The Market Conditions?
Don’t put a round peg in a square hole! It won’t fit no matter how hard you hit it!
Strategies are meant to fit certain market conditions and too often new traders try to “force trades” into the market. You like Iron Condors for example and then every trade becomes an Iron Condor. Make sure that you know what the limitations are of your strategy and fit that strategy to the correct security.
#10 Am I Trading Just To Trade?
Last but not least please don’t trade just to trade. . .
We all know that trading is a thrill and rush but for the love of everything trading, don’t mistake activity (trading a lot) for profitability (making dough). If the trade isn’t good and you know it in your gut then don’t make the trade. Patience is key in this business and you need to pick and choose your spots carefully or you won’t be around much longer.
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Kirk has been the Head Trader at OptionAlpha.com, one of the top options education websites, for the last 7 years. He has been a contributor to Barron’s Magazine, Investing.com, SeekingAlpha and other top publications. Join more than 14,000 people who have taken his free 4-part options trading course.