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business newsWhen Trading, Be a Cherry Picker
Investors and traders should be discerning in the trade recommendations they follow by picking the good cherries, not buying the whole tree.
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While we listen to various esteemed members of various committees drone on, I thought it would make sense to address general concepts and approaches toward how the "less sophisticated" traders and investors make use of those selling services and advice.
There's a school of thought that when you sign up for a trading system, stock-picking software, or newsletter service, you must execute all the suggested trades. Anything less would be cherry-picking and mean you're not fully committed to the overall success or failure of the chosen program. I couldn't disagree more.
For example, if you subscribe to a newsletter or stock-picking service, choose the trading suggestions that you agree with and that make sense to you, not every single one. Any investment decision you make, from choosing a particular mutual fund -- whether it be an index or actively managed fund -- deciding to day trade your individual account, or simply leaving your money in cash or short-term T-bills, you're already engaged in a form of cherry-picking.
That is, you're trying to identify what you believe are the best investment opportunities. And in doing so, you should use multiple resources and tools, including research reports, technical analysis, and yes, even the occasional "tip" from a dubious source.
A Matter of Taste
That means not limiting yourself to blindly following one source for investment ideas, including this one. After researching multiple sources, do your own homework to arrive at what you believe are the best and most appropriate strategies for you.
For example, due to your available capital, you may need to adjust the contract size. Based on your risk tolerance, you may choose an alternate strategy -- for example, rather than simply buying puts outright, you employ the use of a spread, or even sell calls. They're all bearish positions, but they have different risk/reward profiles. It's almost a requirement to pick the one that's best for you, rather than simply mimicking someone else's positions.
Of course, in some instances, there's no need to make any trade at all. But even if you're not participating in a position, that doesn't mean it can't offer some value. There are many people that use these services without actively trading them, and this is especially true for people that are relatively new to options.
The ability to track a real-time portfolio, why different strategies are employed, how they behave under different circumstances, and asset allocation can teach much more than a book or seminar. And compared to a seminar, which can sometimes cost several thousand dollars for a two-day workshop, the cost of most newsletter services is quite reasonable.
Timing Must Be Ripe
And the final piece of advice, no matter what your particular trading style, is don't be greedy and overstay your welcome. This applies to both winning and losing positions. Though this is obvious and oft repeated, it's often easier said than done. This is especially true in options, which, as a decaying asset, often have people holding positions far longer than they should be.Don't Let Positions Turn Rotten
This usually comes in two forms. The first is those that are short options trying to squeeze out the final few pennies of premium on expectations that the option will expire out-of-the-money and worthless. The reward of collecting the last nickel or dime of an options premium is vastly outweighed by the risk that some unforeseen event could cause a sharp move in the underlying stock price and a large increase in the value of the option, resulting in a huge loss.
The other case is people that own or are long options tend to cling to their position based on nothing more than the hope that the options will magically regain their value in the final days prior to expiration. If there's no set news event or catalyst, such as earnings, scheduled prior to the expiration, it's best to accept the loss and move on to the next opportunity.
Look for the Juicy Ones
Successful option traders tend to base their decisions on probabilities. Over the long term, it's better to find trades that have a higher probability of earning even a small profit than trying to hit one out of the park.
Just as a baseball player with a high batting average will carefully choose which pitch to swing at, investors should be discerning in which trade recommendations they follow. It's the ones who are able to pick out the good cherries that will outperform those that simply buy the entire tree.
For more from Steve Smith, take a FREE 14 day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
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