Trading Business Plan Template
Written by Dave Lavinsky
Trading Business Plan
Over the past 20+ years, we have helped over 500 entrepreneurs and business owners create business plans to start and grow their trading companies.
If you’re unfamiliar with creating a trading business plan, you may think creating one will be a time-consuming and frustrating process. For most entrepreneurs it is, but for you, it won’t be since we’re here to help. We have the experience, resources, and knowledge to help you create a great plan.
In this article, you will learn some background information on why business planning is important. Then, you will learn how to write a trading business plan step-by-step so you can create your plan today.
Download our Ultimate Business Plan Template here >
What Is a Business Plan?
A business plan provides a snapshot of your trading company as it stands today, and lays out your growth plan for the next five years. It explains your business goals and your strategies for reaching them. It also includes market research to support your plans.
Why You Need a Business Plan
If you’re looking to start a trading company or grow your existing company, you need a business plan. A business plan will help you raise funding, if needed, and plan out the growth of your trading business to improve your chances of success. Your business plan is a living document that should be updated annually as your company grows and changes.
Sources of Funding for Trading Companies
With regards to funding, the main sources of funding for a trading company are personal savings, credit cards, bank loans, and angel investors. When it comes to bank loans, banks will want to review your plan and gain confidence that you will be able to repay your loan and interest. To acquire this confidence, the loan officer will not only want to ensure that your financials are reasonable, but they will also want to see a professional plan. Such a plan will give them the confidence that you can successfully and professionally operate a business. Personal savings and bank loans are the most common funding paths for trading companies.
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How to write a business plan for a trading company.
If you want to start a trading business or expand your current one, you need a business plan. The guide below details the necessary information for how to write each essential component of your trading business plan.
Your executive summary provides an introduction to your trading business plan, but it is normally the last section you write because it provides a summary of each key section of your plan.
The goal of your executive summary is to quickly engage the reader. Explain to them the kind of trading company you are running and the status. For example, are you a startup, do you have a trading business that you would like to grow, or are you operating a chain of trading companies?
Next, provide an overview of each of the subsequent sections of your plan.
- Give a brief overview of the trading industry.
- Discuss the type of trading business you are operating.
- Detail your direct competitors. Give an overview of your target customers.
- Provide a snapshot of your marketing strategy. Identify the key members of your team.
- Offer an overview of your financial plan.
In your company overview, you will detail what type of trading business you are operating.
For example, you might specialize in one of the following types of trading businesses:
- Retail trading business: This type of business sells merchandise directly to consumers.
- Wholesale trading business: This type of business sells merchandise to other businesses.
- General merchandise trading business: This type of business sells a wide variety of products.
- Specialized trading business: This type of business sells one specific type of product.
In addition to explaining the type of trading business you will operate, the company overview needs to provide background on the business.
Include answers to questions such as:
- When and why did you start the business?
- What milestones have you achieved to date? Milestones could include the number of customers served, the number of products sold, and reaching $X amount in revenue, etc.
- Your legal business Are you incorporated as an S-Corp? An LLC? A sole proprietorship? Explain your legal structure here.
In your industry or market analysis, you need to provide an overview of the trading industry.
While this may seem unnecessary, it serves multiple purposes.
First, researching the trading industry educates you. It helps you understand the market in which you are operating.
Secondly, market research can improve your marketing strategy, particularly if your analysis identifies market trends.
The third reason is to prove to readers that you are an expert in your industry. By conducting the research and presenting it in your plan, you achieve just that.
The following questions should be answered in the industry analysis section:
- How big is the trading industry (in dollars)?
- Is the market declining or increasing?
- Who are the key competitors in the market?
- Who are the key suppliers in the market?
- What trends are affecting the industry?
- What is the industry’s growth forecast over the next 5 – 10 years?
- What is the relevant market size? That is, how big is the potential target market for your trading business? You can extrapolate such a figure by assessing the size of the market in the entire country and then applying that figure to your local population.
The customer analysis section must detail the customers you serve and/or expect to serve.
The following are examples of customer segments: individuals, schools, families, and corporations.
As you can imagine, the customer segment(s) you choose will have a great impact on the type of trading business you operate. Clearly, individuals would respond to different marketing promotions than corporations, for example.
Try to break out your target customers in terms of their demographic and psychographic profiles. With regards to demographics, including a discussion of the ages, genders, locations, and income levels of the potential customers you seek to serve.
Psychographic profiles explain the wants and needs of your target customers. The more you can recognize and define these needs, the better you will do in attracting and retaining your customers.
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Your competitive analysis should identify the indirect and direct competitors your business faces and then focus on the latter.
Direct competitors are other trading businesses.
Indirect competitors are other options that customers have to purchase from that aren’t directly competing with your product or service. This includes other types of retailers or wholesalers, re-sellers, and dropshippers. You need to mention such competition as well.
For each such competitor, provide an overview of their business and document their strengths and weaknesses. Unless you once worked at your competitors’ businesses, it will be impossible to know everything about them. But you should be able to find out key things about them such as
- What types of customers do they serve?
- What type of trading business are they?
- What is their pricing (premium, low, etc.)?
- What are they good at?
- What are their weaknesses?
With regards to the last two questions, think about your answers from the customers’ perspective. And don’t be afraid to ask your competitors’ customers what they like most and least about them.
The final part of your competitive analysis section is to document your areas of competitive advantage. For example:
- Will you make it easier for customers to acquire your product or service?
- Will you offer products or services that your competition doesn’t?
- Will you provide better customer service?
- Will you offer better pricing?
Think about ways you will outperform your competition and document them in this section of your plan.
Traditionally, a marketing plan includes the four P’s: Product, Price, Place, and Promotion. For a trading company, your marketing strategy should include the following:
Product : In the product section, you should reiterate the type of trading company that you documented in your company overview. Then, detail the specific products or services you will be offering. For example, will you sell jewelry, clothing, or household goods?
Price : Document the prices you will offer and how they compare to your competitors. Essentially in the product and price sub-sections of your plan, you are presenting the products and/or services you offer and their prices.
Place : Place refers to the site of your trading company. Document where your company is situated and mention how the site will impact your success. For example, is your trading business located in a busy retail district, a business district, a standalone facility, or purely online? Discuss how your site might be the ideal location for your customers.
Promotions : The final part of your trading marketing plan is where you will document how you will drive potential customers to your location(s). The following are some promotional methods you might consider:
- Advertise in local papers, radio stations and/or magazines
- Reach out to websites
- Distribute flyers
- Engage in email marketing
- Advertise on social media platforms
- Improve the SEO (search engine optimization) on your website for targeted keywords
While the earlier sections of your plan explained your goals, your operations plan describes how you will meet them. Your operations plan should have two distinct sections as follows.
Everyday short-term processes include all of the tasks involved in running your trading business, including answering calls, scheduling shipments, ordering inventory, and collecting payments, etc.
Long-term goals are the milestones you hope to achieve. These could include the dates when you expect to acquire your Xth customer, or when you hope to reach $X in revenue. It could also be when you expect to expand your trading business to a new city.
To demonstrate your trading business’ potential to succeed, a strong management team is essential. Highlight your key players’ backgrounds, emphasizing those skills and experiences that prove their ability to grow a company.
Ideally, you and/or your team members have direct experience in managing trading businesses. If so, highlight this experience and expertise. But also highlight any experience that you think will help your business succeed.
If your team is lacking, consider assembling an advisory board. An advisory board would include 2 to 8 individuals who would act as mentors to your business. They would help answer questions and provide strategic guidance. If needed, look for advisory board members with experience in managing a trading business.
Your financial plan should include your 5-year financial statement broken out both monthly or quarterly for the first year and then annually. Your financial statements include your income statement, balance sheet, and cash flow statements.
An income statement is more commonly called a Profit and Loss statement or P&L. It shows your revenue and then subtracts your costs to show whether you turned a profit or not.
In developing your income statement, you need to devise assumptions. For example, will you charge per item or per pound and will you offer discounts for bulk orders? And will sales grow by 2% or 10% per year? As you can imagine, your choice of assumptions will greatly impact the financial forecasts for your business. As much as possible, conduct research to try to root your assumptions in reality.
Balance sheets show your assets and liabilities. While balance sheets can include much information, try to simplify them to the key items you need to know about. For instance, if you spend $50,000 on building out your trading business, this will not give you immediate profits. Rather it is an asset that will hopefully help you generate profits for years to come. Likewise, if a lender writes you a check for $50,000, you don’t need to pay it back immediately. Rather, that is a liability you will pay back over time.
Cash Flow Statement
Your cash flow statement will help determine how much money you need to start or grow your business, and ensure you never run out of money. What most entrepreneurs and traders don’t realize is that you can turn a profit but run out of money and go bankrupt.
When creating your Income Statement and Balance Sheets be sure to include several of the key costs needed in starting or growing a trading business:
- Cost of equipment and supplies
- Payroll or salaries paid to staff
- Business insurance
- Other start-up expenses (if you’re a new business) like legal expenses, permits, computer software, and equipment
Attach your full financial projections in the appendix of your plan along with any supporting documents that make your plan more compelling. For example, you might include your facility location lease or a list of your suppliers.
Writing a business plan for your trading business is a worthwhile endeavor. If you follow the template above, by the time you are done, you will truly be an expert. You will understand the trading industry, your competition, and your customers. You will develop a marketing strategy and will understand what it takes to launch and grow a successful trading business.
Trading Business Plan Template FAQs
What is the easiest way to complete my trading business plan.
Growthink's Ultimate Business Plan Template allows you to quickly and easily write your trading business plan.
How Do You Start a Trading Business?
Starting a trading business is easy with these 14 steps:
- Choose the Name for Your Trading Business
- Create Your Trading Business Plan (use a trading business plan template or a forex trading plan template)
- Choose the Legal Structure for Your Trading Business
- Secure Startup Funding for Trading Business (If Needed)
- Secure a Location for Your Business
- Register Your Trading Business with the IRS
- Open a Business Bank Account
- Get a Business Credit Card
- Get the Required Business Licenses and Permits
- Get Business Insurance for Your Trading Business
- Buy or Lease the Right Trading Business Equipment
- Develop Your Trading Business Marketing Materials
- Purchase and Setup the Software Needed to Run Your Trading Business
- Open for Business
What is a Trading Business?
There are several types of trading businesses:
- Retail trading business- sells merchandise directly to consumers
- Wholesale trading business- sells merchandise to other businesses
- General merchandise trading business- sells a wide variety of products
- Specialized trading business- sells one specific type of product
OR, Let Us Develop Your Plan For You
Since 1999, Growthink has developed business plans for thousands of companies who have gone on to achieve tremendous success.
Click here to see how Growthink’s business plan advisors can give you a winning business plan.
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5 steps to develop an options trading plan
If you are a beginner or an experienced options trader, here is a guide that can help you—regardless of your trading proficiency. Find links to strategies and powerful tools to discover your next step.
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Having a Trading Plan: Treat Your Trading Like It’s a Business
Learn how to approach your trading like a business with these five essential components.
- Know the five components that should be part of any trading plan
- When creating a trading plan, make sure it aligns with your financial goals
- Having a trading plan and following it can help you avoid making emotional financial decisions
As Benjamin Franklin wisely said in the 1700s, “By failing to prepare, you are preparing to fail.”
Fast-forward to 2021 and apply this to your trading or investing approach. How much have you prepared?
Any small business owner knows a business plan is essential. No bank is likely to give you a loan without a business plan. The goal of trading is to potentially grow your wealth, similar to that of a small business investment. So, if you haven’t taken the time to write a trading plan, carve out some time this weekend. By the way, this is something you can share with your partner.
(Hint: Good communication with your significant other about trading plans can help keep everyone on board with the approach, desired goals, and time investment needed for successful trading.)
Five Essential Components of a Trading Plan
Set specific financial goals. Write down your specific objectives, but try to dig deeper than simply “saving for retirement.” This could be a dollar amount within a specific time frame. For example maybe you want to make a profit of $1,000 a month from your trading. Or it could be a specific percentage gain you want to see in your portfolio within a specific time period. The financial decisions you make should align with your objectives.
Determine your buy criteria. This could take weeks or months to refine and could evolve over time as market environments change. Spend time studying, learning, and developing an approach that works for you. Do you buy stocks based on fundamental or technical analysis, or a little of both? Are you a fundamental stock picker, but like to use charts to fine-tune entry points?
- Write down a specific fundamental criteria to look for in a stock. This could include P/E ratio, annual earnings increases, or rising dividends. It’s a good idea to know earnings and dividend dates ahead of time.
- What indicators do you use and what signals do you need for confirmation? Do you want to follow trends, or do you want to invest in specific asset classes? Develop a plan and paper trade it. Once you’re comfortable, write it down and adhere to it. This is an important step because you’re looking to get the necessary information that can help you make your investing decisions.
Know when to sell. One of the cardinal rules of successful trading is knowing where to exit before getting in to a trade . If the market starts moving against you, you should be prepared to take your losses and exit your position. So, it’s important to plan your exits. If you’re a technical trader, you could use potential resistance levels from long-term charts (think weekly or monthly) or chart pattern targets such as a break in a head and shoulders neckline. Make a plan for exiting profitable and losing trades, write it down, and automate an exit point. You could include the following:
- Stop orders. Sometimes markets can move against you by quite a bit. Placing a stop order at the time you place your entry can help protect your positions. Where you place the stop is related to how much you’re willing to lose on a trade. It could be a percentage or dollar amount. It’s a personal choice and could involve analyzing past price moves to find what works best for your comfort level.
- Trailing stop orders. These are a type of stop order that dynamically follows market prices and can be used to protect long and short open positions. For a long position, a trailing stop can be set at any value below market price, and for short positions, a buy-to-close order can be placed above market price. For example, say you want to buy a stock at $25 per share and would like to protect it with a trailing stop. You could place a trailing stop order of $2, which means the stop order will rise as the stock price rises, but if the stock price falls $2, the stop order becomes a market order to close the position.
Stop market orders do not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.
Plan for tomorrow by setting financial goals today.
Identify your trading or investing time frame. Determine your trading time frame. Are you a short-term swing trader, looking for two- to three-day opportunities, or do you want to hold positions for multi-month moves? Maybe you do both, i.e., have some longer-term investments and some that are shorter term. Write it down.
Develop a risk management plan. Trading is about taking risks, so it goes without saying that risk management is very important to successful trading and investing. Consider setting specific risk parameters that you’re comfortable with, such as when to protect your capital, when to take profits, and the size of your positions. Remember: You’re operating in an uncertain environment, which means you’re likely to have losses. The key is to minimize those losses, and that means you should be ready to take action when necessary. There are different ways to manage risk. Here are a few examples.
- Some traders look for a risk/reward ratio of about 1:3, which means they’re willing to risk $1 to potentially earn $3.
- Some traders follow the so-called 2% rule, which means they’ll never risk more than 2% of an entire portfolio in one trade.
- Some traders allocate specific percentages of their portfolio to different assets for better diversification.
How to Measure Trading Success
When it comes to trading, hard work can pay off. What’s work when it comes to trading? Keeping a trading journal and reviewing trades on a weekly or monthly basis can be helpful. Write down the five essential components of a trading plan and compare your trades against them. What went right? What went wrong? Did you risk too much? Are you following your trading plan, or did emotional trading take over? A review process can help keep you accountable and allow for adjustments as needed to help you pursue your goals and approach trading like a business.
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The Ultimate Trading Plan Template
A proper Trading Plan is essential to your success as a trader.
Anyone thinking of starting a business wouldn’t begin without a plan, if they do, they probably won’t like the end results. Day trading is no different than any other business.
As they say, “If you fail to plan, then you’ve already planned to fail.”
You’re about to learn the same process I’ve used for the past 20 years. It’s also what I currently teach our students.
After completing this post, you should be confident in your ability to write a rock solid trading plan. To speed up the process, I provided a link to our Trading Plan template at the end.
Let’s get into it…
What is a Trading Plan?
A Trading Plan defines a trader’s goals, expectations, routines, risk management, and trading strategies. A successful plan will include the logic underlying the strategies and processes a trader deploys.
Elite traders already know they have won the game before placing a single trade for two reasons.
First, they have a well defined edge that’s repeatable.
The primary goal of your trade plan is to precisely define your processes and strategies, with the end of goal of creating a repeatable process.
Second, elite traders fully understand there is a random distribution between wins and losses for any given set of variables that define an edge , resulting in flawless execution.
First, you need to focus on developing your process. You will work on developing the mindset of winning trader and the ability to think in probabilities (versus P&L) when you begin backtesting and simulated trading.
A simple google search and you will find endless styles and formats for trade plans.
For me, my plan acts as the CEO of my business. defining the big picture items such as rules, processes, routines, analytics, theories and goals.
A lot of traders include their trading strategies in their trade plan, but I prefer defining them in a separate Playbook. I do this for several reasons…
First, I’ve been trading for over two decades, in that time I’ve developed and traded a lot of different strategies.
I’ve always found it beneficial to have all my strategies broken down individually. This becomes extremely valuable as you get more into strategy development.
A lot of the strategies I’ve built were a result of combining the different tools, theories and processes from other strategies I’d previously traded in my career.
Second, I think a Trade Plan that focuses solely on the macro level picture will help you in your review.
When I began my career I was surrounded by elite traders every day. My mentor and the owner’s of the firm kept me in line and made sure I was following their processes. If I was trading poorly, they held me accountable.
If you haven’t already chosen someone as an accountability partner, it should be the first thing you do after reading this post.
Your trade plan will be shared with your Accountability Partner in order to review your progress.
Your playbook will be used in strategy development and shared with your peers for trade review.
Obviously your accountability partner can play both roles if they have a trading background.
However, it’s more important your accountability partner is someone your close to that is committed to helping you achieve goals.
A good accountability partner will call you out and question you when you’re not following your rules, and due to your respect for the individual it should sting a little.
For the remainder of this post we’re going to focus solely on your trade plan.
Once you’ve completed your plan, I have you covered on your playbook as well. (link to Playbook Guide at the end)
Why You Need a Trading Plan
Good trading should be effortless. The preparation is where the hard work comes.
Imagine two runners, on one hand someone completely out of shape trying to run 1 mile in 10 minutes versus a world-class runner. The process looks effortless for the world-class runner, and it is. They put all of the hard work into their preparation, resulting in a process that is effortless.
Your Trade Plan and Playbook are part of your preparation.
The objectivity and clarity that a solid plan provides is essential in a market that requires split second decision making to capitalize on opportunities.
It will empower you to trade objectively, with confidence and less emotional involvement.
Let’s take a look at some categories you will want to include in your plan.
Trading Plan Outline
This outline is a strong base to get you started. You can use this plan for all markets, including Stocks, Forex, Futures, Options, and/or Crypto.
Remember, there’s no formal rules so get creative!
1. Premarket Routine
Developing routines in our lives helps us to stay on track and reach goals.
By analyzing our current routines and making adjustments, we’re able to form new habits. A skill that is rewarded in this business.
Here’s a great video on the importance of simple routines, especially when starting your day.
Try it, what do you have to lose?
Outline the tasks you will perform prior to trading each day.
Examples: -Read trading plan -Review a personal journal entry twice a week and reflect -Read prior day’s trade journal -Review prior day’s trades -Check economic numbers -Read playbook -Mirror reflection -Pre-market Analysis
Visualization and Mantras are great tools to include in your morning routines.
Examples: -Visualize yourself taking a trade and going through all the steps outlined in your Playbook -I accept that I have no idea what the outcome of any individual trade will be -I accept that today could be a negative day -I accept the loss of my next trade financially -I accept I will get stopped out on trades that reverse and rip in the direction of the setup
3. Hard Rules
You want to get very specific with some macro rules for your trading business. They should be reviewed with your accountability partner on a monthly basis at minimum. I recommend meeting weekly or daily if you’re a new trader or not yet profitable.
Examples: -3 losing trades switch to SIM remainder of session -Take a random trade, switch to SIM remainder of session -Two max loss days back to back, SIM for remainder of week -No trading outside RTH
4. Risk Management
You don’t need to over complicate your risk management. Below is what I recommend to my students.
Example: -1% max per trade -3% max per day -5% max per week -15% max per month -Adjust trade size on Monday mornings
IMPORTANT! You should never trade real money until you have proven your ability to be profitable on a simulated account!
I promise, if you can’t make money on a simulated account, you won’t do it on a live account.
Don’t start trading a live account until you’ve proven you have acquired the necessary skills to make money on SIM.
5. Aftermarket Routine
All traders make mistakes. The question is whether or not you will analyze those mistakes to learn from them?
When the trade day ends, you still have work to do.
You should do some journaling and reflection on your execution for the day.
Keeping a trade journal of all your trades as well as grading every trade is essential for growth. Make sure to take screenshots of your trades as well so you can go back and review them.
Here’s a few more examples: -Complete Scorecard for ever trade taken that day -Complete journal entry discussing market conditions for the day and reviewing your execution -Input trades into spreadsheet or whatever you’re using for analytics -Meditate -Workout
Trading can be emotionally challenging at times. There’s not many professions where you go to work and perform your best yet at the end of the day you leave with less money than you started.
Keeping mentally fit is imperative in this business. It’s important you incorporate some stress relieving activities, such as meditating or working out, into your aftermarket routine.
6. Weekend Routine
On Sunday evenings I have a routine to prepare myself for the upcoming week.
-Read trade journal entries from the past week -Review trades from the past week -Check sizing -Goals for upcoming week -Meet with Accountability Partner
7. Monthly Routine
On a monthly basis you should perform a thorough analysis on your trading business.
Examine your processes and trading analytics, looking where you can improve.
Examples: -Review trade analytics and make adjustments to strategies -Backup everything -Check risk management and sizing -Write main goals for upcoming month
The markets are always changing and presenting new opportunities as well as challenges. Even after 20 years, I still find myself learning new things.
Reflecting on why you started trading in the first place is important. Don’t ever lose sight of your goals.
Keep track of your goals and achievements in your trade plan as you progress as a trader. You will find it encouraging as you start to see your progress.
Examples: -Zero random trades for a week -Average trade score of X for the month -First chop comma ($1,000 net day)
While I think all these categories should be included in your own plan, remember to get creative and include anything you feel could potentially improve your trading.
Maybe include some pictures to motivate you.
Free Trade Plan Template (Download)
I created a template in Google Sheets with the categories and examples covered in this post to get you started on your trade plan.
If you would like the template and some other cool trading tools, become a JT Insider. It’s free.
I also recommend you check out this guide “How to Become A Day Trader – (Here’s how I did it…)”. I share with you how I overcame my trading failures by developing an Objective Edge.
Whenever a student comes to me struggling, I ask them for their trade plan. The struggles typically lead back to a rule or set of rules they have outlined in their Trade Plan that they’re consistently breaking.
It’s an essential tool when reviewing your trading with your accountability partner. Remember to select someone close to you must be completely transparent with them or you’re only cheating yourself.
Don’t make trading more difficult than it already is. Write a solid plan and work on having the discipline to follow it.
Anything not mentioned you like to include in your plan? Leave a comment below!
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Options Trading As A Business
Options Trading As A Business The Turnkey System for Explosive Option Profits
My new online video and book course Options Trading As A Business , is an inside look at how I evaluate each and every trade.
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Options Trading As A Business is really more like a franchise than a trading course. Of course, the price is much lower. And there are no royalty fees. But, since I give you my secrets to success, I think your probability of success should be similar.
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Quantified Stock Market Trading Strategies & Systems
How to Create a Business Plan for Your Trading
September 23, 2009 by Austin Passamonte
“Plan your trade and trade your plan” “Treat trading as a serious business” “Bulls win, Bears win, Hogs lose”
How many times have we heard/read those words, or something to their effect? Trading can be as unstructured and wide-open a venture or a structured and quantified approach as we dictate conditions and parameters for.
There are two general schools of thought when it comes to operating a trading method or approach. One side believes we should trade every minute of every day, trying to maximize all potential profit opportunity without missing a beat. Another side believes it is prudent to target specific goals and if hit, bridle back or shut down for the duration until next period arrives. In other words for intraday traders, trade all day every day or trade for x-dollar profit and call it a day until next session.
That’s a two-side discussion which will never find everyone in agreement. Common logic (coupled with human greed) points to the fact that some sessions or periods offer outsized profit potential. It’d be foolish to quit early and pass up large gains when presented. The competitive nature ingrained in most gamblers (gamers = game) who are likewise successful traders scoff at the notion of walking away while cards remain on the proverbial table. Anyone who has traded through periods of high volatility and extreme price action for days or weeks at a time can attest how easy it is to amass weeks’ or months’ worth of gross profit in rapid fashion there. Then there is the aspect of judging trader performance based on potential profit opportunity. If a session or stretch of time offers x-percent profit potential, a trader would be successful only if he/she realized y-booked gains.
All true to various extents. But no trading career is ever based on extreme market conditions. High volatility and large-range sessions are a welcome gift when presented. A brief, welcomed gift. Unfortunately, that end of the bell-curve measuring “normal” price action is no more common than dull periods with tight-range choppy price action as well. Results realized through any extended periods of time include brief blips of wild markets and huge profit potential, what we’d consider normal market movement as the bulk of time and likewise dull market action to offset the wild times before.
What if we opted to construct a business plan based on steady, consistent performance objectives that are reasonable to meet on a regular basis? Instead of grading our performance relative to max potential gains every day, what if we graded performance on achieving reasonable goals averaged consistently over extended periods of time?
As an example, here’s a business-plan objective created for one trading application of my own. Let’s look at that and see if any benefits exist:
ES Trading Business Plan
Trading S&P 500 futures (ES) based on (your choice) method approach with management objective of realizing (your choice) gross profit per session. Trader’s option to continue trade efforts that day if conditions warrant OR shut down with profit objective goals successfully met. Regardless of how or why, cease all trading efforts if/when max loss intraday of (your choice) is hit.
+4pts ES gross gains (example) targeted daily. -8pts ES gross loss (example) max loss shutdown.
$5,000 beginning balance = two ES contracts per full-trade size position 1/2 size = one ES contract full size = two ES contracts 2x size = four contracts
Projections: 100% Objective Attained
ES +4pts daily x 21 trading sessions (on average) per month | +84pts ES per month +4pts x two contracts full position | +$400 daily gross gain +$400 daily gross gain x 21 trading sessions | +$8,400 monthly gross gain (+168% monthly = +2,016% annualized r.o.i)
50% Objective Attained
ES +2pts daily x 21 trading sessions (on average) per month | +42pts ES per month +2pts x two contracts full position | +$200 daily gross gain +$200 daily gross gain x 21 trading sessions | +$4,200 monthly gross gain (+84% monthly = +1,008% annualized r.o.i.)
25% Objective Attained
ES +1pt daily x 21 trading sessions (on average) per month | +21pts ES per month (+42% monthly = +504% annualized r.o.i.) +1pt x two contracts full position | +$100 daily gross gain +$100 daily gross gain x 21 trading sessions | +$2,100 monthly gross gain
In my opinion it’s unrealistic to think that anyone can frequently and consistently capture large percentages of intraday potential profits. Needless to say, just about everyone has toyed with a progressive table at one time or another and pondered possibilities. Start with a few dollars, compound that for awhile and sooner than later we’re talking gazillionaire. How much fun that would be. But that isn’t the true strengths of a progressive table as demonstrated above.
What if we held ourselves accountable to the concept of steady, consistent performance unattached to market behavior? In other words, if we manage to accomplish even 25% of that stated objective on a yearly basis, would that alone be considered a success? If so, would it make sense to judge our individual performance against any other measure? Too many times a trader will be their own worst boss when it comes to judging performance. Holding oneself accountable to unreasonable standards only leads to one end: mental self-destruction. You’ll literally drive yourself insane trying to achieve goals set outside of reasonable reach.
On the other hand, if we can visually see that small to modest incremental growth does lead to potential results acceptable enough in the end, that can serve as a guideline of measure to keep us grounded. Considering the very top-rated futures CTAs manage to attain roughly 200% annual returns, is it reasonable to believe anything similar regardless of initial start-up capital is equally admirable? Retail traders who begin with $5,000 and end with $25,000 total without compounding at year’s end accomplished the exact-same mathematical feat as professional CTAs who began with $500,000 and ended with $2.5 million. The sole difference is perception… aka “spendable” dollars in the end. There may be slight to vast differences when in comes to emotional management with small accounts versus large, but the science or math goes unchanged.
Traders need some sort of measuring stick to follow as a guide for measuring performance and production. It cannot be ridiculously low or unreasonably high to achieve. The term “reasonable” always returns to mind. Basing some type of table on personal ability, potential from market(s) traded and other known variables are pulled together for comparative measure. That type of baseline gives us permission to target realistic goals rather than unrealistic or even unstructured goals of performance. Many traders desire while others eschew such business plans. In the end we’ll all end up somewhere. How we get there and why is up to each of us along the way.
Austin Passamonte is a full-time professional trader who specializes in all commodity markets. Mr. Passamonte’s trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. Click here to visit CoiledMarkets
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About Austin Passamonte
Austin Passamonte is a full-time professional trader who specializes in E-mini stock index futures and commodity markets. Mr. Passamonte’s trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. You can find more of Austin's work at his website CoiledMarkets .
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Trading as a Business: The Ultimate Guide
Options trading 101 - the ultimate beginners guide to options.
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There is one thing in common about successful traders, they manage their trading as a business.
This requires a level of seriousness and discipline that the average retail trader does not have.
This article will outline the importance of setting goals, understanding costs, and evaluating performance.
How Much Money Do I Need to Start Trading for A Living?
What are realistic levels of returns.
- What is My Realistic Level of Return?
- Picking The Right Brokerage
- Having The Right Data
- Miscellaneous Costs And Poor Execution
Know Your Competition
Who is the competition.
- If I Don’t Have A Trading Business, What Would I Do Instead?
Your Business May Fail
- Your Business May Succeed
Does It Make Sense to Trade?
When trading as a business there is one key metric we need to consider:
(Total Capital x Expected Returns) – Costs > Alternative Work Net Income
One of the most common questions people have is the minimum amount of capital one needs to start trading for a living. It is easy to open brokerages accounts with as little as a few hundred dollars.
Despite this it is impossible to generate enough returns to live on this account size for a day, let alone a year.
An account with $500 and a return of 100% annually, would still put an individual in extreme poverty in Somalia, let alone the United States.
Despite that with an account of $1,000,000 achieving a modest 10% annually provides 200 times the return of the smaller account making 100%.
This illustrates that while anyone can trade having access to capital makes trading as a business a lot more feasible.
A business that has a lot of capital but loses or fails to make money is not going anywhere.
If I buy hats for $50 and sell them for $40, I am a poor businessman. The same goes for trading.
Over 90% of investors fail to beat the index over long periods of time. While this may be discouraging, remember the same statistics are true for all entrepreneurs.
For every Shark Tank success story there are a hundred failed vegan fusion restaurants.
Trading, like entrepreneurship, has a lot of potential convexity, but it is not without its risk .
Taking average long run index returns of 7% can be a starting point.
If you are not confident in beating these returns the best decision for your business is passive investing and working another job.
This allows you to save while increasing your capital.
What Is My Realistic Level Of Return?
Establishing your own expected return is done by taking your investing performance and comparing that to a benchmark.
A long stock portfolio that went up by 20% may sound great until you realize that in the same year the index went up 30%.
To measure a realistic level of return one needs to have either a long track record or a clear understanding of the risks and rewards of your investments.
One of the biggest failures of individuals is underestimating how much luck goes into life let alone investing.
Simply because you got lucky and have had excess returns that does not mean you have any advantage in your investing method.
This is in the same way that a roulette player can win money but still have no edge over the casino.
Being able to state out clearly why you are generating the returns you are is an important part of managing expectations and defining risks.
The most dangerous trait of an investor is perceived skill.
A deceiving thing presented to new traders is that a workstation must be overly complicated.
A quick search for traders’ workstations will show pictures such as below.
Source: Investors Underground
Last time I checked the number of screens you have doesn’t have any correlation to how much money you make…
So why does everyone have all these screens?
You will notice the photos that come up are from the same guys flashing pictures of them sitting in a rented Lamborghini on their social media.
The goal from this “promoter” is to simply convince the investor that because of this complex set up they are smart. Have you been fooled?
As a caveat there are some professionals who need many screens though these are likely mainly market makers who are streaming multiple quotes and have an operator running them.
If you think you can compete in the high frequency game, think twice.
I will bet on the multimillion-dollar company with cables wired directly to the exchange before you in your parents’ basement anytime.
So, What Do You Need?
A laptop that works and is functional. Perhaps a second screen if you would like. A desk and a comfortable chair. That’s it!
The most important thing is you have a clean comfortable place away from distractions that can allow you to work efficiently.
Any additional expenses in your workstation are a cost that reduces the profitability of your business, so should be evaluated as such.
Simplicity is key.
The amazing thing about a simple set up is you can trade from almost anywhere.
Though I do not recommend bringing your workstation to a beach.
Source: The Lazy Investor
Picking the Right Brokerage
Choosing the right brokerage is another important decision in how you run your business. Commissions and transaction costs are part of the business, but the goal should be to have these as low as possible.
While a small commission of a few dollars may seem negligible, over the course of a year, it adds up.
This can flip a trading strategy from being profitable to one that loses money. While commissions should be kept as low as possible there is a caveat.
Picking a commission free broker may actually leave you worse off.
This is because the broker will simply sell your order flow.
Ironically, your resulting fill prices may be worse than simply paying the small commission in the first place.
If you don’t pay for the product, you are the product.
Another important thing for your broker to have is a professional reputation.
Asking yourself questions such as does this broker have frequent outages? What are the products and services offered that I could trade?
A few times an amazing trade comes up and one of my friends lacks permissions or the brokers ability to trade on that instrument.
That is an opportunity cost.
Overall choosing a brokerage with a complicated and unappealing user interface is often better than one with flashy bells and confetti.
To recommend a few choosing Interactive Brokers or TD Ameritrade are reasonable brokers while something like Robinhood should be avoided.
Though it is important for each investor to do their own due diligence to find the best broker for them based on their trading style and business.
Having the Right Data
Having access to data is another crucial part of your business.
Back before computers, investors would read the morning newspaper to get updates on their stocks.
Imagine the advantage if you could get access to the ticker tape at the exchange!
Nowadays a lot of the data has been democratized.
Hence getting things such as real time quotes and some analytics is generally available somewhere for free.
Nevertheless, it is often still subpar to paid data sources.
There is a reason why professionals pay over $30,000 for a Bloomberg terminal.
Hint…it’s not for the fancy keyboard!
Give a monkey a Bloomberg Terminal and it’s still a monkey.
Paying for data you gain no benefit from is like paying for a gym membership if you never go.
Added costs and reduced profitability of the business ensue.
Simple Conclusion. Pay for data if you cannot get it free if the added value exceeds its costs.
Miscellaneous Costs and Poor Execution
It would be nice to perform every investing decision perfectly as per a set out business plan. Unfortunately, in trading things get in the way.
Holding positions that didn’t work out to avoid a loss and changing variables to suit one’s emotional needs are a few examples of how a strategy can be poorly executed.
Even if one is diligent with their rules there is always the issue of fat fingered trades and mistakes.
These are purely unintentional, simply like a restaurant waitress spilling a drink. If most businesses have a section for accidental slippage, you should consider it to.
On a personal level it is always very annoying when these types of mistakes happen.
Yet by acknowledging they are part of the business and will happen in the future you may not be as hard on yourself, after all you are not a robot.
Trading is a competition not a test.
Gone are the days of a good job sticker for trying on top of your preschool art project.
The market does not care about fairness of profits, and it is unforgiving.
While this may seem unappealing it is no different than any other entrepreneurial business.
Imagine I want to sell custom made hats.
After selling a few to some friends, I placed an order for a thousand hats to be produced from a low-cost factory in China.
The hats arrived and it turns out I can’t sell them.
Everyone is already selling custom hats on Etsy and my friends were just pitying me by buying a few.
The money’s gone and all I have to show for it is a garage full of UV protection.
So, who is my competition?
Some of the world’s smartest people are involved in the financial markets.
They have access to better data and resources to you. Some might even have insider information.
They are sophisticated.
Often, they have degrees in mathematics or financial engineering.
They are faster than you.
They might work at market making firms such as Virtu or Susquehanna which make profit on almost 99% of all trading days.
If this sounds daunting, it should be.
Yet there are some distinct advantages you have in your retail business.
Firstly, while these firms have better tools, they also have more costs.
Data costs, insurance, Manhattan offices and six figure associate salaries to pay out.
These are substantial and can cause many funds to fail.
Another issue comes about because of their capital size.
Now you may be thinking, I thought you said the more capital the better right? Well, the irony is that capital can work as a double-edged sword.
Once funds grow large enough beating the market becomes increasingly difficult.
For example, a retail investor buying a hundred shares of Apple has virtually no market impact.
Contrast that to a fund buying a million shares, they are going to pay a price…
Now let’s imagine that the fund wants to buy the same amount of a small cap like Microvision.
Not going to happen.
The first slice of the pizza is always the best.
If I Don’t Have a Trading Business, what would I do Instead?
A key aspect of any successful trader is making the optimal decision with the highest positive expected value.
Naturally, even if one makes profits while trading it comes at an opportunity cost. That cost is time.
For a full-time trader, that time could be viewed as the potential earnings accrued in job one is qualified for.
That may be flipping Big Mac’s at McDonalds or as a top lawyer, it varies on your personal skills.
By taking one’s potential income, we can create a fair value for their time.
If trading will learn less than that value, then maybe it’s important to keep your day job.
Obviously making the decision comes down to more than purely economic reasons.
Perhaps you would enjoy trading more than flipping burgers, I know I would.
Hence using a calculation like net utility would make more sense.
Taking the best decision for you can be unique.
Maybe you work a full-time job while trading on the side.
Perhaps you realize you do not want to take it that seriously but enjoy the thrill as a hobby.
It is all about making the best decision for you while considering all the alternatives.
In trading understanding variance is part of the game.
If you can’t deal with prolonged drawdowns, you are playing the wrong game.
There are freak events that happen that cause severe dislocation of prices. There are also long periods of time where strategies that should pay off simply do not work.
For example, if you invested in the Japanese stock market Nikkei in 1985 you would still be down today.
These events should be at best prepared for, although at the end of the day we must live so that they may happen, and our business could ultimately be unsuccessful.
No risk, no reward.
Your Business May Succeed
The amazing thing about the market is it does not care where you came from.
You could be a Harvard graduate, high school dropout, black, white, overweight, autistic, or a social reject.
None of these things have anything to do with being profitable in your trading business.
While the path is hard with the right resources, attitude, and the desire to continue to learn incredible things can happen.
One thing, no matter the journey, it will all be on your own terms.
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice . The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
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Great, well written article, Gavin!
This, and many other articles, in your web site show you are a real trader, sharing your real and valuable experience (just as important as your know how or more).
If I was a beginner I will not hesitate to take you as my mentor and reference point. It will save me years of learning curve and thousands of market tuition. I suppose in the following paragraph “learn” has to be replaced by “earn” (a minimal and insignificant typo): “If trading will learn less than that value, then maybe it’s important to keep your day job.” In a sea of delusional marketers, you are a rare pearl Warm regards.
Thanks, much appreciated.
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If you've been reading about investing during this time of historical volatility, you've probably heard of options trading.
Options are complex financial instruments which can yield big profits — or big losses. Here's what you need to know about how to trade options cautiously.
What is options trading?
Options trading is when you buy or sell an underlying asset at a pre-negotiated price by a certain future date.
Trading stock options can be complex — even more so than stock trading. When you buy a stock, you just decide how many shares you want, and your broker fills the order at the prevailing market price or a limit price you set. Options trading requires an understanding of advanced strategies, and the process for opening an options trading account includes a few more steps than opening a typical investment account.
» Is options trading better than stocks? Learn about the differences between stocks and options
In 2022, the stock market saw its share of highs and lows amid concerns about inflation, Russia's invasion of Ukraine and rising oil prices. When the market is volatile, options trading often increases, says Randy Frederick, managing director of trading and derivatives with the Schwab Center for Financial Research.
“You can use options to speculate and to gamble, but the reality is ... the best use of options is to protect your downside,” he says. "Options are one way to generate income when the markets aren’t going up.”
According to the Options Clearing Corporation, there were 939 million options contracts traded in March 2022, up 4.5% compared with March 2021. It was second-highest trading month on record.  OCC . OCC Total Volume for March 2022 Second Highest Month on Record, Up 4.4% Year-Over-Year . Accessed Apr 18, 2022. View all sources
» Need to back up a bit? Read our full explainer on what options are
How to trade options in four steps
1. open an options trading account.
Before you can start trading options, you’ll have to prove you know what you’re doing. Compared with opening a brokerage account for stock trading, opening an options trading account requires larger amounts of capital. And, given the complexity of predicting multiple moving parts, brokers need to know a bit more about a potential investor before giving them a permission slip to start trading options. Wendy Moyers, a certified financial planner at Chevy Chase Trust in Bethesda, Maryland, says people who know the market well, and have time to watch it, are better suited to options trading than busy, beginner investors.
"It’s definitely more complicated, and you have to be on top of it all throughout the trading day," she says.
Brokerage firms screen potential options traders to assess their trading experience, their understanding of the risks and their financial preparedness. These details will be documented in an options trading agreement used to request approval from your prospective broker.
» Ready to get started? See our list of the best brokers for options trading
You’ll need to provide your:
Investment objectives. This usually includes income, growth, capital preservation or speculation.
Trading experience. The broker will want to know your knowledge of investing, how long you’ve been trading stocks or options, how many trades you make per year and the size of your trades.
Personal financial information. Have on hand your liquid net worth (or investments easily sold for cash), annual income, total net worth and employment information.
The types of options you want to trade. For instance, calls, puts or spreads. And whether they are covered or naked. The seller or writer of options has an obligation to deliver the underlying stock if the option is exercised. If the writer also owns the underlying stock, the option position is covered. If the option position is left unprotected, it's naked.
Based on your answers, the broker typically assigns you an initial trading level based on the level of risk (typically 1 to 5, with 1 being the lowest risk and 5 being the highest). This is your key to placing certain types of options trades.
Screening should go both ways. The broker you choose to trade options with is your most important investing partner. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading.
» Need some help? Learn how to choose an options broker
2. Pick which options to buy or sell
As a refresher, a call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price — called the strike price — within a certain time period. (Learn all about call options .) A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract expires. (Learn all about put options. )
Which direction you expect the underlying stock to move determines what type of options contract you might take on:
If you think the stock price will move up: buy a call option, sell a put option.
If you think the stock price will stay stable: sell a call option or sell a put option.
If you think the stock price will go down: buy a put option, sell a call option.
Frederick says to think of options like an insurance policy: You don’t get car insurance hoping that you crash your car. You get car insurance because no matter how careful you are, sometimes crashes happen.
"You buy options hoping you don’t need them,” he says.
This is just a very basic overview. For a look at more advanced techniques, check out our options trading strategies guide .
3. Predict the option strike price
When buying an option, it remains valuable only if the stock price closes the option’s expiration period “in the money.” That means either above or below the strike price. (For call options, it’s above the strike; for put options, it’s below the strike.) You’ll want to buy an option with a strike price that reflects where you predict the stock will be during the option’s lifetime.
For example, if you think the share price of a company currently trading for $100 is going to rise to $120 by some future date, you’d buy a call option with a strike price less than $120 (ideally a strike price no higher than $120 minus the cost of the option, so that the option remains profitable at $120). If the stock does indeed rise above the strike price, your option is in the money.
Similarly, if you think the company’s share price is going to dip to $80, you’d buy a put option (giving you the right to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 plus the cost of the option, so that the option remains profitable at $80). If the stock drops below the strike price, your option is in the money.
You can’t choose just any strike price. Option quotes, technically called an option chain or matrix, contain a range of available strike prices. The increments between strike prices are standardized across the industry — for example, $1, $2.50, $5, $10 — and are based on the stock price.
The price you pay for an option, called the premium, has two components: intrinsic value and time value. Intrinsic value is the difference between the strike price and the share price, if the stock price is above the strike. Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, among other elements. For example, suppose you have a $100 call option while the stock costs $110. Let’s assume the option’s premium is $15. The intrinsic value is $10 ($110 minus $100), while time value is $5.
This leads us to the final choice you need to make before buying an options contract.
4. Determine the option time frame
Every options contract has an expiration period that indicates the last day you can exercise the option. Here, too, you can’t just pull a date out of thin air. Your choices are limited to the ones offered when you call up an option chain.
There are two styles of options, American and European, which differ depending on when the options contract can be exercised. Holders of an American option can exercise at any point up to the expiry date whereas holders of European options can only exercise on the day of expiry. Since American options offer more flexibility for the option buyer (and more risk for the option seller), they usually cost more than their European counterparts.
Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable. Longer expirations give the stock more time to move and time for your investment thesis to play out. As such, the longer the expiration period, the more expensive the option.
A longer expiration is also useful because the option can retain time value, even if the stock trades below the strike price. An option’s time value decays as expiration approaches, and options buyers don’t want to watch their purchased options decline in value, potentially expiring worthless if the stock finishes below the strike price. If a trade has gone against them, they can usually still sell any time value remaining on the option — and this is more likely if the option contract is longer.
Why trade options?
"The pros are you could make a little bit extra money on investing in the short term," Moyers says. "The con is you could lose everything, depending on how you structure your options trading."
Once you have learned the strategies and you're willing to put the time in, there are several upsides to options trading, Frederick says. For instance, you can use a covered call to help you generate income in a sideways market.
Frederick says most covered calls are sold out of the money, which generates income immediately. If the stock falls slightly, goes sideways, or rises slightly, the options will expire worthless with no further obligation, he says. If the stock rises and is above the strike price when the options expire, the stock will be called away at a profit in addition to the income gained when the options were sold.
» Ready to learn more? Read 5 basic options trading strategies
On a similar note...
by Dale Brethauer
December 7, 2017
By, Dale Brethauer
This will be a three-part series on developing a trading business plan. This is a principle that separates successful traders from the wanna-be overnight millionaires, that are really just gamblers at a casino, and the house always wins. However, with the right foundation and strategies in place you can become the house, I can show you how, lets get started.
Crucial Trading Principle The number one reason why small businesses fail is they don’t have a plan. They’ve got a good idea and they take it so far, but they don’t have a plan of where they’re going to go from that point on. You need to treat trading like a business and you need a business plan. You need to have rules. You need to follow the rules. That’s what we’re going to develop with your trading business plan. This is going to be an evergreen document. As you become more successful you might want to modify a couple of things.
I first presented this topic at the Trader’s Expo in Las Vegas in November of 2009. This was greatly appreciated by a lot of the people. I’ve taught it to my mentees over many years, and I have recently modified it to bring everything up to date for you people that are now listening.
One of the first things we will do is study losing traders. This was a study that came out of a book by Dr. Van Tharp. I attended one of Dr. Van Tharp’s seminars. It was a weeklong seminar. He taught me a lot about the psychology, about how to handle my ego, about how to look at realistic goals. I give him a lot of credit. He is the author of ‘Trade Your Way to Financial Freedom’. If you don’t have that book, I highly suggest you get a copy of it. You can go onto Amazon. It’s relatively inexpensive. It’s a fun read, and it’s just jam-packed with good information.
Dr. Van Tharp is not a trader per se. He’s a psychologist who works with traders and investors and helps them to become the best they can be. If we take a look at the list of losing traders and what they do, I don’t think you’ll be surprised. Take note, with your trading, do you have all these items?
Why Traders Lose
The trader has not set goals.
I think this is very common with a lot of new people that get into investing. They pick up a Wall Street Journal. They look at a chart. Of course, we always trade on the right-hand side of the chart where we don’t know what’s going to be happening in the future. It’s very easy to look at a chart in the middle and say, “Oh, I would have sold there”, or “I would have bought there”, and they just start. They have no goal in mind. They just want to make a lot of money. Well, what is the goal? You need a goal.
An excited prospective trader starts with a very small account and expects to quit their day job and become a millionaire trading the stock market...tomorrow. Very unrealistic expectations. You need to have realistic expectations. You need to be willing to put in the time and the effort in the beginning stages for it to become effortless later on. if this turns you off then your money is better used elsewhere.
There was a book written called ‘Outliers’ that talks about any professional needs to put in about 10,000 hours in their profession to become great. You wouldn’t expect to read a book on brain surgery over the weekend and perform your first surgery on Monday, but a lot of people go to the library or the bookstore or Amazon and pick up a book on stock market trading and read it over the weekend and say, “I got it. I’m going to trade for a living”.
You have to have realistic expectations. Unfortunately, a lot of people consider the stock market as a big casino. They have a need for action, and that kills them. You need to be patient. Don’t let the market trade you. You trade the market when you know you have an edge.
Poor Risk Management
The third reason for losing is exposure to too much risk. Too much money is allocated to any given trade. If it goes against them, they possibly jump out of the trade prematurely. If it goes with them, they’re too quick to take profits because they have so much invested. They’re exposing themselves to so much risk. There is so much anxiety. They jump and they’re quick to take profits and they let their losses run.
Lack of Confidence
The fourth reason is people have a lack of confidence and it stems from no plan, no system, no rules. I’m a professional. I’ve been doing this for 35+ years and I have losing trades. I have a string of losing trades, and it does not shake my confidence at all. I embrace them because that’s part of trading and those loses are already built into my models. Conversely, when I have a 5, 10, 15, winners in a row I do not think I'm god to the markets either.
Records and Back Testing
The fifth reason traders fail is because there are no rules in place and no records. Why did that trade go bad? Write it down. If those rules are back-tested, are paper traded and then are traded with real money and they work, those are the rules that you have to follow.
Lack of Strategy & Systems
The sixth and final reason traders lost is that they start without a strategy. No system in place that designates, prior to entering a trade, what the course of action is if its a loser, if its a winner, if its break even. What defines a trader is our ability to grab value so how will you do that when your emotions kick in during these trades. Emotionless, Planned, trading is the path to success.
Jack Schwager Got is Right Jack Schwager says in his book, ‘The Market Wizards’ - which is an exceptional book that you ought to pick up too - he interviews a lot of very successful traders, he says the number one reason that people lose is they don’t have a trading plan. Well, the next three webinars, that’s what I’m going to teach you. This is just a framework for you to go by. You can expand yours as much as possible. Now, in Schwager’s book, he says, “Trying to win in the markets without a trading plan is like trying to build a house without blueprints. Costly mistakes are inevitable. If you do have a plan, those mistakes are avoidable”. He goes on to say a trading plan simply requires combining a personal trading strategy with specific money management and trade entry and exit rules . Those are three very, very important elements.
Your Trading Business Plan | Overview
I’m going to go a little bit further with my trading plan. I’m going to look into all the reasons why traders lose and try to develop a strategy to get around the losing mentality. My trading plan, the elements are, you need to have goals. That knocks the first one reason for losing. Those goals need to be affirmations. You need to tell yourself. You need to write down what your goals are and how you’re going to obtain them. Reinforce that daily by saying them aloud. Make your grey matter believe what you’re doing.
Next you need to have realistic expectations. How much money do you really need from the market? What is your objective in being in the market? What are your realistic expectations? We don’t want to go to the casino. Casinos are all over nowadays. Just walk into a casino, put it on red and black and get your need for action out of the way.
The stock market is not a gambling house. Those who gamble lose. You don’t want to expose yourself to too much risk. Therefore, I’ve developed a number of rules to determine, for your given portfolio, what should be your maximum trade size to trade like a professional?
When you start doing these things and you start seeing your equity curve going up, your confidence is going to grow.
Next, you need rules. You need trading rules. They can be simple rules, but you need to have rules. A lot of these that I’m going to show you, it’s things that I have developed. Some of them I’ve changed the numbers and so forth, but I want to give you an example of how you might put this together.
You need to go on your own path and make sure that the trading business plan fits your trading needs. You need a strategy. What are you going to do? Are you going to buy when the stock is oversold? What does that mean? Are you going to sell when it’s overbought? What does that mean? When are you going to get out? You need trading strategies.
Then I’m going to show you how I structure my portfolio. My portfolio is mostly in stock and trading the S&P 500 ETF and also the RUT and some of the big indices. Then finally, we’re going to talk about the learning curve.
Start out with paper trading. When you’re making money paper trading, you’re ready to invest your hard-earned money.
Successful Trading Tactics | Overview
You can see that the trading business plan elements that I’ve defined here are aimed at attacking all the problems that losing traders have.
Part one: Goals and Affirmations, Most Losing Traders skip this step..
Goals and affirmations. I believe this is the beginning phase of what you need to further develop your strategies and how you’re going to tackle this. You need to know why you’re in the market, you need to have affirmations and you need to convince your grey matter that those affirmations will come to fruition.
Part two: Trading Strategies
Trading strategies, the trading rules and trade size to manage your money.
Part three: Portfolio Structure & System Deployment
Demonstrate how you should structure your portfolio as you grow and the very important learning curve.
Part 1: Goals & Affirmations
Let’s go ahead and talk about the goals and affirmations. For your goal, I want you to determine a specific monetary amount that you desire on a yearly basis. Think about your financial situation. Think about what would make a big change in your lifestyle for the better. Not “I want to hit the lottery” and who knows what you’re going to do with the winnings. I want you to think about the stock market as a vehicle to fulfill your goal, to benefit you financially.
I want you to be realistic. Here I’m just giving an example of saying, “Well, $5,000 a month would pay for my monthly expenses”. If that’s the case, that is a fantastic goal. That is something that is obtainable if you put the time and the effort into it.
Let’s say your goal is “I want to make $5,000 per month or $60,000 per year in the stock market”. Realizing that it’s not going to be a straight line up, you’re not going to be able to say “At the end of this month I made $5,000 I’ll put it in the bank. Then the next month I’m making…” No. You’re going to have an equity curve that is going to go up and down. Sometimes you’ll make more than your goal, sometimes you’ll bank less than that.
You want an equity curve that goes up nice and smooth so that on average you can pull out some money to help you in your financial situation. Make this a realistic goal. Take time. Think about it. Talk to your significant other. What makes sense? What would really help you? Be in this together. Set down a specific monetary goal.
For the time being, don’t worry about how much you have and how you’re going to do that. What I want you to do is determine the ultimate goal that will make you financially free. Once you have that goal in mind, I want you to write it down on paper. Then I want you to write a focused affirmation based on where you’re at today.
Now, let’s say you’ve only got a $30,000 portfolio or any amount that you have. Remember, we want to make $60,000 a year. Well, how are you going to do that on just a $30,000 portfolio? You’re not going to double your money year after year after year. That’s unrealistic. This is not going to happen. Let’s get realistic.
Your affirmation might be, “I will be a consistently successful trader”. Well, that’s all well and good, but how? How are you going to do that? Better to say “I’m going to have a goal of $1,500 per month. Now, I’m going to use that to build up my portfolio to the point where I can consistently make $5,000”.
You’ll be able to put a curve together and that’s going to be about 10 years. At that time it’s going to require this amount of money for my portfolio. Now you have a long-term goal. It’s a realistic goal. It’s not going to happen overnight. I’m going to learn as I’m going through here. I’m going to give myself time to reach my ultimate goal. How am I going to do that? I’m going to trade the SPX indices and I’m going to do directional credit spreads. Okay.
Now let’s look at this affirmation. This affirmation says that you’re going to be consistently successful. This is your immediate goal, realizing you’re not going to make that every month. You’re going to slowly build your account, and you’re in no hurry because you’re learning, you’re building and ultimately this is where you want to go. You’ve got time to do that. These are the two vehicles you’re going to use to get there.
Now, you have an affirmation that is tied to your goal that you can now tell yourself. I want you to write this down. I’ve been doing this for many years, and I change on a regular basis. I started many years ago, and I’ve got so many iterations of my goal because my goal has changed over the years. You want it to be evergreen.
There are other things that I’ve completely missed on my affirmation. But, in retrospect it’s better that I had them because they absolutely had an adjacent impact on my success.
Think of your affirmations as an evergreen document. Make sure it’s realistic. Write it down. Say it to yourself. Make your grey matter remember it, and you’ll be well on your way to being a success in the stock market. Those are the first two elements of your trading business plan. What is your goal? What are your affirmations?
That’s part one of my trading business plan webinar. I look forward to continuing this in part two. Part two, we’re going to be talking about trading strategies and the rules around those trading strategies. That’s a very important portion. It’s a continuation of this base that we’re developing here on part one.
If you have any questions please go to the website, click on contact in the upper right hand corner, and send us a message.
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What Is a Stock Option?
- How It Works
Trading Stock Options
Employee stock options.
- Calculate the Value
- Exercise Stock Options
Stock Options and Taxes
Types of stock option plans.
- Stock Option FAQs
The Bottom Line
- Options and Derivatives
Strategy & Education
What Are Stock Options? Parameters and Trading, With Examples
James Chen, CMT is an expert trader, investment adviser, and global market strategist.
Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).
Investopedia / Nez Riaz
A stock option (also known as an equity option ), gives an investor the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date. There are two types of options: puts , which is a bet that a stock will fall, or calls , which is a bet that a stock will rise.
Because it has shares of stock (or a stock index) as its underlying asset, stock options are a form of equity derivative and may be called equity options.
Employee stock options (ESOs) are a type of equity compensation given by companies to some employees or executives that effectively amount to call options. These differ from listed equity options on stocks that trade in the market, as they are restricted to a particular corporation issuing them to their own employees.
- Stock options give a trader the right, but not the obligation, to buy or sell shares of a certain stock at an agreed-upon price and date.
- Stock options are a common form of equity derivative.
- One equity options contract generally represents 100 shares of the underlying stock.
- There are two primary types of options contracts: calls and puts.
- Employee stock options (ESOs) are when a company effectively grants call options to certain employees as compensation.
Understanding Stock Options
Options are a type of financial instrument known as a derivative . This means their worth is based on, or derived from, the value of an underlying security or asset. In the case of stock options, that asset is shares of a company's stock. The option is a contract that creates an agreement between two parties to have the option to sell or buy the stock at some point in the future at a specified price. The price is known as the strike price or exercise price. Stock options come in two basic forms:
- Call options afford the holder the right, but not the obligation, to buy the asset at a stated price within a specific timeframe.
- Put options afford the holder the right, but not the obligation, to sell the asset at a stated price within a specific timeframe.
Therefore, if XYZ stock is trading at $100, a $120-strike call would become worthwhile to exercise (i.e., convert into shares at the strike price) only if the market price rises above $120. Or, an $80-strike put would be worthwhile if the shares drop below $80. At that point, both options would be said to be in-the-money (ITM), meaning that they have some intrinsic value (namely, the difference between the strike price and the market price). Otherwise, the options are out-of-the-money (OTM), and consist of extrinsic value (also known as time value). OTM options still have value since the underlying asset has some probability of moving into the money on or before the option expires. This probability is reflected in the option's price.
Equity options are derived from a single equity security. Investors and traders can use equity options to take a long or short position in a stock without actually buying or shorting the stock. This is advantageous because taking a position with options allows the investor/trader more leverage in that the amount of capital needed is much less than a similar outright long or short position on margin. Investors and traders can, therefore, profit more from a price movement in the underlying stock.
Exercising an option means using the option holder's right to convert the contract into shares at the strike price.
Stock Option Parameters
American vs. european styles.
There are two different styles of options: American and European . American options can be exercised at any time between the purchase and expiration date. European options, which are less common, can only be exercised on the expiration date.
Options contracts exist for only a certain period of time. This is known as the expiration date . Options listed with longer expiration dates will have more time value since there is a greater chance of an option becoming in-the-money the longer there is for the underlying stock to move around. Option expiration dates are set according to a fixed schedule (known as an options cycle ) and typically range from daily or weekly expirations to monthly and up to one year or more.
The strike price determines whether an option should be exercised. It is the price that a trader expects the stock to be above or below by the expiration date.
As an example, if a trader is betting that International Business Machine Corp. ( IBM ) will rise in the future, they might buy a call for a specific month and a particular strike price. For example, a trader is betting that IBM's stock will rise above $150 by the middle of January. They may then buy a January $150 call.
Contracts represent a specific number of underlying shares that a trader may be looking to buy. One contract is equal to 100 shares of the underlying stock.
Using the previous example, a trader decides to buy five call contracts. Now the trader would own five January $150 calls. If the stock rises above $150 by the expiration date, the trader would have the option to exercise or buy 500 shares of IBM’s stock at $150, regardless of the current stock price. If the stock is worth less than $150, the options will expire worthless , and the trader will lose the entire amount spent to buy the options, also known as the premium.
The premium is the price paid for an option, It is determined by taking the price of the call and multiplying it by the number of contracts bought, then multiplying it by 100.
In our example, if a trader buys five January IBM $150 Calls for $1 per contract, the trader would spend $500. However, if a trader wanted to bet the stock would fall they would buy the puts.
The volatility of the underlying security is a key concept in options pricing theory. In general, the greater the volatility, the higher the premium required for all options listed on that security.
Stock options are listed for trading on several exchanges, including the Chicago Board Options Exchange ( CBOE ), the Philadelphia Stock Exchange ( PHLX ), and the International Securities Exchange ( ISE ), among several others.
Options can be bought or sold depending on the strategy a trader is using. Continuing with the example above, if a trader thinks IBM shares are poised to rise, they can buy the call, or they can also choose to sell or write the put. In this case, the seller of the put would not pay a premium but would receive the premium. A seller of five IBM January $150 puts would receive $500.
Should the stock trade above $150, the option would expire worthless allowing the seller of the put to keep all of the premium. However, should the stock close below the strike price, the seller would have to buy the underlying stock at the strike price of $150. If that happens, it would create a loss of the premium and additional capital, since the trader now owns the stock at $150 per share, despite it trading at lower levels.
Another popular equity options technique is trading option spreads . Traders take combinations of long and short option positions, with different strike prices and expiration dates, for the purpose of extracting profit from the option premiums with minimal risk.
Example of Stock Options
In the example below, a trader believes Nvidia Corp’s ( NVDA ) stock is going to rise in the future to over $170. They decide to buy 10 January $170 calls which trade at a price of $16.10 per contract. It would result in the trader spending $16,100 to purchase the calls. However, for the trader to earn a profit, the stock would need to rise above the strike price and the cost of the calls, or $186.10. Should the stock not rise above $170, the options would expire worthless, and the trader would lose the entire premium.
Additionally, if the trader wants to bet that Nvidia will fall in the future, they could buy 10 January $120 Puts for $11.70 per contract. It would cost the trader a total of $11,700. For the trader to earn a profit the stock would need to fall below $108.30. Should the stock close above $120 the options would expire worthless, resulting in loss of the premium.
Companies sometimes grant call options to certain employees as a form of equity compensation to incentivize good performance or reward seniority. Employee stock options (ESOs) effectively give an employee the right to buy the company’s stock at a specified price for a finite period of time. ESOs often have vesting schedules that limit the ability to exercise. If the stock's market price has risen once the vesting periods end, the employee can benefit greatly by exercising those options.
For example, if you begin to work at a startup, you might be given stock options for 12,000 shares of the startup's stock as part of your compensation. These options aren't given to you immediately; they vest over a designated period of time. Vesting means it becomes available to use. So after one year, you might be able to exercise 3,000 shares, then another 3,000 each year after that. By the end of four years, all 12,000 shares will be vested.
Employee stock options usually come with a " cliff " as well. This is the amount of time you must work with the company to receive your shares. If you get a new job before you reach the cliff, you lose all your stock options. After that cliff, even if you leave the company, your options will continue to vest on schedule.
Options often come with an expiration date, which is the last point at which you can exercise your option. This could be a set number of years after the option is granted or a set number of days after you leave the company. The details of the expiration date should be in your contract.
Employee stock options are not publicly-traded: they are granted exclusively by corporations to their employees. Upon ESO exercise, the company must grant new shares to that employee, which has a dilutive effect as it increases the overall number of shares. Investors should pay attention to the number of employee options that have been granted to understand their fully-dilutive potential.
How to Calculate the Value of Your Stock Options
If the company you hold options for is publicly traded, the value of your stock options depends on the current value of the stock. Calculate how much it would be worth if you were buying or selling the number of shares you have an option for at the public price. Then, calculate how much it would be worth to buy or sell the same number of share at the price of your option. The difference between them is the value of your stock option.
If the company isn't publicly traded, it becomes a little trickier. If the business has received a valuation that determines how much each share in it is worth, then can give you a starting point to value your options. But that's still a speculative number.
The number of shares (or options) out there also affects the value of yours. The more shares there are (for example, if most employees have been given stock options they can exercise), then the lower the value of each individual share in the business.
The value of your options also depends on the value of the stock itself. If you have an employee stock option to buy 20,000 shares at $2 a share, but the stock is currently trading at $1 a share, then your option currently has no value. If the price of the share rises to $3, however, then your stock options have a value of $20,000.
How to Exercise Your Stock Options
When you exercise your stock options, that is when you actually buy or sell them. An employee with stock options, for example, can only exercise those options after they have vested.
If you are buying stock from an option, you buy it at the option price, regardless of what the current price of the stock is. So if you are an employee with an option to buy 12,000 shares of stock at $1 a share, you will need to pay $12,000. At that point, you would own the shares outright. You would be able to sell them (if you think the price is going to go down) or keep them (if you think the price is going to go up).
If you don't have the cash available, there are a few ways you can still exercise your stock options:
- Exercise-and-sell : Purchase your options through a brokerage and immediately sell them. The brokerage handling the sale will effectively let you use the money from the sale to cover the cost of buying the shares.
- Exercise-and-sell-to-cover : Purchase your shares through your brokerage, then sell just enough to cover the cost of the transaction. You keep the rest of the shares.
If you exercise your stock options, you will need to pay taxes on any profit that you make. How your taxes are calculated depends on the type of option you have and how long you wait between exercising your option and selling your shares.
Taxes for Statutory Stock Options
Statutory stock options are granted through an employee stock purchase plan or an incentive stock option (ISO). For this type of option, you aren't taxed when you are granted the option. In most cases, you will be taxed when you exercise the option. If that happens, your employer will report the income on your annual W-2 form.
If you are taxed after your exercise your option, it will be on the bargain element, which is the difference between the market value and the price you paid. For example, if the public price was $2 per share, and you exercised an option to buy 10,000 shares at $1 a share, you would pay taxes on the $10,000 difference between the two prices.
You would also have to pay capital gains tax whenever you sell your shares. If you hold the shares for less than a year after you sell them, they count as a short-term capital gain (or loss) and are taxed at your ordinary income rate. If you hold them for more than a year, they are taxed at the long-term capital gains rate (0%, 15%, or 20% depending on your income and filing status).
Taxes for Nonstatutory Stock Options
Nonstatutory stock options aren't granted through either an employee stock purchase plan or an ISO plan. In this case, you may have taxable income when you receive the option itself. For nonstatutory stock options, the taxable income you are considered to have depends on how readily determined the fair market value of the option can be.
If the stock is publicly traded, the fair market value can be readily determined. In that case, the option is treated as taxable income at the time it is granted to you. The tax rate for that income will depend on your total income and tax bracket. When you later exercise the option, you do not have to pay tax on any amount of income from the option.
Most nonstatutory stock options, though, don't have a fair market value that can be readily determined. In that case, it is not treated as income until you exercise or transfer the option. Once you do that, you report the fair market value of the stock you receive (minus the amount you paid) as taxable income. This is usually taxed as a capital gain or loss.
There are different ways of structuring a stock option plan. These provide different levels of risk and incentive to both employers and employees.
Why Would You Buy an Option?
Essentially, a stock option allows an investor to bet on the rise or fall of a given stock by a specific date in the future. Often, large corporations will purchase stock options to hedge risk exposure to a given security. On the other hand, options also allow investors to speculate on the price of a stock, typically elevating their risk.
What Are the Two Main Types of Stock Options?
When investors trade stock options, they can choose between a call option or a put option. In a call option, the investor speculates that the underlying stock’s price will rise. A put option takes a bearish position, where the investor bets that the underlying stock’s price will decline. Options are purchased as contracts, which are equal to 100 shares of the underlying stock.
How Do Stock Options Work?
Consider an investor who speculates that the price of stock A will rise in three months. Currently, stock A is valued at $10. The investor then buys a call option with a $50 strike price, which is the price that the stock must exceed in order for the investor to make a profit. Fast-forward to the expiration date, where now, stock A has risen to $70. This call option would be worth $20 as stock A’s price is $20 higher than the strike price of $50. By contrast, an investor would profit from a put option if the underlying stock were to fall below his strike price by the expiration date.
What Is Exercising a Stock Option?
To exercise a stock option involves buying (in the case of a call) or selling (in the case of a put) the underlying at its strike price. This is most often done before expiration when an option is deeply in the money with a delta close to 100, or at expiration if it is in the money at any amount. When exercised, the option disappears and the underlying asset is delivered (long or short, respectively) at the strike price. The trader can then choose to close out the position in the underlying at prevailing market prices, at a profit.
Options contracts are derivatives that give the holder the right to buy (in the case of a call) or sell (in the case of a put) a quantity of the underlying security at a specified price (the strike price) before the contract expires. Options on stocks come in standard units of 100 shares per contract, and many are listed on exchanges where investors and traders can buy and sell them with relative ease. Options pricing is an important financial achievement, where volatility has been identified as a key component of options theory,
ESOs are a form of equity compensation granted by companies to their employees and executives. Like a regular call option, an ESO gives the holder the right to purchase the underlying asset—the company’s stock—at a specified price for a finite period of time. ESOs are not the only form of equity compensation, but they are among the most common.
Chicago Board Options Exchange. " Rules of Cboe Exchange, Inc. (Updated as of December 15, 2020) ," Pages 1 and 6.
U.S. Securities and Exchange Commission. " Investor Bulletin: An Introduction to Options ."
Internal Revenue Service. " Topic No. 427 Stock Options ."
Internal Revenue Service. " Publication 525 (2022), Taxable and Nontaxable Income ."
Internal Revenue Service. " Topic No. 409 Capital Gains and Losses ."
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- Glossary of Terms
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When most people think of investment, they think of buying stocks on the stock market, and many are probably completely unaware of terms like options trading. Buying stocks and holding on to them with a view to making long term gains is after all, one of the more common investment strategies. It's also a perfectly sensible to way invest, providing you have some idea about which stocks you should be buying or use a broker that can offer you advice and guidance on such matters.
This approach is known as a buy and hold strategy and can help you increase your wealth in the long run, but it doesn’t provide much, if anything, in the way of short term gains. These days, many investors are choosing to use a more active investment style in order to try and make more immediate returns.
Thanks to the range of online brokers that enable investors to make transactions on the stock exchanges with just a few clicks of their mouse, it's relatively straightforward for investors to be more active if they wish to. There are many people that trade online on either a part time or a full time basis; buying and selling regularly to try and take advantage of shorter term price fluctuations and often holding on to their purchases for just a few weeks or days, or even just a couple of hours.
There are plenty of financial instruments that can be actively traded. Options, in particular have proved to be very popular among traders and options trading is becoming more and more common. On this page we have provided some useful information on what is involved in options trading and how it works.
- Definition Of An Options Contract
- Why Trade Options
- Where to Trade Options
- How Options Really Work
- Key Terms & Phrases
What Does Options Trading Involve?
In very simple terms options trading involves buying and selling options contracts on the public exchanges and, broadly speaking, it's very similar to stock trading. Whereas stock traders aim to make profits through buying stocks and selling them at a higher price, options traders can make profits through buying options contracts and selling them at a higher price. Also, in the same way that stock traders can take a short position on stock that they believe will go down in value, options traders can do the same with options contracts.
In practice however, this form of trading is far more versatile than stock trading. For one thing, the fact that options contracts can be based on wide variety of underlying securities means that there is plenty of scope when it comes to deciding how and where to invest. Traders can use options to speculate on the price movement of individual stocks, indices, foreign currencies, and commodities among other things and this obviously presents far more opportunities for potential profits.
The real versatility, though, is in the various options types that can be traded and the range of different orders that can be placed.
When trading stocks you basically have two main ways of making money, through taking either a long position or a short position on a specific stock. If you expected a particular stock to go up in value, then you would take a long position by buying that stock with a view to selling it later at a higher price. If you expected a particular stock to go down in value, then you would take a short position by short selling that stock with a hope to buying it back later at a lower price.
In options trading, there's more choice in the way trades can be executed and many more ways to make money.
It should be made clear that options trading is a much more complicated subject than stock trading and the whole concept of what is involved can seem very daunting to beginners. There is certainly a lot you should learn before you actually get started and invest your money. With that being said, however, most of the fundamentals aren't actually that difficult to comprehend. Once you have grasped the basics, it becomes much easier to understand exactly what options trading is all about.
Below we explain in more detail all the various processes involved.
Buying an options contract is in practice no different to buying stock. You are basically taking a long position on that option, expecting it to go up in value. You can buy options contracts by simply choosing exactly what you wish to buy and how many, and then placing a buy to open order with a broker. This order was named as such because you are opening a position through buying options.
If your options do go up in value, then you can either sell them or exercise your option depending on what suits you best. We provide more information on selling and exercising options later.
One of the big advantages of options contracts is that you can buy them in situations when you expect the underlying asset to go up in value and also in situations when you expect the underlying asset to go down.
If you were expecting an underlying asset to go up in value, then you would buy call options, which gives you the right to buy the underlying asset at a fixed price. If you were expecting an underlying asset to go down in value, then you would buy put options, which gives you the right to sell the underlying asset at a fixed price. This is just one example of the flexibility on these contracts; there are several more.
If you have previously opened a short position on options contracts by writing them, then you can also buy those contracts back to close that position. To close a position by buying contracts you would place a buy to close order with your broker.
Selling & Writing Options
There are basically two ways in which you can sell options contracts. First, if you have previously bought contracts and wish to realize your profits, or cut your losses, then you would sell them by placing a sell to close order. The order is named as such because you are closing your position by selling options contracts.
You would usually use that order if the options you owned had gone up in value and you wanted to take your profits at that point, or if the options you owned had fallen in value and you wanted to exit your position before incurring any other losses.
The other way you can sell options is by opening a short position and short selling them. This is also known as writing options, because the process actually involves you writing new contracts to be sold in the market. When you do this you are taking on the obligation in the contract i.e. if the holder chooses to exercise their option then you would have to sell them the underlying security at the strike price (if a call option) or buy the underlying security from them at the strike price (if a put option).
Writing options is done by using the sell to open order, and you would receive a payment at the time of placing such an order. This is generally riskier than trading through buying and then selling, but there are profits to be made if you know what you are doing. You would usually place such an order if you believed the relevant underlying security would not move in such a way that the holder would be able to exercise their option for a profit.
For example, if you believed that a particular stock was going to either remain static or fall in value, then you could choose to write and sell call options based on that stock. You would be liable to potential losses if the stock did go up in value, but if it failed to do so by the time the options expired you would keep the payment you received for writing them.
Options traders tend to make their profits through the buying, selling, and writing of options rather than ever actually exercising them. However, depending on the strategies you are using and the reasons you have bought certain contracts, there may be occasions when you choose to exercise your options to buy or sell the underlying security.
The simple fact that you can potentially make money out of exercising as well as buying and selling them further serves to illustrate just how much flexibility and versatility this form of trading offers.
What really makes trading options such an interesting way to invest is the ability to create options spreads. You can certainly make money trading by buying options and then selling them if you make a profit, but it's the spreads that are the seriously powerful tools in trading. A spread is quite simply when you enter a position on two or more options contracts based on the same underlying security; for example, buying options on a specific stock and also writing contracts on the same stock.
There are many different types of spreads that you can create, and they can be used for many different reasons. Most commonly, they are used to either limit the risk involved with taking a position or reducing the financial outlay required with taking a position. Most options trading strategies involve the use of spreads. Some strategies can be very complicated, but there are also a number of fairly basic strategies that are easy to understand.
You can read more about all the different types of spreads here .
Benefits of Trading Options
There are actually a number of benefits this form of trading offers, plus the versatility that we have referred to above. It's continuing to grow in popularity, not just with professional traders but also with more casual traders as well. To find out just what it is that makes it so appealing, please read the next page in this section – Why Trade Options?
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5 Elements of a Smart Trade Plan
The decision to buy a stock usually comes down to a hunch that you can turn a profit. But markets are unpredictable, and a lot can happen on the journey from inspiration to success, which is why seasoned traders draft trade plans before putting any money on the line.
In short, a trade plan means setting parameters for getting into and out of trades, how much money you're putting at risk, and a profit strategy. Think of it as tool for keeping a cool head as you build and reshape positions when markets are on the move.
It starts with a quick self-evaluation:
- What is the basis of your hunch? Are you looking at fundamental factors focused on company performance, or technical factors based on market trends and patterns in stock charts?
- Which investing style do you prefer? For example, are you looking for fast-moving growth stocks or underpriced value stocks? Are you trading a trend or a countertrend?
- What's your view of market sentiment? Is momentum generally tilted up or down?
Once you have your bearings—and you've identified a list of stocks or exchange-traded funds (ETFs) suited to your preferred method of research ( fundamental, technical, or both )—you're ready to draft a plan. Here are the five key elements to include.
1. Your time horizon
How long you plan to hold a stock will depend on your trading strategy. Generally, traders fit into one of three categories:
- Single-session traders are very active and look to gain from small price variations over very short time periods (minutes or hours) throughout the trading day.
- Swing traders target trades that can be completed in a few days to a few weeks.
- Position traders seek larger gains and recognize that it often takes longer than a few weeks to achieve them.
2. Your entry strategy
Look for entry signals—for instance, divergences from trend lines and support levels—to help you place your trades. The signals you employ and the orders you use to make good on them hinge on your trading style and preferences.
Here's an example of one moving outside a support or resistance level with increasing volume, also known as a breakout.
Is this stock poised for a breakout?
Example is hypothetical and for illustrative purposes only.
In the chart, XYZ has just broken through a resistance level—the price where selling might be strong enough to prevent further price increases. With breakouts, consider limiting trades to stocks that have broken through resistance areas and where trading volume is above average, not just for the trading day but for the specific time of day.
A trader looking for an entry point could consider buying XYZ at slightly above the resistance level, in this case that could mean buying at $123. To help manage their risks in the event of a reversal, the trader could also place a stop order at $120. If the stock drops below $120, the stop order would become a market order to sell the stock. However, there's no guarantee that execution of a stop order will be at or near the stop price, so risk is not entirely eliminated.
Here's another example with a stock that is experiencing a pullback, meaning it has fallen from a recent peak. What we're looking for here is a possible entry should the stock just be taking a temporary breather before rising again.
Has this stock pulled back?
Examples is hypothetical and for illustrative purposes only.
Start by looking for some area of support—a price level at which demand might be strong enough to prevent further declines—such as the stock pulling back to a moving average or an old low. Some traders even wait until the stock moves above the high of the previous day—a sign that the pullback might be over. In this case, XYZ is still trading above the support level of $30.50, so entering at $31 could make sense.
3. Your exit plan
When it comes to an exit strategy, plan for two types of trades: those that go in your favor and those that don't. You might be tempted to let favorable trades run, but don't ignore opportunities to take some profits. For example, when a trade is going your way, you could consider selling part of your position at your initial target price and letting the rest of your position run.
To prepare for when a trade moves against you, you can set a stop order at a price below a support level to help manage your risk if the stock breaks below that level.
4. Your position size
Trading is risky. A good trade plan establishes ground rules for how much you're willing to risk on any single trade. Say, for example, you don't want to risk losing more than 2%–3% of your account on a single trade. You could consider exercising portion control, or sizing positions, to fit your budget.
Here's a scenario: A trader with $150,000 in total capital is interested in a stock trading at $67 a share. The trader could set a maximum budget per trade of 10% of the account, or $15,000. That means the maximum number of shares the trader can buy is 223 ($15,000 ÷ $67).
Let's also imagine the trader doesn't want to lose more than $3,000 of their $150,000 on this trade. If we divide that amount by 223 shares, that means the trader can tolerate a drop of $13.45 per share ($3,000 ÷ 223). Subtracting that amount from the stock's current price, gives the trader a target stop price of $53.55 ($67 – $13.45). The trader may never have to use this stop order, but at least it's in place if the trade moves the wrong way.
5. Your trade performance
Are you making or losing money with your trades? And, most importantly, do you understand why?
Look over your trading history to calculate your theoretical trade expectancy, meaning your average gain (or loss) per trade. You start by determining the percentage of your trades that have been profitable versus those that haven't. This is known as your win/loss ratio. Next, compute your average gain for profitable trades and average loss for unprofitable trades. Then, multiply your win/loss ratio by your average gains/losses to find your average gain per winning trade and average loss per loser. Subtract the latter from the former to determine your trade expectancy. Here's an example of how that might look:
How profitable are your trades?
A positive trade expectancy indicates that, overall, your trading was profitable. If your trade expectancy is negative, it's probably time to review your exit criteria for trades.
The final step is to look at your individual trades and try to identify trends. Technical traders can review moving averages, for example, and see whether some were more profitable than others when used for setting stop orders (e.g., 20-day versus 50-day).
Sticking to it
Even with a solid trade plan, emotions can knock you off course. This is particularly true when a trade goes your way. Being on the winning side of a single trade is great, but far better is to score a series of them. Understanding what goes into a smart trade plan is the first step to prepare you for your next trade.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Schwab does not recommend the use of technical analysis as a sole means of investment research.
Past performance is no guarantee of future results.
Investing involved risk including loss of principal.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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