People become involved in trading or investing in the markets hoping to make lots of money. Often, they have no plans or methodology to be successful. Much of their buying and selling will be dictated by their emotions. This is one of the reasons that more people lose money than earn consistent profits. Profitable trading is not easy to accomplish. If it were, there would be millions more people in the millionaire’s club. There are two things that can help you improve your results. One is using a simple trading system. The other is simply trading without emotional interference.
What is your purpose for being involved in the markets? Is it just to make money? Maybe it is to satisfy an inner craving or the need to express your emotions. Some people trade for the thrill of being involved in the markets. Like a roller coaster, they love the ups and downs and the emotional attachment to price movements. Understand the true reasons you are attracted to the markets. This will help you to create a simple system to overcome your emotional risks.
For example, let’s look at options and the emotions involved. Many people cringe when they hear the word option. They have heard many “bad” things about trading options. Traders have formed a barrier to understanding how options work. Advertisements claim huge gains can be made trading options. Gains of 300%, 500% or 1,000% in a short period of time can, in fact, be made. For the trader, the possibility of these types of returns creates excitement and the thought of untold riches. Unfortunately, is it difficult to consistently make these kinds of gains. Money can be easily lost when trading the wrong options at the wrong time. The possibility of large sudden gains plays havoc on the emotions of an investor. It is easy to become blind to the risks involved.
Much of the risk in trading options comes from the fact that they can lose value over time. Many out of the money options expire worthless because they have lower probabilities of becoming profitable. One simple way to reduce the major risk in trading options is to buy only deep-in-the-money options. The advantages are that there is often little loss of value from the passage of time. Also, they have a much higher probability of closing in the money. And, they often move dollar for dollar with the underlying security.
For example, a stock might move up in price from $70 to $75 per share, for a $5 gain or about 7%. An out-of-the-money option might only move from $200 to $400, for a $200 gain. True, that is a 100% return. There is a low probability of doing that consistently. The probability for that option ending up in the money might only be about 30%. Trading a deep-in-the-money option, it might move from $1,530 to $2,000, for a gain of $470 or about 30%. This is a lower return percentage wise, but this option gained more in dollar value. The probability of losing your entire option premium is very low.
Substituting high probability options in place of buying the actual stock conserves capital. In this example, purchasing 300 shares of stock would cost $21,000 (300 X $70). The equivalent for options is three contracts costing $4,590 (3 X $1,530). This is a simple strategy risking about 80% less capital to realize a gain of $1,410 verses $1,500. Essentially, you have protected $16,400 from market risk. ($21,000-4,590). The tradeoff is about $90 less in profits using options. Trading in this manner is far less emotional, and has a higher probability of success. Losses can be controlled using a stop. That is the name of the game, preserving capital at all costs.
It is easy to develop a simple trading system. Numerous systems can be created by using a 20, 47 and 200 ema, or exponential moving average. Use these on a 60 minute chart with an RSI indicator set to 5 periods. With this set up, you can watch for price moves above and below the 200 ema. Look at prices over several months, and you will see that they regularly oscillate around the 200 ema. With the 60 minute chart, you get quicker signals than with a daily chart. After a move higher, prices will have a tendency to find their way to the 200 ema. They will either test this average and bounce back up, or break through. When prices have sunk well below the 200 ema, they have a tendency to rise back toward it. This is where the RSI comes into play. A deep swing in this indicator to below 10 or 15, is often a good short term buying opportunity. Remember that most traders are buyers. They will always try to buy when prices are falling. They can’t resist attempting to buy a bargain. This causes strong rebounds in price that often test the 200 ema before falling back down again.
When you make trading easy and uncomplicated, you have a greater chance for success. Adding more screens, more indicators and more trades will not make for more profits. You can design your own stress-free trading system and have fun trading without the emotional ups and downs. If you are always shooting for the big home run, you can expect many strike outs. That can wreck your emotional stability. Learn to take smaller amounts out of the market on a regular basis. Once you have mastered your system, it becomes easier to do this on a consistent basis. All those singles and doubles will add up much faster than an occasional home run. The key is to keep losses small. You can tame your emotions by making trading simple. Ignore all the flashy ads. Maintain your sanity with a self designed trading strategy. That way, it is sure to be adaptable to your style and suited to your emotional personality.
