*(This is not financial advise)

Establishing Rules To Guide Options Trading

Setting clear rules will keep trading on track to realize success. A couple rules to consider are as follows.

Before Making a Trade

  • Allocate Trading lot sizes: Determine the percentage of your trading capital to allocate per trade. An optimal lot size is 10% of trading capital as the benchmark of the Compound 20 Trading Challenge so as to manage risk. More risk averse traders only use 2% of their total account value for each trade, pick a trading lot size that fits your risk profile but never trade all of your account value at once. Alternately when trading on smaller account values (for example, less than $3,000) identify a dollar amount for a lot size that gives optimal return in a timely manner based on risk tolerance.
  • Taking Profits/Closing Positions: This involves establishing clear rules for closing trade positions to lock in profits made and to ensure a positive trajectory for the Compound 20 trading journey, this also preserve and protects your capital. Before making each trade, have in mind a clear take profit point based on what the market appears to be able to give on that trading day. Be prepared to take less profit if market movement and momentum is not favorable based on your timeline for that trade.
  • Do not guess the direction of the market, instead wait for indications and setups that show winning a trade is most probable. Look for market setups that present a discount on stocks or options that you normaally trade. These can include;
    • Chart setups for over-sold or over-bought positions which indicate a reversal is likely
    • Positive or negative news that may influence the direction of a stock. Be sure to be able to tell when it is a buy or sell the news situation.
    • Technical or fundamental analysis that supports a direction of a stock.
    • Discount opportunities in the market.
  • Before you place a trade, ensure that no rules are broken

Risk Management

  • Respect your money
  • Set a stop loss order as soon as you open a trade. Set a positive stop loss order as soon as you are in profit. For example you can set a stop loss at a 10% profit once you are in profit of 20% or over. You can make this into a trailing stop loss also. You can now decide whether to re-enter the trade if the opportunity is till there for profit.
  • Use a stop loss when scalping in the opposite direction of a clear trend.
  • Use a hard stop loss of 15% on all trades.
  • Use a soft stop loss of 12.5% on all trades. With this stop loss, if a position falls below 12.5% then goes positive again, only to fall below 12.5 % again, close this position.
  • Some traders use options as a stop loss in and of itself, meaning if $300 is used to make a trade, the max you can lose is $300 but if market moves in your favor you can make multiples of your trade for example 200% to 500%, or more. Decide how you want to use a stop loss on your options trading.

When to stop Trading

  • When you reach your daily goal.
  • When you exceed a max loss tolerance for the day.
  • After you have made your daily goal but subsequent trades cause a loss of half of your daily goal.
  • When there are no clear opportunities for a profit in the market that day.

Other rules

  • Take profits when scalping in the opposite direction of a clear trend.
  • Set a minimum initial capital to start trading with.
  • Do not dollar cost average(DCA) more than a total of two positions against a trend so as not to be cut by trying a catch a falling knife.
  • Because the market opens up high does not mean it is going up.
  • Do not chase a trend especially after the move has happened.
  • Do not be quick to make a trade, take time to watch the direction of the market, be patient, and look for the right market setups that are likely to be profitable.
  • Do not trade everyday, look for market setups that puts risk reward in your favor.
  • Develop a broader outlook to improve swing trades.
  • Some days it is OK to make no trades, cash is always a good position.