I was a cocky beginning trader. Soon after attending a stock trading seminar, I had several big wins. In my own mind, I was the exception to any and all stock market trading principles. I could do no wrong. My short-lived reign as a trading Adonis came to an abrupt end. All my money began raining down into the pockets of real stock market professionals. Fortunately, I wised up before it was too late.

In short, I was a young punk who knew everything about nothing. I often times had to learn things the hard. Learning to trade in the stock market was no exception. So, here are my top three ways to prevent an STD.

#3 Way To Avoid An STD

Perform thorough market research! Taking proper research for granted is a one-way ticket to Brokeville. Trust me, I know. Due diligence is required in order to side step a poor stock decision. Remember, getting into a bad trade is simple…getting out is costly. Give market research the time and attention it deserves.

#2 Way To Avoid an STD

Remove hope from your emotional make up when trading! Wishful thinking is a dangerous mindset to be in when you are a stock trader. Hope and wishful thinking lead to irrational decisions based on emotions rather than factual information. Going down with the ship is far from an act of nobility. You will make mistakes. As a trader, you must be willing to make corrections quickly. In the stock market, making too many errors, too fast will certainly cause you to be prematurely ousted from the markets if you do not adhere to the method #1.

#1 Way To Avoid an STD

Make use of a protective stop loss! After placing your order, ALWAYS set a protective stop. Failure is not to far off in the distance for a trader who handles the duties of risk management in the absence of a stop loss. A stop loss is not perfect but the only insurance policy a trader has against stock trading career ending losses. Stop being a philanthropic trader who continues to give money away to the markets.

Using a protective stop loss continues to be the most effective method of risk management. Fortunately, it is also the easiest of the three to apply. Methods 1 and 2 are developed over time as you gain experience. Simply use my top three ways of preventing an STD and you have cut your chances of getting burned.

The numbers don’t lie! 9 out 10 stock traders will fail, miserably! That is the same ratio for starting a business. At least in the case of running a business, there’s a 5-year failure window. I would say that a very small minority of beginning traders makes it past their first year. The reason for such an unbalanced success/fail ratio is simple. 9 out of 10 people entering the market would be better categorized as gamblers and not traders. Yes, I too, was one of those gamblers masquerading as a stock market trader.

Successful traders employ proven, winning trade strategies. Most beginning traders systematically make the same mistake over and over again. Venturing into the market without a sound trading plan is financial suicide. Here is a guide to structuring your own winning trading strategy.

Many principles of running a successful business can be applied to stock trading. Having a trading plan is essential to the success of your new venture. Consider this trading plan to be your road map that guides you to stock trading mastery. Skipping this step will ensure your permanent residency in Loss Vegas.

The trading plan must outline the why or purpose for trading the markets. If your purpose is to simply make money, you are in for a rude awakening. The number one objective of a stock trader is to trade well NOT make money. Focusing on trading well will result in you making money. Making profitable trades is a by-product of trading well. Calculating profits while practicing your trade is counter-productive to your efforts. You certainly wouldn’t want a lawyer tabulating his fees while researching your case, would you? The same focus needs to be applied while you trade. There will be plenty of time for counting your windfall once you have closed out your position.

After committing yourself to learning to trade well, the next step in the process is executing the plan. This includes but is not limited to:

1. Conducting Market Research-stock selection, risk/reward ratios

2. Pinpointing Entry Points

3. Money Management- where to place protective stops

4. Establishing Exit Points

5. Trade Review

I use this exact process when trading stocks and options. Deviating from your trading plan can hinder your progression as a trader in two areas. First, the effectiveness of a trading strategy cannot be accurately measured when a trader is inconsistent in the execution of a trading strategy. And secondly, altering your strategy in the midst of a trade is hazardous to your wealth. A prime example would be moving your protective stop in the opposite direction of your trade. This allows for a wider, much riskier stop loss cushion. Moving protective stops in the opposite direction of the trade is a sure sign of a rookie trader.

Following this simple formula will not eliminate visits to Loss Vegas but will ensure shorter, less frequent stays. Happy trading and here’s to your success!

1. How much of your total portfolio will be used to enter a trade. For the purchase of regular blue chip shares, I would suggest between 10-20% no more. If trading CFDs Options etc, you may want to lower this figure to 5-10%

2. What is that maximum you are prepared to loose on this trade, if it goes bad? This is where your stop loss will be used. I would recommend not risking any more than 10-15% of the amount that you have invested.

3. If you were to get stopped out; how much of your total portfolio would you loose?

For example if you have $10,000 in your trading account. You use $2000 to enter a trade (20%), you set a stop loss 10% below your buy price. The maximum that you could loose would be $200 or 2% of your total account which is acceptable. It is best to keep this figure within 1 to 3%.

Stop Losses

If you are to become a successful share trader, it is imperative that you develop robust risk management strategies which enable you to cut your losses short, should the trade go against you. Part of your strategy should always be using Stop Losses.

A stop loss is a price point where a trader will sell a security once a certain price has been reached. So as the name suggests, stop losses are there to limit an investor’s loss on a stock position. Basically, a stop loss is used to either preserve capital when a recently entered trade has turned against you or to protect your profits in a winning trade.

Stop Loss to Preserve Capital

This is where it is easy to make a mistake because the stop loss you place will be dependant on the market and instrument you are trading and whether you are using leverage to trade with. For example, the stop loss you might use to trade blue chip shares would likely be different to one you place on a speculative stock due to volatility.

Also, if you are using leverage to trade, a 10% move in a stock could equal to a move of 100% or more in an options or CFD trade. So, it is essential that when setting your stop loss you understand the market you are trading.

Before you make the decision to enter a trade, you should know (using your trading plan) what the maximum capital you are prepared to risk and set you stop loss accordingly.

How to set a Stop Loss?

When setting your stop loss you need to be close enough to the buy price so that you do not lose more than 1% to 3% of your total capital (although, if you are starting with a small trading account, exceeding this level may be unavoidable) but far enough away so that the stock has room to move in case it falls briefly after you buy into it.

When setting a stop loss on regular Blue Chip shares; you can either set it as a percentage of the buy price or at a price point. In your trading plan, it is best to work out both stop losses, and then use the one that gives you the least amount of loss.

For example: You want to buy ABC Corporation as you believe it will rise in price. The stock is currently trading at $10.00. Say your trading capital is $100,000 and you want to use 20% ($20,000) to purchase the stock, and set a stop loss of 15% below your buy price. Your stop loss calculation should look like this:

Buy price $10.00 x 15% = $1.50. Stop loss equals the buy price of $10.00 minus $1.50 which equals $8.50. If the stock price was to fall below $8.50, the trade would automatically be closed.

Protecting Profit

Stop losses can also be used to protect profit in a trade that is going well. The rules that you have set out in your trading plan to enter and exit a trade will come into play here. We will cover them later in the course.

However many traders will use a trailing stop loss; which means as the stock price moves into profit, your stop loss incrementally moves with it maintaining a safe distance and always there should the trade turn against you unexpectedly.

In the above example of ABC Corporation. If you were to set a trailing stop loss $1.50 below your buy price of $10.00 and the stock reached a high of $13.50 before turning against you. The stop loss would have been executed at $12.00, locking in a $2.00 per share profit or $4000 in this case.

Until next time…Happy Trading!

It is programmed with a certain set of rules and these rules govern trade decisions. A stock trading system takes the emotion out of trading. Traders do not need to speculate on a prospect. If the numbers are right, the stock trading system will prompt them to buy and sell. This prevents a trader from falling into greed or being swayed by misdirected instincts. Many traders have successfully adopted stock trading systems but you must consider the option carefully before purchasing a system of your own.

When buying one of the newer seats, people should look at the hardware package for two foam-and-epoxy washers. To fix the new toilet seat, they should turn the seat upside down, and center one on the bottom of each bolt-head housing. When the stage is set for the seat to be mounted, the protective tape must be peeled off to expose the bottom of the two washers. Once the epoxy is exposed on the bottom of each washer, turn the seat over, line up the holes, and set the hinge in place. Finally, the bolts may be pinned through the hinge and the bowl.

Trading Systems provides detailed information on Trading Systems, Forex Trading Systems, Stock Trading Systems, Future Trading Systems and more. Trading Systems is affiliated with Option Trading.

The underlying probability calculation assumes that the stock price movements are random events, like throwing dice. Of course, stock price movements are not purely random, but are affected by news, rumors, crowd psychology and many more factors. But it isn’t a bad approximation for the reality, especially when averaged over many stocks and over long periods of time.

The essence of the problem derives from the old financial adage, there’s no free lunch. If you were to establish trades with these probabilities, the returns will be rather small, of the order of 7% to 10%. But the losses would be huge, of the order of 90% to 100%. The bottom line is that the one or two losses each year would be large enough to wipe out all of the gains for the year. Thus, there is only a small probability of a losing trade, but when it happens, it will be a devastating loss.

Some traders will readily acknowledge that these high probability trades don’t make sense, and will sell the idea of so called “low risk” trades, where the potential loss is small, hence the label of low risk. These trades are simply the mirror image of the high probability trade. The low risk trade is characterized by a huge potential gain, of the order of 200% or more, but there is a very small probability of that successful outcome. In this case, one would lose a small amount on the trade 10 or 11 months out of the year and then have 1 or 2 large gains. The problem is that the large gains would not compensate for the large number of small losses.

In either case, the outcome is the same, a small net loss, especially after commissions and other costs of trading. So is options trading inherently a losing game? No, not necessarily, there are many examples of successful, long term options traders. They succeed by paying attention to two critical factors: 1) keeping one’s ratio of winning trades to losing trades as high as possible, and 2) minimizing the losses on the inevitable losing trades. But those topics require a much more extensive treatment than can be done in a short article.

One’s choice of either the high probability trade or the low risk trade is not a financial issue – neither is inherently superior. Neither trade will be successful long term without other considerations. One’s choice of the high probability or the low risk trade is primarily a matter of matching one’s trading style and risk tolerance with the right trade.

There are two basic options: calls and puts. A call is the option to buy a stock at the strike price. The object of a call is to have the stock price go up. Your option is considered out of the money if the stock price goes down and never rises above your strike price before expiration, then you will lose your premium – the amount you paid to buy the option. Your option is in the money if the stock is trading above your strike price.

A put is just the opposite of a call. The object of buying a put is having the underlying stock price go down. A put is the option to sell a stock at the strike price. A put is in the money if the underlying stock is trading lower than your strike price, and a put out of the money if the stock price is trading higher than your strike price.

An option can still have a premium if it is out of the money. This is considered time value. An option premium is determined by two factors: tive value and intrinsic value. Intrinsic value is how much the option is in the money.

More Advanced Options Trading

You can also sell calls and puts. Selling (or writing) a call while you hold the current stock is termed a covered call. Covered calls are used very often and it’s a way the investor can bring in extra money during a stagnant or down trending market. If you sell a call without holding the underlying stock, this is termed a naked call. Naked calls are very risky because the stock price can go up infinitely and when the calls are exercised you are obligated to give the buyer the shares at the strike price but you have to buy them at the market price (you lose the difference between the strike price and the price on the open market).

Buying a put while holding the underlying stock is termed a married put. An investor buys the put for protection or insurance from the stock price falling. A married put is like an insurance policy – you are guaranteeing yourself a sell price of your stock until expiration.

Selling (or writing) a covered put means you have the cash secured in your margin account to cover the cost it would take to buy the stock back at the strike price from the buyer if the stock is put to you. If you don’t have the cash secured upon selling the put, then this is termed a naked put. You are liable for the cost of all the shares at the strike price if the put is exercised (put to you).

A straddle is buying both a call and a put at the same time. The object of a straddle is that the investor believes the stock is going to significantly move up or down. If the stock price rises above your call strike or falls below your put price, then you are in the money. A straddle is used when the stock is very volatile and is expected to move, but you just aren’t sure which way.

A short stradle is the opposite of a straddle. A short straddle involves selling a call and a put at the same time. The investor thinks the underlying stock is not going to move allowing the options to expire worthless and the investor profits the premiums from selling the options.

A spread is the buying and selling of the same option type (call or put) at the same time.  A credit spread is when a higher premium option is sold and a lower premium option is bought. The investor is credited more than is debited (the money made from selling the options is more than what it cost to buy your options). A debit spread is just the opposite – more money is spent on buying then options then what is received from selling the options.

A calender (or horizontal) spread is when the expiration dates on the long and short leg of the option differ. A verticle spread is when the strike prices of the long and short leg differ, not the expiration date.

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Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD).

1. The stock’s past history and movement.

2. Expected earnings reports of the stock’s parent company.

3. Volatility and volume of shares traded daily.

4. Any current news concerning the company’s growth or profitability.

5. The price of the option with respect to how you think the stock will perform. If you do not feel the stock’s movement will handily offset the cost of the option, plus the trading fees, then buying or selling the option would be fruitless.

6. Supply and demand of the underlying stock. (Industry group market action.)

Once you have decided upon which stock to pick, you next need to decide whether you believe the stock’s price is likely to rise or fall. (With stock options you can make money in either direction.)

By purchasing a Call option:

1. You expect the price of the underlying stock to rise, so you can then purchase it at the lower strike price, making a profit in the transaction.

2. You have the right to control 100 shares of stock for a fraction of the cost of purchasing the stock outright.

3. You are managing your risk by limiting the downside to the premium paid for the option. The major downside to buying any option is time decay. Your option expires within a finite period of time. If the underlying stock price behaves as expected, you will not need to be concerned about execution.

Having shown you the benefits of buying Calls over the risks of purchasing the stocks outright, we must emphasize the fact that buying short-term Calls has its associated risks as well. A Call buyer, especially a short-term Call buyer, is severely limited by the time-decay factor. The nearer to the expiration of an option, the less the option is worth, and the less time is remaining for the option to become profitable. Within the leverage used by gambling casinos (the house), the concept of short-term Call buying is completely understood, as well as exploited, as gamblers are considered short-term Call buyers.

Example: Consider your long-term Put, or Call, as a 6 to 8 month license to operate a casino. It allows you to capture short-term premiums; money that gamblers continuously give to you in attempting to beat the odds by speculating they will make profits on very risky bets. They feverishly feed the slot machines, ante up at poker, double-down on blackjack, or spin the roulette wheel. The odds are overwhelmingly against these short-term buyers. You, as the casino owner, continuously capture these short-term premiums, easily offsetting the expense of the license to operate the casino, then earning substantial, clear profits in the following months. They know the odds are with the casino owner, but they still take the enormous gamble on the slim chance they will hit a jackpot. The lottery works in the same manner.

On one side of the position, the transaction is definitely gambling, while on the other, the casino is simply engaging in business. Would you rather bet on the remote chance of a gambler’s rare, limited success, or rake in the steady, routine premiums captured from operating a successful business? Yes, occasionally a gambler does beat the odds to enjoy a limited, windfall return on his bet. For the casino owner, that is simply part of the cost of doing business. But we all know where the true, long-term profits lie. 30%, 40%, 50% and more, are common, and in short periods of time. The odds are with the short-term option seller, not the buyer.

When you choose a stock for short-term Call buying, you not only must carefully consider the proper stock for the type of option you are purchasing, you must also decide which direction the stock will move, then, that movement must occur within a specified, very limited period of time. Many investors have gone broke by attempting to make those same decisions. In short, time is not on the side of the short-term option buyer. It is on the side of the option seller.

Summary: 1. Buying stocks is risky.

2. Buying short-term options is less risky, but still risky.

3. Selling short-term options is the least risky, especially with a hedge, or insurance.

By selling a Call option:

1. You expect the underlying stock price to fall, so the option will not be exercised, but expire, worthless.

2. You can capture the entire premium that was paid to you, as profit. If the underlying stock price rises, you are obligated to sell 100 shares of stock at the lower strike price. If you do not already own those shares, you would then have to buy them at a higher market value, then sell them at the strike price, in order to meet your obligation. This situation is called a “Naked,” or “Uncovered” position, and is extremely dangerous. Anytime you sell a Call option you should consider buying the same option with a slightly lower strike price, and longer expiration date. This will reduce your profit potential, but will also reduce your risk considerably. (Remember the parallel twins, Risk and Reward

- If you want to reduce risk, you must also give up some degree of potential rewards. You may wish to lower your cost basis in the stock, to the extent of the premium received.

By purchasing a Put option:

1. You expect the price of the underlying stock to fall, allowing you to sell stock at the higher strike price, and thereby earning a profit.

2. This option is also used in a combination strategy as a hedge against selling Puts. We will explore that strategy later, in detail.

3. Buying Put options could also be used as a hedge, or insurance, against the possibility of a price drop in stock you already own. Consider the following:

You own 100 shares of ABC stock, and are concerned that the stock price could suddenly fall. You purchase a Put option on the same stock, with a strike price at current market value. If your stock falls in price, you would have the right to exercise your option and sell 100 shares of ABC stock at the higher strike price. The premium you paid for the option could be far less than the loss you would have incurred without that insurance. In this instance buying Puts acted as a hedge against the possibility of a price decrease in the stocks you already own. If the price of the underlying stock increases, your loss is limited to the premium you paid for the option. The option acts as an insurance policy against possible loss.

Selling a Put option without an opposing hedge -”Naked” You expect the price of the underlying stock to increase, causing the Put option you sold to expire worthless. You can then capture the entire premium paid to you, as profit. If the underlying stock price were to fall below the strike price, then you would be obligated to purchase the stock at the strike price, or pay the difference between the strike price and the stock price, if you do not want to own the stock. Your upside is limited to the premium received for selling the option. Your downside is potentially unlimited to the base value of whatever you could sell the stock for on the open market, or to the difference between the strike price and the stock price. This is a “Naked,” or “Uncovered” position, and should never be allowed to occur, unintentionally. Without the implementation of combination strategies, the main objective of the Put seller is to hope the option expires, allowing him to capture the entire option premium as profit. Nearing expiration, if the stock price moves below the strike price, changing the option’s value to ITM, and highly vulnerable to exercise, then the option seller must move quickly to buy back the option, perhaps lessening his profit potential, while also managing his risk. Even so, a small loss would be better than having to buy 100 shares of stock at inflated prices. Also, the loss can be immediately compensated for by simultaneously selling another Put expiring in the following month. We use OPM (Other People’s Money) to buffer downside risks, while buying more time for the stock price to rise.

Stock Option Trading, when done properly, can drastically reduce, or even eliminate, these two stumbling blocks to stock market success. In the first place, A trader of stock options never is not required to own the underlying stock in which an option is based. He or she can design a trade in such a way that downside risk is limited to the cost of the option, which in itself is a fraction of the cost of the stock. We capitalize on traders and speculators greed to get rich who purchase overvalued short term options bid up to inflated levels by an excess of demand over supply, by being the house or casino owner and capturing the inflated premium from the players or buyers. We buy reinsurance at a low cost by purchasing a longer term ( 5 to 6 months) out of the money option to sell the stock at a fixed price no matter how low it may drop. We buy this reinsurance ( puts ) to create a profitable hedge and sell overvalued puts repeatedly, month by month to bring the cost of our hedge down to zero and a credit so that we can enjoy a free ride capturing this inflated premium income. This strategy is known as diagonal put spreads and you do not need to pick a winner to profit.