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Quote from mark trader:



Questions:

1. Trading Rules: I want to establish a disciplined trading style for myself from the start, so I don't form any bad habits going forward. I am sure as I gain knowledge and experience the trading rules would be adjusted according to my skill level, however what rules should I adhere to at my current level?
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Let me tackle the questions one at a time during the day to make it easier to discus.

The first set of rules anyone should follow focus 100% on risk management. Right now as a newbie so to speak you are not fully aware of all trading strategies enough to know exactly what your trading style is and approach for finding positions comfortable just yet. So the first step is risk management with respect to position sizing and capital at risk. Of course a lot of this depends on what is your available capital, be it $1,000, $10k or $100k. Either way your first steps for discipline is as follows:

1. Never let anyone position have a maximum risk equal to your total portfolio. This one rule alone and if you are disciplined to follow it will hopefully ensure you never blow out.

2. I would add to rule #1 even more and never put a position one with more than 50% of your portfolio at risk.

3. If you are doing pure debit spread type of plays, look to risk in the 1 - 10% range max depending on your account size. As you get more experience you can adjust this, maybe put more risk in what you deem higher probably plays and less risk in home run type of plays.

4. I think credit spreads and condors might be much at this point for some reasons I will go into later, but I would make sure you adhere to rule #2 if you choose to do iron condors. I would add that to be more disciplined and ensure that you never hold an Iron Condor if the unrealized loss is hits 20 - 25% of your total capital. If your account balance makes these parameters difficult to abide by then your account may not be sizable yet for these kind of positions. I may have had hits on Iron Condors when the market had unexpected dives or runs but since I limited maximum risk religiously, I never was at risk for an account blow up.

5. For now, decide on a percentage of your portfolio you will not touch for a bit while you learn, be it 20% or 40% or whatever. This means your account for trading is only 60 - 80% of original capital. Then apply rules from above. The more resitrctive you are initially on max loss and capital allocation, the easier it will be to learn discipline and prevent mistakes from taking you out. Ignore these rules and the one time you go joy riding is the one time you will see money leave your account really fast.

I know these are not option trading rules per se, more risk management rules but I can guarantee you one or two things on these rules:

Guarantee 1. Adhereing to these rules will ensure you can limit losses, prevent an account blow up, and last longer during the learning curve.

Guarantee 2. You will violate one or more of these rules in the future and suffer an unnecessary loss.

Guarantee 1 should prevent 2 but we are human and we all fall prey to the greed bug and take stupid losses. I think that is also part of the learning curve. Try hard to adhere to the rules and you will have more capital to work with and learn.

As for discipline for specific strategies we can get to that as well depending on the strategy. However let me get through your questions FIRST and then we need to discuss THETA and VEGA briefly.
 
Quote from optioncoach:

Let me tackle the questions one at a time during the day to make it easier to discus.

The first set of rules anyone should follow focus 100% on risk management. Right now as a newbie so to speak you are not fully aware of all trading strategies enough to know exactly what your trading style is and approach for finding positions comfortable just yet. So the first step is risk management with respect to position sizing and capital at risk. Of course a lot of this depends on what is your available capital, be it $1,000, $10k or $100k. Either way your first steps for discipline is as follows:

1. Never let anyone position have a maximum risk equal to your total portfolio. This one rule alone and if you are disciplined to follow it will hopefully ensure you never blow out.

2. I would add to rule #1 even more and never put a position one with more than 50% of your portfolio at risk.

3. If you are doing pure debit spread type of plays, look to risk in the 1 - 10% range max depending on your account size. As you get more experience you can adjust this, maybe put more risk in what you deem higher probably plays and less risk in home run type of plays.

4. I think credit spreads and condors might be much at this point for some reasons I will go into later, but I would make sure you adhere to rule #2 if you choose to do iron condors. I would add that to be more disciplined and ensure that you never hold an Iron Condor if the unrealized loss is hits 20 - 25% of your total capital. If your account balance makes these parameters difficult to abide by then your account may not be sizable yet for these kind of positions. I may have had hits on Iron Condors when the market had unexpected dives or runs but since I limited maximum risk religiously, I never was at risk for an account blow up.

5. For now, decide on a percentage of your portfolio you will not touch for a bit while you learn, be it 20% or 40% or whatever. This means your account for trading is only 60 - 80% of original capital. Then apply rules from above. The more resitrctive you are initially on max loss and capital allocation, the easier it will be to learn discipline and prevent mistakes from taking you out. Ignore these rules and the one time you go joy riding is the one time you will see money leave your account really fast.

I know these are not option trading rules per se, more risk management rules but I can guarantee you one or two things on these rules:

Guarantee 1. Adhereing to these rules will ensure you can limit losses, prevent an account blow up, and last longer during the learning curve.

Guarantee 2. You will violate one or more of these rules in the future and suffer an unnecessary loss.

Guarantee 1 should prevent 2 but we are human and we all fall prey to the greed bug and take stupid losses. I think that is also part of the learning curve. Try hard to adhere to the rules and you will have more capital to work with and learn.

As for discipline for specific strategies we can get to that as well depending on the strategy. However let me get through your questions FIRST and then we need to discuss THETA and VEGA briefly.
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How about max risk on credit spreads?

On unrealized lost, what would be the max unrealized lost for credit and debit spreads, same as condors at 20-25%?
 
Quote from mark trader:

How about max risk on credit spreads?

On unrealized lost, what would be the max unrealized lost for credit and debit spreads, same as condors at 20-25%?
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I may have overlapped some of my ideas in the previous post and caused some confusion so I apologize so lets take your question here clearer.

If you do a debit spread, I advocate only doing spreads with risk/reward greater than 1:1 for the most part. This will always keep you in a debit spread with greater reward potential than risk. In other words, risk $3.00 to make $7.00 in a debit spread.

Yes there may be some spreads where the debit is higher than the potential reward, such as for example ITM bull call spreads, which you can do if you truly feel the odds are in your favor (we will discuss ways to make such determinations soon). However I think a good rule of thumb is 1:1 or better.

As for debit spreads and total portfolio risk, the most you are willing to risk on a debit spread should not be more than 5-10% of your portfolio as a general rule. Depending on the size of your portfolio and your confidence in a position you may go over that but starting out with 1:1 or better debit spreads, try to keep the risk of each position controlled versus your entire portfolio value. If you put on 5 debit spreads and they all lose MAX value, which is a rare situation assuming you let all 5 go to $0 doing nothing, then you are not blowing out your account. Sometimes in managing your risk is not a bad idea to assume a given debit spread will be held to $0 and see how much risk that is for your account. Obviously we will not sit on a losing debit spread going to $0, but start off thinking of worst case scenerios to build up discipline.

As for credit spreads, the risk/reward is usually poor in most positions. In other words, people will risk $4.00 to make $1.00. The beauty of credit spreads such as bear call or bull put spreads is you know your maximum risk up front. I think 5-10% rule can still be employed but in this case the max risk might be larger but your cut off to bail is sooner.

FOr example, you might sell 10 credit spreads for $1.00 with max risk of $4.00. If you have a $20,000 account, I would consider bailing on the position if the unrealized loss hit $2k.

Strict rules like this are really difficult to impose as the situations are so different with respect to debit and credit spreads and taking into account time to expiration and potential unrelized losses from b/a spreads or intraday fluctuations.

If my suggested numbers seem to restrictive then use them as a guide to develop limited numbers more in line with your account balance. I cannot say my suggestions are mandatory, just trying to give you a guide. The bigger picture is not the numbers or cut-offs you choose but the fact that you are making a decision to limit risks in each positions to balanace your overall risks over many positions and prevent any one or two from blowing you out.

Hope that helps. More of a guide to get you thinking. After the greeks we will discuss ways of determining exit points and ways to make these determinations.
 
Quote from optioncoach:

Let me tackle the questions one at a time during the day to make it easier to discus.

The first set of rules anyone should follow focus 100% on risk management. Right now as a newbie so to speak you are not fully aware of all trading strategies enough to know exactly what your trading style is and approach for finding positions comfortable just yet. So the first step is risk management with respect to position sizing and capital at risk. Of course a lot of this depends on what is your available capital, be it $1,000, $10k or $100k. Either way your first steps for discipline is as follows:

1. Never let anyone position have a maximum risk equal to your total portfolio. This one rule alone and if you are disciplined to follow it will hopefully ensure you never blow out.

2. I would add to rule #1 even more and never put a position one with more than 50% of your portfolio at risk.

3. If you are doing pure debit spread type of plays, look to risk in the 1 - 10% range max depending on your account size. As you get more experience you can adjust this, maybe put more risk in what you deem higher probably plays and less risk in home run type of plays.

4. I think credit spreads and condors might be much at this point for some reasons I will go into later, but I would make sure you adhere to rule #2 if you choose to do iron condors. I would add that to be more disciplined and ensure that you never hold an Iron Condor if the unrealized loss is hits 20 - 25% of your total capital. If your account balance makes these parameters difficult to abide by then your account may not be sizable yet for these kind of positions. I may have had hits on Iron Condors when the market had unexpected dives or runs but since I limited maximum risk religiously, I never was at risk for an account blow up.

5. For now, decide on a percentage of your portfolio you will not touch for a bit while you learn, be it 20% or 40% or whatever. This means your account for trading is only 60 - 80% of original capital. Then apply rules from above. The more resitrctive you are initially on max loss and capital allocation, the easier it will be to learn discipline and prevent mistakes from taking you out. Ignore these rules and the one time you go joy riding is the one time you will see money leave your account really fast.

I know these are not option trading rules per se, more risk management rules but I can guarantee you one or two things on these rules:

Guarantee 1. Adhereing to these rules will ensure you can limit losses, prevent an account blow up, and last longer during the learning curve.

Guarantee 2. You will violate one or more of these rules in the future and suffer an unnecessary loss.

Guarantee 1 should prevent 2 but we are human and we all fall prey to the greed bug and take stupid losses. I think that is also part of the learning curve. Try hard to adhere to the rules and you will have more capital to work with and learn.

As for discipline for specific strategies we can get to that as well depending on the strategy. However let me get through your questions FIRST and then we need to discuss THETA and VEGA briefly.
More...

This is some great advice, money management keeps you in the game. "Market Wizards" has some great money management advice.
 
Quote from mark trader:


2. Risk/Reward: I am now pretty familiar with the mechanics of credit spreads and condors. However, need knowledge on how to find the best strike to get min risk and max profit, an other words premium that gives me the best return based on the risk I am willing to take on

3. Market Experience: From reading your postings on SPX Credit Spread trader, I know you know the market like the back of your hand and this took many years of experience. What advice would you give me to gain market knowledge, what to watch out for credit spreads, condors? what/how to study the market to avoid costly mistakes? I read in your other postings summer is a quite time in the market.... for a newbie, these are the types of things that we don't know about.....
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These two questions above are sort of related. I do not know the market like the back of my hand but you nailed another point, "experience". One thing I do daily and throughout the day is study charts of the underlying I am trading options on (in the current case, SPX and NDX). Studying the price charts is what gives you a feel for the movement of the underlying, but most importantly, support and resistance. I advocate studying the price charts but I do not have any fixed technical analysis tools I would preach one to use.

As for technical analysis let me say this. What ever technical analysis tools you use, realize this, they are all just tools to guide you in analyzing one thing- price action. Technical analysis is not a substitution for personal analysis or a black box system for determining S/R levels or liklihood of price action. I basically focus on reading the price charts for trends and S/R. I may use some MAs or slow stochs for guidance but mainly focus on looking at the price action on the daily charts and consider the fundamentals of the overall market (market situation, economy, data releases, sentiment, Fed, time of year, Sector issues, etc...).

I do this mainly on indexes but you obviously can do the same on underlying stocks.

For example, assume you want to go long GOOG via a 530/540 bull call spread for a debit of $4.00 (making this up so do not focus on whether these are the real numbers). So risking $4 to make $6 which is good r:r ratio. GOOG right now at $526. Let's assume that after studying the charts we see from previous lows and the major gap that $515 is a strong support area. If $515 is broken the stock is more likely than not to keep moving lower, possibly to close the gap at $450. Well obviously that kind of move would push your bull call spread to be worthless if you sat there and held it as the stock dove through support and never made it back higher as expiration approached. So using your analysis of S//R levels of GOOG you can determine that if GOOG closes below $515 and breaks support you will bail on your bull call spread. If there is time to expiration left then the spread will still have some value and you are not taking the full $4.00 loss.

Therefore you are using the analysis of the underlying price action to determine your stop loss on the debit spread and it presents a logical exit point. This may make more sense that simply saying you will bail if spread goes to $2.00 since you are ignoring the price action. That is why I say focus on the max risk of the debit spread so that you size the position accordingly and can stay in unless the price action tells you to get out.

So before every debit or credit spread or any position you wish to enter, find logical S/R levels or price action points which alert you to potential changes in trend or sentiment or price direction and use those as signals for profit taking or exiting to limit losses.

S/R is what I discussed in the SPX thread on where I selected strikes, i.e. choosing strikes a few strikes beyond S/R points. If S/R was broken, I would get out, among other stop loss targets I would employ. so my advice to you to gain market knowledge is to simply study the price charts and different areas of technical analysis that provide you with tools you find useful to analyze price action to understand what the underlying is doing as best as you can. Doing this daily helps you better sense what the stock is more likely than not going to do and then select strikes accordingly. This is not a trick you pick up once but a skill to be learned over time.

I study NDX and SPX charts daily to keep honing my skills as well as keep my informed what is going on.
 
Coach, thanks for the invaluable information on risk management and how to gaining knowledge to trade the underlying.

To prepare myself for live trading, which indices should I focus on studying. My philosophy is to get very very good in 1-2 strategies and 1-2 indices to begin with. If this limits me to not be able to trade all the time, I am fine with that. What I want is to have a solid base to work with and as I gain confidence and knowledge I would then master other strategies one at a time.

My current goal is to make consistent income (limited risk & rewards) so I started with conservative strategies like iron condor, spreads, I have not look into butterfly or calendar spread, etc, since my understanding is that they yield higher rewards however requires a more precise understanding of volatility and timing and not the best vechicles for consistent income.

So my 2 key questions are:
1. Which indices to focus on to get me started (SPY, NDX, IWM)?
2. Which strategies to master so it is inline with my current goal
 
Sorry been in and out this whole week. Let me say that SPX and NDX are the best to start out with to study the price charts since they are the most widely followed indexes and studying S/R levels in line with fundamental and techinical news is the best way to develop the skills.

I will get back to the other question shortly.
 
Quote from optioncoach:

Sorry been in and out this whole week. Let me say that SPX and NDX are the best to start out with to study the price charts since they are the most widely followed indexes and studying S/R levels in line with fundamental and techinical news is the best way to develop the skills.

I will get back to the other question shortly.
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No problem at all, no apologies needed, I am very appreciative of your willingness to take the time at all, have a great 4th!
 
I am a member with Options Mentoring with John Ondercin and my experience went like this. he teaches you high risk, low reward but high probability credit spreads to start. I did well at first but if you account is small you wont make alot of money and if you lose it will take you a long time to make the money back. He really specializes in teaching collars trades which requires a substantial amount of money moe like 50K and up. I did well until the recent market crash in october were i got caught on the wrong side of the trade and couldn't get out due to volitility spiking too high. i lost most of my account (remember high risk and low reward). In general if it wasn't for the unusual market crash i would probably be very happy but like i said it takes a long time to rebuild account.

John
 
Quote from JohnCondor:

i lost most of my account (remember high risk and low reward). In general if it wasn't for the unusual market crash i would probably be very happy but like i said it takes a long time to rebuild account.

John
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It sounds like Ondercin doesn't teach money management which is a very important aspect of any type of trading.
 
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