Butterfly Options » Invest

Holy Grailism and Trading Systems â Why Do so Many Traders Fail?

admin — Sun, 03 Jan 2010 12:11:45 +0000

Humans are hard wired in life to succeed and by definition we measure success by successful achievements. When people try their hand at stock market trading they try use the same measurement and inevitably become stuck in a loop of jumping from system to system tweaking this and that and eventually giving up.

This brings us to what in my opinion is one of the principle causes for the 90%ers of Net-Losers-United which Holy Grailism. The average loser comes up with a good system, however irrespective of win rate all systems can and will go through strings of losses. What will the average spread better do when faced with the inevitable, a succession of trades going against them? They lose faith, dump their system, and go looking for a new one. Not everybody will agree with me on this, but I am firmly convinced that a good, robust system, a system that is aligned with how markets work, would have worked in the day and age of Jesse Livermore just as well as today. Reminiscences of a stock operator is what taught me trading, and that book is a hundred years old. I do not think that markets change, simply because humans don’t change, and humans are the ones that drive markets, be it discretionally or through computer models that humans wrote, it’s always a human at the end of the day that influences what happens. Markets just simply are not predictable… Why are markets not predictable? Because Markets are nothing else than the collective result of all their participants actions… Actions driven by hope, fear and greed, on what will happen next. There is no inner logic to markets, there is no system to markets, and there is no secret explanation to price development… Anything can happen at absolutely any time if somebody influential gets a brain fart and shares that with the media, or if a large enough order pushes a market in a direction opposed to what your clever analysis would have you believe should happen next… Markets are simply constantly being pushed to and fro by the diverging interests of all their participants, all following their own agenda. A market is nothing else than a conglomeration of huge numbers of participants all following totally different objectives… You have hedgers, you have speculators. You have fundamental traders, you have technical traders. You have scalpers, day traders, swing traders, position traders. You have participants that see the same price levels, yet for some the price is too high, for others it’s too lowâ¦etc Every participant in the markets has a different perceptive, different objectives, and different risk parameters. That is why the notion of predictable markets which follows some inner system is nonsense, and thatâs why the search for the Holy Grail to unlock the hidden market secrets is a quest best left to the 90% of net losers. The market is composed not of an inner logic or system that is separate from its constituting participants, no, a market is nothing but the sum of its constituting participants, each of whom has his own agenda, doing his own thing. Anybody who honestly believes that markets do what technical analysis says they should do next should just watch Mr Soros buy 10 Billion Euros and see what happens to all their clever analysis.In fact you can generate a random chart of anything, and that chart will look exactly like a real chart of a real instrument! Anybody who honestly believes that a chart of a real instrument will look different than its random counterpart has just never looked at a random chart. BUT, where academia gets it wrong, is that randomness of markets absolutely does not mean you cannot profitably trade them. Random charts have tradeable trends just like all charts do. The real problem is that people like to believe that they are clever, and that they can, through their cleverness, analyse situations, come up with the correct answer, and solve problems. Ego dictates that people have a real need to believe that success is their very own achievement, while lack of success is usually attributed to circumstances beyond their control. Look, we know that trading has nothing to do with being right… Brett Steenbarger says â…As a rule, maximizing batting average/minimizing drawdown comes at the cost of lowering overall system profitability….â Why do people still insist on wasting time, money and effort on solving problems that do not exist, on trying to outwit what cannot be outwitted, markets that are nothing else than the sum of all our actions ? There is no pattern that tells you what will happen next, BUT you do not need that to make more money than you can ever spend. Stop chasing the holy grail, stop believing that if you just keep on studying markets you will one day be able to predict what happens next, you do not need to feel that you understand price to get rich. Markets can go up, down or sideways, that is all they do. All you need to make a fortune is to do what any kid in kindergarten could do, grab a chart, eyeball where the path of least resistance is, jump on board, cut your losses when and as they occur, and otherwise ride that trend all the way until it bends. Trading is nothing than a probability game. You create your positive expectancy not through predicting markets. You create your net profitability through your preferred combination of risk / reward ratios and win rate, through either on average letting your winners run longer than your losers with a lower win rate, or by cashing in smaller winners than losers albeit with a higher win rate. That is all trading is, it’s not about being right, it’s about making money by understanding that it’s just a numbers game. Next time someone tells you they have a great new system thatâs going to beat the markets just give Mr Soros a call and tell him to buy ten billion worth of EUR/USD while watching your friends pipe dream go up in smoke. Like Exile says, trading is simple, maybe not easy, but simple.KISS!

Rick Redmont Bases Trading on Wyckoff Theories

admin — Sat, 19 Dec 2009 12:24:49 +0000

Off-floor trader Rick Redmont gained his first experience trading stocks as a college student during the bull market of 1961. “I had $10,000, which turned into $20,000. I followed the Chartcraft (Inc.) point and figure book-but it didn’t really matter what you bought. The only thing that made you mad was if your friend’s stock went up more than yours did.”
“Then in 1962, I started losing. The reason I was losing was because the stock market wasn’t going straight up anymore,” Redmont explained. “I turned $10,000 into $20,000 and $20,000 into $2,000.” Redmont jokes that his family members gave him books for Christmas that year with title like I was a teenage bankrupt. However, Redmont was spurred on by his financial setback. “I decided anything that had the potential to double my money and lose it all was worth learning about,” he said.
He launched into a study of “almost everything that has been written from 1900 to date” on trading and technical analysis. After graduate school, Redmont joined the brokerage business and remained a broker until several years ago, when he broke away to trade for his own account. One of the books Redmont read early on was the classic Technical Analysis of Stock Trends, by Edwards and Magee.
However, Redmont thought “intellectually, if it’s this easy-if all you have to do is look at head and shoulders, triangles and rectangleseverybody would be rich!”
Through his exhaustive reading of the materials available on financial markets and trading, Redmont happened upon a course offered by the Stock Market Institute that really hit home for him. “It is all based on the work of Richard D. Wyckoff. It teaches you how to use real point and figure charts and the origin was from floor traders back in the 1800s.”
“It teaches you the relationship of volume and price and point and figures. From there, I really learned how to understand how the market operates,” Redmont continued. Tbough he added, “I spent three years on this.” Additionally, Redmont notes that he enrolled in an Elliott wave course offered by C. Ralph Dystant and learned about an indicator called %D. Now, Redmont calls himself strictly a technical trader. “I use Wyckoff, I use Elliott, and the indicator I use is fast %D.”
Currently, Redmont trades “about 98% OEX options.” Redmont trades on an intraday basis, though he does hold positions overnight but overall, he tends to be a short-term trader. Throughout the day Redmont monitors five minute charts, 30-minute charts and 60-minute charts. “I look for divergences between the Dow, the OEX and the S&P (500).”
“I look at different time periods. I look at the premium. I look at the advance/decline line on a five minute basis and tick volume,” Redmont added. While Redmont bases his trading primarly on Wyckoff’s volume theories, he admits “there is no system. It’s total discretion-it’s as good as I am. I keep it simple. I buy calls and I buy puts. I don’t spread them. I just want to know what direction it is going.” Redmont champions Wyckoff’s volume theories saying “it works because it is the market. You are analyzing the law of supply and demand,” he explained.
To further explain a basic premise of Wyckoff’s volume theory, Redmont gives a simple example. “You are looking at a stock. It trades 10,000 shares and goes up one point on the first day. The same thing happens on the second day. On the third day, it trades 20,000 shares and goes up 1 point. On the fourth day, it trades 40,000 shares and goes up half a point. On the fifth day, it trades 80,000 shares and is unchanged.”
“On the third day, you had to exert twice as much effort to get the same result (as the first day),” Redmont noted. “The key to analyzing supply and demand is that the demand side burns itself out. There is no pressing reason, except being caught short, why someone should buy something. But, there are a million reasons to sell something.”
“When the buying is through and satisfied-there is always supply there. That’s why prices go down faster-because supply is always there and demand is not. All you have to do is withdraw people who want to buy and prices fall.”
While Redmont primarily trades OEX options, he believes that Wyckoff’s volume theories are just as applicable to the futures markets. “What difference does it make if you are analyzing the S&P or sugar or cotton or the Japanese yen-the analysis is the same,” he said. In his trading, Redmont notes he does monitor the size of market’s corrective retreats and rallies. “As (Fibonnaci numbers) became more popular, the markets started connecting 61.8% and 38.2%. Today, very rarely do they correct 50%.”
Based on work by Fibonnaci, many technical analysts have speculated that financial markets tend to move in sequences that can be measured by these numbers-including 61.8% and 38.2%. However, Redmont said, “these things work in the markets because people use them-it’s not because it’s mystic, or in plant life, or in the pyramids.” For example, in watching the markets, Redmont said, “if you have a move up and you have a correction, you want volume to drop off and you want that to fall into a 61.8%.”
While Redmont notes that Wyckoff theory works for him, he suggests potential traders read two books-Market Wizards and The New Market Wizards, by Jack Schwager. “Read them with one purpose in mind-to understand that there are 40 people who were successful doing different things.” When asked what some of the characteristics he believes are necessary to successful futures trading, Redmont answered, “dramatic concentration powers to understand the markets and to spend the time learning the niche of whatever it is they do.”

Buying and Selling Options

admin — Fri, 18 Dec 2009 23:42:41 +0000

Now, let’s consider stock and stock options for a moment. Consider the ubiquitous XYZ Corp., currently trading at $95 per share on 2/1/03. If you pay $4 per share for a March call on 100 shares of XYZ at the $100 strike price, you have acquired the right to buy 100 shares of XYZ for $100 per share, any time before the third Friday in March. This cost you $400, plus commissions.
If XYZ is investigated for “irregular accounting practices” (the equivalent of discovering a toxic waste spill in the backyard), the share price may drop to $50. The call you paid $400 for is probably worth about $20. You’ve lost nearly 100% of your investment, and I wouldn’t count on getting it back. But you’ve only lost $400.
Imagine if you had owned 100 shares of XYZ stock. What was worth $9500 yesterday is now worth $5000. That’s a loss of $4500! Sure, you can wait for the stock to recover — there’s no time limit with stock.
The call, on the other hand, will expire worthless (or you’ll sell it for next to nothing) in a few weeks, but would you rather lose $400 or $4500? Would you prefer to hang on for years, waiting for XYZ to double in price so you can break even, or would you rather accept your $400 loss and move on to the next opportunity?
On the other hand, suppose XYZ announces that they’re coming out with the world’s first odorless, tasteless, wireless, weightless, invisible widget (the diamond mine in the rose garden). The stock jumps to $150. Now your call is worth about $6500. Not bad for a $400 risk.
Imagine if you had owned 100 shares of XYZ stock. What was worth $9500 yesterday is now worth $15,000. Awesome. But look at the percentages. The stock increased 58%. Incredible. A gain of $5500. But the call increased a whopping 1525%. A gain of $6100. Of course, these numbers are fictitious, unrealistic, and tailored to make a point.
Stocks don’t usually move like that. People rarely discover toxic dumps or diamond mines. But the point is that options move with the underlying, while costing you less and having a fixed, limited risk. Time is the one factor that is against you with options. It is the one gotcha you have to watch out for when buying options.
Selling Options
Now, let’s look at the same events from the seller’s viewpoint. First, let’s suppose that the seller of the XYZ call also owns 100 shares of XYZ stock. This is known as a covered call. It is considered a conservative options position. Many IRA accounts that will not even let you buy a call or put will still let you sell a covered call against stock you own.
So, our call seller owns 100 shares of XYZ and sells a call against it. The irregular accounting practices investigation is announced and the stock plummets. The seller is stuck holding a stock that just lost nearly half its value. The one consolation is that the call premium, the $400 received for selling the call, is his to keep. Very little consolation, actually.
Holding stock has inherent risks, as the last few years has made abundantly clear. Selling the call put cash in his pocket, independent of the risk of holding the stock. In fact, had he held the stock, and not sold the covered call, he would have been $400 worse off.
Given the same 100 shares of stock and one short (meaning he sold) call, let’s examine the diamond mine scenario. Here the stock shoots up over 50%. This is the part that makes call sellers very sad indeed. Instead of having a 50% increase in his stock, he has the $400 premium.
The call buyer is surely going to exercise his option to call the stock away from him at the strike price. That is, the call seller will have to sell his stock for $100, since that’s what the strike price of the call is, even though the stock is now worth $150. He sold, for $400, his right to enjoy that big move.
But that is an emotional loss, not a financial one. He still sold his stock at the anticipated price, and pocketed the $400 option premium, as well. The fact that the stock climbed above his strike price is disappointing, but not a loss of money.
Sometimes the stock goes up just a little, or hovers near the strike price. If the stock goes up to $102, the call seller sells a $102 stock at the $100 strike price, but has still pocketed $4 per share on the call, and still ends up ahead. If the stock is at or below $100 on expiration day, the short call expires worthless, and the call writer has both the stock AND the $400 option premium. He can then write another call against the stock.
Naked Options
Now let’s look briefly at the result of selling naked calls. In this scenario, the call writer simply sells the call and does not own any of the underlying stock to cover the short call. If the stock plummets, the call writer is very happy and relieved.
The premium of $400 is his to keep, and no one will be knocking on his door asking to buy the stock for $100 per share, since it is available on the open market for $50. It’s his ideal scenario. Actually, any stock price at or below the strike price will be in his favor.
However, here’s a very bad scenario. The call writer sells short a naked call. And the stock leaps 50%. He’s got big problems. Somebody’s going to want to buy XYZ from him for $100 per share, just as the option contract states.
But he doesn’t own any shares of XYZ. So he now has to go to the open market and buy 100 shares at the current market price, which is $150 per share. He took in $400 of premium and now has to cover is with a $15,000 stock purchase, for which he will only receive $10,000. He loses $4600 ($10,000 – $15,000 + $400). Not a happy ending.
Do NOT even consider selling naked calls. Your broker probably would not allow you to anyway. However, until you really know what you are doing, don’t sell naked puts either. When the bottom drops out of a market, naked put holders get very, very badly hurt. They are forced to pay high prices for low priced stock. You do NOT want to be in this position!
An option gives you something called leverage. Leverage is when you are able to control a large amount of money with a small investment. Each option contract lets you control 100 shares of stock for far less than the cost of buying those shares. But leverage is not the best reason to trade with options.
True, with the leverage that options afford you, you stand to risk less and make more, assuming things move in your favor AND in your time frame. Remember the expiration date! You have traded leverage for limited shelf life. If things don’t move your way soon enough, you lose. So, what is the main reason to trade options? Spreads!

Naked Options

admin — Fri, 18 Dec 2009 13:47:33 +0000

Options are one of the oldest trading vehicles man has ever used. Around a 1000 B.C Aristotle Thales predicted by the stars that there would be a bumper olive harvest and bought options on the use of olive presses.
When the harvest did in fact prove to be a great harvest Thales was able to rent the presses at a significant profit.
When you buy an option you have the right but not the obligation to buy (call) or sell (put) a specific underlying asset at a prearranged price on or before a given date.
Similar to futures, options can give the holder protection against adverse price moves.
Call options when bought allow you to buy an asset at a fixed price (strike price) on or before a specific exercise date.
Exercise date: some options can only be exercised on a particular date and they are commonly know as European options. Options that can be exercised on or before the due date are commonly known as American options).
A Put options is the reverse of the call option. When you buy a put option it gives you the right but not the obligation to sell an underlying asset at a predetermined date.
Now let’s look briefly at the result of selling naked calls. In this scenario, the call writer simply sells the call and does not own any of the underlying stock to cover the short call. If the stock plummets, the call writer is very happy and relieved.
The premium of $400 is his to keep, and no one will be knocking on his door asking to buy the stock for $100 per share, since it is available on the open market for $50. It’s his ideal scenario. Actually, any stock price at or below the strike price will be in his favor.
However, here’s a very bad scenario. The call writer sells short a naked call. And the stock leaps 50%. He’s got big problems. Somebody’s going to want to buy XYZ from him for $100 per share, just as the option contract states.
But he doesn’t own any shares of XYZ. So he now has to go to the open market and buy 100 shares at the current market price, which is $150 per share. He took in $400 of premium and now has to cover is with a $15,000 stock purchase, for which he will only receive $10,000. He loses $4600 ($10,000 – $15,000 + $400). Not a happy ending.
Do NOT even consider selling naked calls. Your broker probably would not allow you to anyway. However, until you really know what you are doing, don’t sell naked puts either. When the bottom drops out of a market, naked put holders get very, very badly hurt. They are forced to pay high prices for low priced stock. You do NOT want to be in this position!
An option gives you something called leverage. Leverage is when you are able to control a large amount of money with a small investment. Each option contract lets you control 100 shares of stock for far less than the cost of buying those shares. But leverage is not the best reason to trade with options.
True, with the leverage that options afford you, you stand to risk less and make more, assuming things move in your favor AND in your time frame. Remember the expiration date! You have traded leverage for limited shelf life. If things don’t move your way soon enough, you lose. So, what is the main reason to trade options? Spreads!

The Joy of Options

admin — Sun, 13 Dec 2009 11:32:38 +0000

Owning stock has only two, maybe three, possibilities. The stock goes up. Or the stock goes down. Or, as a third possibility, it does a little of both. If you buy a stock, all you want it to do is go up.
If you sell a stock short or close a position (or consider buying it and then decide not to , all you want it to do is go down. I call this one-dimensional trading. You’re long, you’re short, or you’re flat. Your gains and losses travel up and down the number line you may remember from elementary school in lock step with the movement of the stock. Not only that, but it takes a big move to make a big profit. And a big move against you can mean a big loss. Potentially all the way down to zero.
You need to add a second dimension to your trading. You need more choices than picking a direction and hoping you are right. You need to limit your losses, improve your returns, and increase your flexibility. You need options.
For many people, options are something to avoid, being dangerous, complex, and scary. I would like to introduce you to the joy of options. Any time you think you want to buy a stock, I’d like to get you in the habit of first looking at how you could do more with less using options.
In the stock and commodities markets, the type of option we just described would be known as a call. A call typically represents 100 shares of a stock. In the commodities markets, a single option contract represents a single futures contract. (For simplicity, from this point forward, I will talk about options on stock. Just remember that the same discussion applies to options on futures.)
Owning a call gives the owner the right to buy 100 shares (usually) of the underlying stock at the agreed upon strike price at or before the expiration date. (I say “usually” 100 shares because, due to splits or acquisitions, there are times when an options contract may represent something other than 100 shares.) Selling a call gives the seller the obligation to sell, if asked, 100 shares of the underlying stock at the agreed upon strike price any time up until the expiration date.
The other kind of option is called a put, and it is exactly the same as a call with one simple difference. A put gives the owner the right to sell 100 shares (again, usually) of the underlying stock at the agreed upon strike price at or before the expiration date. You can think of a put as insurance. No matter how badly the stock price crashes, having a put means that you can sell your stock for the strike price. On the flip side, selling that put means you may be obliged to buy stock at far more than its current market price.
An important distinction to always keep in mind: Buying an option gives you rights. Selling an option gives you obligations. Buying an option cannot cost you more than what you pay for the option. Selling an option can cost you far more than what you receive for selling the option.
Let’s examine the terminology of calls and puts. The underlying is the actual instrument such as a stock or commodity that is being represented by the options contract. In the real estate example, the house would be the underlying. Options are said to be derivatives because their value is directly tied to or derived from that of the underlying. An option has no meaning without an actual asset underlying it. It is the right to buy or sell that underlying asset that gives the option a reason for being and some value.
The strike price is the agreed upon price for which the underlying can be bought or sold under the terms of the option contract. In the real estate example, the strike price was $100,000. The expiration date, obviously, is the date when the option expires. The day after expiration, an option is worthless. This is the single most important fact about options that you must remember. This is why your friends think you are crazy for your interest in options. Unlike a stock, which you can hold forever, an option has a clearly defined shelf life.
One term remains, and that is the premium. The premium is what you pay for the option, when you are the buyer. Or what you receive for an option, when you are the seller. In our real estate example, the premium was $500. That’s what it cost you to hold the right to buy the house any time in that thirty-day period. The last day of the thirty-day period would, again, be the expiration date.
We have barely scratched the surface. I say that not to intimidate you, but to make you realize that you only have enough knowledge to be dangerous to yourself. Please do not think that you are ready to go out and buy calls or place spread trades. You are not. You don’t know how an option moves relative to moves in the price of the underlying. You don’t know what time does to the value of an option. You don’t know what volatility is or how it plays into option prices. You don’t know the types of spreads or what they are used for.
Please, please get yourself better educated before you start putting money into option trades. Resist the temptation to buy some cheap options, just to try it out. This is expensive education. There are plenty of advantages to trading options, but it’s still a ruthless market, happy to take your money, your wallet, and your hand if you give it an opportunity. Learn the rules of the game before you put money on the line.
Trading options can be satisfying, rewarding, stimulating, and fun. I invite you to add another dimension to your trading by including options to your repertoire.

Butterfly Options » Invest

Holy Grailism and Trading Systems â Why Do so Many Traders Fail?

Rick Redmont Bases Trading on Wyckoff Theories

Buying and Selling Options

Naked Options

The Joy of Options

Holy Grailism and Trading Systems â Why Do so Many Traders Fail?