The 10 Commandments of Options Trading in 2020

If you're new to Money Morning, my name is Chris Johnson, and I have 23 years of experience as a Wall Street quant (quants are like the "rocket scientists" of investing).

I began building my proprietary trading models in 1998, analyzing about 2,000 records per day. Today, that database, which I designed and coded from scratch, analyzes a staggering 700,000 records per day.

But today I want to introduce you to something simpler.

I've developed 10 easy-to-follow, must-know "commandments" that could save you years of trial and error.

Here they are...

My 10 Options Trading Commandments for 2020

  1. The trend is your friend.

Stocks are much more likely to continue a trend than to break it, so you don't want to bet against the trend without solid reasons to believe the stock will change direction.

  1. Don't run with the crowd; avoid bandwagon stocks... unless you're driving.

The latest stock making headlines is rarely a good target for an options play because the odds of getting a good entry price diminish quickly when everyone's piling on it at once.

If you're in the trade before the crowd, however, all of that extra attention can set you up for a huge windfall.

  1. Cheap can always be cheaper; expensive can always become more expensive.

Amazon's sky-high price/earnings ratio hasn't stopped it from beating the Dow nine-fold over the past five years. Just because a stock is technically "overbought" or "oversold" doesn't mean it will suddenly reverse.

  1. Don't pick up pennies in front of a steamroller.

Listen to the overall market narrative. If an external force like trade, politics, or war is putting pressure on the markets, there's no reason to try to get clever on a "contrarian" play. If you do, you're likely to be "steamrolled" by the prevailing market action.

  1. The "smart money" rarely tells you what it's doing.

Trying to follow along with the big institutional investors is a losing game. They operate with different rules and on a different scale than average traders. If a big bank isn't buying, that doesn't necessarily mean you shouldn't, and vice versa.

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  1. Short sellers are a bull's best friend...

When a stock has a short interest ratio (or short ratio) greater than 6, it means there is a lot of money betting against the stock. If the stock starts to go up, the short investors will buy shares to cut their losses, driving the stock price even higher...

  1. ... and so is volatility.

Market panic creates the big price swings that yield life-changing options profits. When the CBOE Volatility Index (the "VIX") is under 25, markets are calm, and a trend reversal is unlikely. When the VIX spikes, however, opportunities soon follow.

  1. Round numbers are natural support and resistance levels - the more zeros, the better.

Look out for multiples of 10, 100, or even 1,000 on stock price charts. Traders are human, too, so breaking above (or below) one of these levels can lead to more buying (or selling).

  1. Stocks are driven higher by speculation, not fundamentals.

When investors and traders are willing to put money in riskier assets, the market rises. When investors get cautious and move to "safe" industries like healthcare and utilities, volatility declines, and the markets stagnate.

  1. There's an exception to every rule.

Technical indicators are powerful predictive tools, but if they were right every time, everyone would use them, and they'd become useless. Your safest bet is when multiple technical signs agree.

If you stick to them, my 10 options trading commandments should guide you to a profitable new year.

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About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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