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Editor's Note: Many investors steer clear of options, thinking them too difficult or risky to trade. That's a common misconception – one Tom's determined to set straight. He first identified these four simple steps to options success in 2015, but they stand the test of time. Here's Tom…
A Money Morning reader recently wrote in and summed up what we often hear: "Options scare the heck out of me."
It's common for investors to think options are too risky for them. That's why many never bother to try.
But the options trading strategies I teach you can reduce risk by up to 90% compared to if you bought the underlying stock. And in 2008, when many lost 50% of their savings to the stock market plunge, options could have reduced that loss to 10%.
The markets will do whatever they want. It is not what happens in the markets that will make or break you. It's how you deal with what the markets do after you make your entry decisions that will set you – and your profits – apart from others.
My goal is to have you learn exactly what options can do for you. Understanding the potential reward as well as the risk can help you overcome your fear. I'll show you the proper principles and rules to follow so you know what to do and what not to do.
Let's get started…
Four Steps to Options Success
The options trading process involves four basic components. Follow all four – and give equal importance to each – and you'll become comfortable with this strategy and with options.
Here are the four key factors to successful options trading:
- Find a reward-to-risk trade setup that favors reward
- Utilize a low(er) risk trading strategy to take advantage of it
- Have a clear entry and exit plan
- Stay disciplined
The first part – finding a reward-to-risk trade setup – means finding a stock we believe can make a move. I find this using technical analysis.
Technical analysis involves analyzing different charts to find repeatable price moves and patterns. It does not matter which direction the repeated pattern makes; there are strategies that can make you money if a stock moves up, down, or sideways. The first goal is to find these setups.
The second component is to use a strategy to take advantage of these moves. Options involve a "lower risk" trading strategy because they require less capital than buying a stock, so you're risking less money. As I've outlined in previous articles, long calls, long puts, and the bull-call spread are examples of ways to spend less and earn more.
To establish an entry/exit plan, first you need to know how much you want to risk on each trade as a percentage of your trading or overall portfolio. Then know under what conditions or at what price you will open or take the trade. Then have a clear exit plan both for profit or loss. I outline these when I highlight opportunities to readers in Money Morning, in my Power Profit Trades publication, and in my premium trading services.
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.