Entry is Key...Exit is Everything! ^TM

Thou Shalt Not

Review these 10 Rules at least once a week.

The rules of the game... follow them and prosper... reject them and suffer the consequences!

Rule No. 1: A wise man never puts all his eggs into one basket!

If you are going to play the options game, then sound money management is key to your success.

My rules to live by when trading options are:

• Only invest with money you can afford to lose.

• Never put all your money into one trade. If you have $2000, then invest into four $200 - 500 plays; if you have $5000 then 5 or 7 plays; and if you have $10,000, then diversify most of your capital into several smaller plays.

• The general rule is never having more than 10% of your available capital in any single option trade.

• Diversification is the quickest way to long-term wealth...and if you have a bad trade, you still have capital to try again—once you put all your money into one play, you are sure to lose all of it!

• Keep your plays separate by diversifying into Calls, Puts, Spreads and LEAPS.

Rule No. 2: Know your exit!

I cannot emphasize enough that you better know what you want out of a trade before you decide to pull the trigger with your real money. Always plan your trade, then work your plan. For those who just take a shot, it’s like sailing a ship without a rudder; and you are destined to hit the rocks and sink! 

Watch out for GREED, this is enemy number one, then there is FEAR, which is enemy number two. Once you control one, the other takes over—you have to practice at controlling both. The ONLY way to begin to control them is trading live with small lots; because a paper trading account cannot teach you to protect what you do not have...skin in the game!

What I have found that a paper trading account can teach you is real-time experience to prepare you for trading with your actual money; however, it is important that you develop proper trading habits and not reckless ones—your subconscious mind does not differentiate reality from fantasy, so live in the moment and play for real!

The best way to start with a paper trading account is to fund it with 50% LESS in buying power than you plan to trade a live account with. Once you start, you MUST trade with 100% of the funds every time until you can double that same amount of money 10 times in a row. You cannot put in stop losses because you will not learn from a safety net—it's all about understanding your limitations and then mastering them that makes you a professional trader.

When you are successful, then, and only then, you can fund your account and start trading with real money.

When you do start trading with real money, the first emotion that most traders experience is fear of loss. If you have properly trained with your practice account, then you should overcome this one quickly.

The next emotion that will blow up any and all trading accounts you fund is GREED. In order to slay that dragon, you trade small lots and take profits often. Never use more than 10% of your capital in a single trade; and fix your initial  profit targets at 50-100%. By trading small lots, and taking profits often, you build confidence and proper discipline. 

I used to recommend placing stop losses, but through my 20 years of day trading experience, I have learned that stop losses give you a false sense of security. If you think you need a stop loss, then you are trading with too much size. Many traders are willing to accept a 50% loss, so why not simply reduce your size to 50% of what you wanted to trade; and let the chips fall where they may. Also, stop losses tend to get hunted down by algorithms taking you out of what usually becomes a profitable trade later—if your analysis is correct when you enter the trades.

Remember,  if you are trading small, your fear of loss is diminished so you can spend your time managing your winners and compounding your size with profits!

Once you have built up profits, then you can expand into more strategies like: White Whale and Lotto Trades that can become massive winners!!!

My trading motto is: "Live to fish for another Lotto Trade pay day!"

Rule No. 3: In the Options market, "Time" is always your enemy.    

Never play options that are too far Out-of-the-Money (OTM) for short-term plays. There is an enemy called time-decay, and when you play the deep OTM options, the stock has to move dramatically in your direction to overcome the depreciation of said time-decay.

The fallacy is cheap options allow you to buy more contracts; thereby giving you a larger profit, but you have to ask yourself, why are they so cheap? Novice traders like them and the Market Makers know it; it's like taking expensive candy from a baby—this is gambling and not investing to win and if you want to gamble, come to Las Vegas where you get some entertainment while you lose your money.

Rule No. 4: When you go shopping, never buy at the Market.  

NEVER place a "Market Order" when trading options unless you do not care what price you get filled at. Too many times throughout the day, I see novice traders get filled on options $0.10 to $1.00 higher as Market Makers practically have a license to steal! It seems unfair, but it’s called the "fast-market-rule" which allows the Market Makers to fill you inside a very large price range—and it’s rarely in your favor.

Watch the 1-minutes charts and you will see wicks on the candlestick bars spike up or down from the current price—this usually indicates a market order was filled.

When you see the prices (BID/ASK) displayed, they are ALWAYS packed with implied volatility (IV) or slippage by the Market Makers. Therefore, you should always place "limit" orders at the "BID" or even lower because many times you will get "price improvement" and that increased your profits later!

If you really want it, and do not care at what price you plan on getting it at, then go for it; however, I would NEVER place a market order before the opening bell.

Rule No. 5: The winds of change are a cruel master.

It has been said by many: "Never try to catch a falling knife" or try to "stop a fueled rocket." Well, with one less finger and a burnt hand as I type this, I can relate and spare you the pain. When the stock you are looking to trade is exploding up on news or earnings, wait for it to tell you its done (climactic advance on huge volume for instance) before you buy a PUT and or short it or when it’s dropping like a rock, watch for the bounce (with large volume) off well defined support (see charting) before you jump in.

Too many times, novice traders think they've got it all figured out and try to pick the tops or bottoms; only to experience the pain of impulsive decision making—with experience, you will recognize when a stock gives you a clear signal it’s time to jump in.

Rule No. 6: Greed has many faces but the results are always disastrous.

You cannot go broke taking profits! Too many times I have tried to stretch profits on a winning trade; only to see a modest profit reverse and end up losing money—not to mention, taking all my original investment along with it too.

Once you have been fortunate enough to make a 100% return on your investment...take at least 50% of it and see where the rest can lead to. If momentum is strong, and you have more profits building, then you can consider buying in again with 50% of your taken profits; however, ALWAYS put in orders LOWER than the current BID.

When you are trading stocks, then you can follow with a trailing stop; however, with options, you do not have the same ability; and Market Makers will definitely take advantage of you. What I like to do is TAKE PROFITS on half my position and follow the rest with a wide trailing stop.

If you have the urge to jump in again, I highly recommend you just look for a new trade. Too many times, I have jumped back into a winning trade only to lose all my profits from the first trade and usually the initial capital I used in the first place.

If the stock is really moving, then ALWAYS buy options ITM (.75 Delta) with no more than 50% of the profits you made on the first trade;and DO NOT SET STOP LOSSES—this trade should always be "All or Nothing!"

If you want to be a pro vs. a gambler, then see my training section on the power of compounding your profits here.

Rule No. 7: Make the Trend your Friend.

When the market is racing forward and or the sector you are playing, then stick with a winner; however, watch out for news announcements as this can sideswipe any good play. The rule of thumb is: good news will last one to three days and bad news can last for months. Even if the market is up, the sector is up, the sky is blue, any bad news story, downgrade or natural disaster will have just that, disastrous results for your winning play. Getting into the habit of taking profits and compounding size into the next trade(s) is the best way to make the trend your friend.

Rule No. 8: If an earnings report is due tomorrow, then today is the day for taking profits.

Over 80% of the time (historically) a stock will drop in price after their earnings announcement comes out, even if it's been running like the wind. Once the news is out, the chances are greater that inventors will "sell the news", especially if the stock has run up in price prior to the announcement. (See Rule 5 and 6 for clarification.)

My very first option trade was on Dell Computer (DELL) the night before an earnings report. The rumor was they were going to beat the estimates and announce a split. Being a complete novice, I jumped in before the close (with OTM options) looking for a nice pop up in the price the next morning. After the bell, Dell only meets its earnings estimates and immediately drops 10% in after hours trading!! (There is NO options trading in after hours).

When trading opened the next day, I was devastated! My dreams of quick riches were shattered. I lost all my money because I had options that were out-of-the-money; and I was confused to say the least; since Dell actually met their earnings estimates; but they did not meet the "whisper number" and no split was announced.

That first trade I placed resulted in a ($1,400) loss because my options expired worthless—ouch!

Rule No. 9: Emotions are a wonderful thing, if kept in check!

Even with all my experience, I still have to keep a handle on my emotions. Fear to trade is your first hurdle, then comes fear of loss or admitting a mistake, and finally, the biggest account killer is GREED. Once you have conquered greed, the fear of loss will kick in again as you will reach the next level of trading—bigger contract size.

My best advice is to stick to Rule 2 and add to your financial empire consistently. You must treat this venture like a business and not a hobby—businesses can make money and hobbies always cost you money.

If you practice sound money management and keep up with your training and continued education, your business will reward you emotionally like a hobby!

Be sure to thoroughly review my section on controlling losses.

Rule No. 10: Education combined with experience is the key to your success!    

There is a great proverb I like:

Go to the ant, O sluggard, Observe her ways and be wise....

There is never an end to your education. Read, practice, plan, rehearse and repeat! Never take what we or anyone says as your final decision to place a trade.

At OptionRadio.com  our goal is to teach you how to fish rather than feed you. Once you learn to fish, you will feed yourself the rest of your life.

Think about it this way. If you invest $10,000 and get a 20% return on your money (compounded monthly), in one years time, you can have $90,000 in your account!—That's a better living than most people make in this country working 40+ hours a week.

Once you achieve that level, then you possess the skills to do it again, and by year two, you could grow your account to a whopping $950,000. Now that my trading friends is enough money for you to retire on for the rest of your life—properly managed of course! 

Once you have become successful, use some of your profits to do good things for others.

Profits Up!

The donFranko