Monday Morning Case Study

Mike has agreed to be our case study today. He left a comment over the weekend that if he doesn't see a profit by June, he was going to hang it up. Since none of us want to see Mike quit on fulfilling his goals, why don't we lend a hand here are objectively analyze his trading rules? He joked that this would be a crisis to his self-esteem, but I disagree. It's a free evaluation of what you are doing/not doing that could end up helping you in the long run. From the readers perspective, you get to see a list of rules to compare or contrast to your own.

Here is a copy of the rules he sent in. Do your worst. I'll give my take on them later today, right now I am trying to get together a watchlist and hopefully a video going today. It's hard getting through the e-mail traffic today.

If you would like to participate in something like this, let me know. A couple people dropped out over the weekend, and I imagine others are on the brink. If something like this can save you, let me know.

Rules: Poke holes in this system. Find areas to improve or modify.

Mike’s trading system

Definition of success: 15% annual profit minimum and a 35% annual profit target in all accounts.

Breakout entry rules (Triangle, double bottom, head and shoulder, 52 week high/low, etc)
Calculate target price for potential breakouts.
Breakout target should be at least a 10% move.
Buy option when stock closes above resistance with at least average volume, higher volume preferred but not required.
If you miss the breakout, you may buy the next day only if you can get the trade within 30 cents of the previous close.
Do not enter trade if the stock has moved more than 5% from the breakout point.
Don’t chase missed breakouts.
Option trade needs to exhibit at least a 2:1 profit/loss ratio.
Don’t risk more than 1% of account value based on 50% of the options cost.

Breakout exit rule
Sell when target is hit
Sell on 2 consecutive down days
Sell if option loses 50% of its value.
Sell if underlying stock closes below short term support by more than 1%
Don’t hold over earnings.
Use mental stops based on the underlying stock.

Support bounce entry rules
Buy when stock is within 1% of support
Buy if stock bounces off support with better than average volume plus a close higher than the previous day.

Support bounce exit rules
Use a hard stop 3% below support.
Move stop up to breakeven when stock closed $1 higher than purchase price.
Sell if stock closes 3% below long, med or short term support depending on time frame of trade.

Other rules
Don’t trade GOOG
Don’t take aggressive trades if you can’t watch it intraday

Mike,

I think you have a good start to your rules. They look similar to mine. I added a few rules that make me follow the trend of the stock...calls in uptrends, puts in downtrends. I don't countertrend trade, so I miss out on reversal patterns. I plan to trade H&S and double bottoms/tops in the future. I also pay attention to industry groups and accumulation/distribution.

I keep a daily log that encourages me to look at my trades' action and compare it to the action of the overall market. For example, if the target price hasn't been met, but the market is at resistance, I can make the decision to stay in the trade and ride the pullback or take the profit and move on.

Risk management has been the key. I don't have it perfect. I am trading the stocks that fit my signals, but I am losing more trades. At least, I am keeping the losses small and allowing my winners to run. They run slow, but at least they are running.

I think allowing us to look at your strategy will help us all grow and become better traders. I know I can use the insight. Thank you!

Amy

Jeff and Eric, You guys both rock. What you both have given back is tremendous. You've cut the learning curve in half if not more, and I for one thank you for that. I'm here for the top notch teachings you both bring, day in and day out. Anyone looking to get out because a little deversity in their accounts needs to requalify their resolve and COMMIT or do indeed get out while the getting is good.


The Power of Commitment


“Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative and creation, there is one elementary truth, the ignorance of which kills countless ideas and splendid plans. That the moment one definitely commits oneself, then providence moves too. All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one’s favor all manner of unforeseen incidents and meetings and material assistance, which no man could have dreamed would have come his way. Whatever you can do or dream you can do, begin it. Boldness has genius, power and magic in it. Begin it now”.

Mike,

Do NOT quit. You just need to spend some time soul searching and figure out: 1) is trading something you absolutely live for? and 2) what are you doing wrong?

As i told you, my account has been shelled several times and quitting is not something i'm ever going to do so i don't really have a choice but to get better.

In my estimation (from my experience), your problems lie in your exit strategy.

1) selling when target is hit is a good strategy, but a better one would be, "set stop at target when it's hit". This would allow you to capitalize on a much larger move beyond your target. I'd also recommend using the current ATR on trades you have a gain in, unless support is just below it.

2) Never look at the option's value, and never trade on it. Trade the action of the equity. Period. If you set up your trade properly, that rule shouldn't matter.

3) Moving your stop to breakeven if the stock moves up $1 will kick you out of many big winners. Basically a retest will kick you out. Retests happen all the time. Sometimes a bounce will bounce twice before retesting old highs. Just use the trendline or support line.

4) Don't trade GOOG is one of my old rules but i got over it. It's actually a great stock to spread.

Hope this helps. Remember, quitting is what most people do. Passion should keep you here. If you don't have it, you should be doing something else.

Tough love, i know, but you need it right now.

Hi Mike-
Hang in there! your rules are your rules...the key is to be consistent. While your rules may not follow mine, doesn't mean they are wrong! I think there is a tendency to want everything now. Try to give some time and treat it like a business. Remember it takes time to build up. It's a marathon, not a race!

good luck!

Mike:

Thanks for sharing your rules - this can only be good for you; this group will give you good feedback imo.
A couple of comments on the breakout rules:
(1) You said "Do not enter trade if the stock has moved more than 5% from the breakout point." and "Option trade needs to exhibit at least a 2:1 profit/loss ratio.". I assume by profit/loss you mean reward/risk. If so, these 2 rules can be in conflict since the difference between entry price and your stop determines your risk and hence your reward/risk ratio. Try to distill these rules to the minimum, non-redundant set; that way they will be simpler. So, you can get rid of the 5% rule if you keep the 2:1 rule. (Do you have a reliable way of figuring reward/risk?)
(2) You said "Buy option...". Which option? ATM, ITM, OTM? Front month, next month, LEAPS? Do you evaluate whether the option is reasonably priced?
(3) You said "If you miss the breakout, you may buy...". Think of a rule that would admit the miss, but places the stock on a watchlist for potential entry at retracement. Why? If you can get it the next day within .30, the breakout might be a weak one and not worth pursuing.
(4) You said: "Sell if underlying stock closes below short term support by more than 1%" and "Use mental stops based on the underlying stock." These are redundant, right? I was envisioning a couple of OCOs - one based on the underlying and one based on the option price. But when you say mental stop, I'm not sure what your stop rule is....

One parting thought Mike: if you continue to work on, simplify, and improve your rules, you WILL be successful; there's no doubt.

Cheers,

John V

Relax!!!!We have all been thru this.Make your trades smaller and use paper until you feel better,,this takes some time I know I'm learning daily,,BUT keep in there and listen to Jeff and Eric,,As my Father always said when you run into problems STOP and go back to the basic's and make it more simple sometimes we get to deep into it and we can't see the forest thru the tree's,,Mark

John V,

You stated to Mike, "Do you have a reliable way of figuring reward/risk?" Can you please share what you use as a reliable way of figuring this out?

You also stated, "Do you evaluate whether the option is reasonably priced?" What do you use to see if it's reasonably priced?

Thanks!

Mike,
I have definitely been where you are, and not that long ago. In December I was so close then I took a step back and decided to do what I have heard for so long. The rules you have may or may not work for you. You need to test them for yourself based on what you see in the charts. We all see different things based on our preferences and experiences.

What I did was to set up the paper trade account and made a firm committment that I would test my rules on this account and only trade with the real account when I had proved my system would double my paper trade account.

The reason I did this was that just paper trading was not real for me. There had to be a consequence to how I did there so that the trades would invoke the emotional response I get when real trading. Your system has to work when your emotions are at play. It has worked so far. I find that I am modifying my rules and fine tuning them and they are my rules, adapted for my trading style and personality form the education from Jeff and others. I am developing rules that work without wiping out the capital which I will put into full force when my rules have been tried and proven.

I couldn't agree with Brett more. The only thing we have to hold on during this process is the passion for trading and the determination to succeed. If this feels right for you in your core then don't quit. The results you seek will come with time and due diligence.

Mike,
First off thanks for having the courage to share your rules and let us all learn in the process. Second congrats on having developed a thoughtful set of rules, many traders don't do it at all. This gives you the opportunity to review and refine those rules and make them even better.
ENTRY SUGGESTIONS
1)On Entries for break-outs that is where I look for HIGH volume in order to sustain a break-out; otherwise they are more likely to fail.
2) On Entries for support bounces is where I will enter with LOW volume as you will typically find the volume low at that end of the pull back. Also being close to support can significantly reduce risk of trade with exit on break of support being clear.

EXIT SUGGESTIONS
1)Exiting on 2 down days will likely pull you out of some winning plays too soon. Using short term support or ATR would likely work better.
2) Perhaps considering selling 50% to 75% of options at target and letting 25% run would help capitalize on those home-run plays.

One last thought; I like to see a 3:1 risk reward on OPTION plays due to time decay/volatitlity etc.

Again, thanks for sharing!!! Back-testing your rules would likely also give you some good insight for fine-tuning your rules.
Hang In There
Loretta

Mike,

grab some WTI and DVA July puts and ride out the next few months in style. That should get you back in the game.

Well, first a big thanks to Jeff and Mike for this topic. I have no right to comment on the rules really as we are new to this ourselves. I could not agree more on the passion statements though. If what you are doing you would not do for free it may not be worth it. You should love what you do! It is validating to me to see more experienced traders making suggestions that I would have said. My rules also include:
1. Do not enter if options are only on one exchange. Learned from ORBC my first trade.
2. Options and Stock are liquid - whatever that means for your rules.
3. No more than 10% in anyone industry, etc. Do I hear Eric?
One more thought - if you do quit, I am interested in your plan B. Is it then to turn your money over to investment brokers and if so I need to share with you some of their professional success with my money that would make you appear a genius I bet.
I would be really interested in hearing from those of you that have achieved great results or have they all moved on from this Blog?
Bob H.
CA

Two of the biggest ones I have gotten burned by is trading in the first half hour of the day and taking a trade someone else insists is a winner without agreeing with it or making the determination myself. Both are pretty much based on emotion (Getting caught up in the rally) and not trusting my own instincts. Also...don't take it personally..everyone goes through it. You're not bad at it..you're just learning like we all are. Take a step back to regroup if you need to or until the market seems to be going in one direction consistently.

To the outsider, some of the rules seem vague. Here are some questions (not all) and how I interpret the rules while not knowing these answers…

1. Do you find yourself exiting trades before their target price and not exiting your losses before the 50% of the option value?
2. What type of option are you looking to buy, ITM, ATM, OTM? I think it is important to know this to set your stop losses or if a stop loss will be used at all.

I see an example of being hopeful for losers by giving them 50% to loss while willing to cut winners after 2 consecutive down days. With a 2:1 risk reward, this seems like too much room for losers and not enough for winners. Maybe increase the ratio to 3:1 and cut your loses when the trade goes bad. You should also know when the trade goes bad based on your R/R analysis. This will eliminate some of the emotional aspect of trading. “Some” being the operative word. You should listen to listen to Kelly Altmen’s 2/28/07 Mastertalk on “Controlling Emotion with Hard Data” if you have access to the Mastertalks.

You can eliminate some steps you use to not enter trades by deciding at the point of entry whether or not it fits within your R/R rule. You won’t have to worry about chasing breakouts or if a stock has moved 5% or more. Wait for a retest. If you it doesn’t retest, you missed it just like a lot of people. There are so many trades out there that you don’t have to agonize over missed opportunities.

I hope this helps. It has certainly helped me.

John
Rhododendron, Oregon

Mike,

One thing I do to stay consistent is to fill out a trade sheet completely each time I jump into a trade. I have a trade sheet I use for calls/puts, another one for credit spreads, another one for selling puts, etc. I fill the trade sheet out completely to ensure I have looked at everything from IV, historical volatility, risk, reward, support, resistance, news, earnings, position sizing, stop loss, etc. Once I have this filled out I print the interactive chart and a copy of my rules for that trade. For example, if I am jumping into a bull/put spread then I fill out my CREDIT SPREAD TRADE SHEET, INTERACTIVE CHART & BULL/PUT TRADE RULES. I staple all three together and put it into my open trade bin on my desk. My trade rules are very detailed and read like instructions from entry to exit. As I enter the trade I go through each of those rules and mark them off as I follow them. If at any time I break one of those rules I log it on my sheet so that at month end when I evaluate all trades I can see why I won or lost. This keeps me doing the same thing on every trade and if I am constantly failing then I will see a pattern at month end and can adjust where I need to. Last month during my evaluation of all trades I saw that I had a 30% success ratio and still lost 2% of my account. After going over each trade & reviewing my notes I saw a pattern on my winners. I saw that on each one my entrance was late causing me to miss out on a portion of the move. I saw also that my stops were not positioned properly according to my rules. I also saw that on my biggest winner of the month I failed to follow my rules of tightening my stop once my target is hit. I gave back 50% of my profits because of that. So, if I would have followed my rules I would have realized an 8% profit on my total account instead of a 2% loss. This is exciting to me because I feel like I am constantly getting closer and closer to success. By the way, I saw a good movie last week called "The Pursuit of Happyness", it was very inspiring to watch this man consistently fail and get knocked down and continue to get up and keep going. We all have times of weekness and thats why its very important to get around other traders so they can encourage you! Don't give up!

Mark

Hi all,

Thank you for the gracious comments. Some responses to questions follow:

I've never been more passionate about anything in my life except my wife. She would suggest I'm more passionate about trading and if you counted up quality time with her vs. the computer, she would be right. I believe in my heart and soul that I can do this.

However, I'm also a pragmatist. I know that if all this desire and study isn't getting anywhere, I'm just wasting time and cheating my family out of time with Dad. I could be out serving my community or my family or bettering myself in some other way. I would then just drop my money in mutual funds and pray.

I did not include all the other trading scenarios in my rules, like when to go OTM vs ITM or when to sell a covered call vs move up a stop. I don't have fixed rules for these and react more to the scenario with what I think gives me the best reward/risk scenario.

I'm not sure I could even write a hard rule for every scenario though I could describe possible plans for the given situation. So I just showed the ones I follow for most entries and exits. It was a remarkably hard excercise to write up and be relatively clear as discussion topic.

I calculate reward/risk on options like this: [(target intrinsic value - current price)/50% of the current price].

Mike

For those of you still working on or refining your rules see Dave Johnson's Trading Room last week on this topic under Application. It is nearly two hours long but 45 minutes on questions if you want to skip them. He gives the bull flag rules that he uses which I found helpful. Also, Jeff's article on the topic shown on this blog.
Bob H.
CA

How about a real world excercise.

I'm going to show my rule results on a WTI trade as I would interpret them.

WTI - Desc Triangle. Target price is 23 base on $4.5 move. Breakout occurred on better than avg volume at 27.50.
Earnings just occured so don't have to worry about that. The potential move is well over the 10% move rule. Because the triangle formed over 3 months I'm looking at the July options. OTM strikes are no good on this play as the pattern target doesn't support a large enough move. July 30 strikes will probably cost me at least $4 tomorrow. At target of 23 the option will eventually be worth at least $7. Reward/Risk= (7-4)/(50%of 4) = 3/2.
This is not 2:1 so I should skip the trade. However, I really like the setup and a close 1% over 27.50 should get me out of the trade with less than a 50% loss getting me close to that 2:1. It appears low risk in an industry group going sideways and an ACC/Distr in the red. Mental stop is a close over 27.80.

Mike

Because the trade was close, I checked ACC/Distr and Industry group for additional support in my favor. I didn't write this in my normal rules but looked for this additional confirmation.

Mike,

Hang in there. Just so that you know I've been at this since Dec 06 and have not made 10% of my startup investment. To some, that can be seen as a failure. One thing we all must keep in mind: Persistence and patience. I have read several books and one thing stands out above all. persistence. A lot of great traders have at one point or another gone to a low point in their career, but they were persistence and were successful at the end. This venture is no easy task and is not for the weak. It is not going to work over night.

I, myself see things slowly starting to get better. At first I lost quite a bit, but now my losses have stablized and I'm begining to see profits here and there. That was 1 years worth of work @ about 3-4 hours a day (not weekend), Reading books, analyzing charts. I am now more ethusiatic than ever.

Consider this quote: "Take care of your losses and the profits will take care of themselves." -Amos Hostetter.

I also found that entering a trade is easy. Your exit strategy will ultamitely determine if you are going to be successful or not.

Hang in there and Good luck.

Mike, I can sure relate to that quality time on the computer comment. I am not sure I know enough here but...on a descending triangle isn't the volume to be declining as the triangle forms and then have higher volume at downside breakout? False breakout?
Those that have tracking forms willing to share?
Bob H.

Mike:

I mostly concur with the above. You don't mention what % of your portfolio is in options? I limit options to 10% and keep the rest in stocks and lower yielding but higher probability spread trades.

Allen

This is my first time, Jeff I first want to say Thanks for this informative forum. My esperience
with trading rules are that you have to apply them to every trade no matter what the excuse may be. I'm new @ option trading and already have well over a hundred trades in 4 mo. I made money in the beginning by chance or beginners luck!I haven't had the same luck since Nov. 28 of last yr. I'm still on the positive side and I still don"t think it is completely skill.I've went through boot camp and now have some form of regimentation.I still believe over analyzing leads to paralysis. Look @ Agix what volatility.I played short 10.00 straddle and long 12.5 call hope to collect some nice Prem.I'm good till under 4.00 Can you blog this? Craig

Mike,
There's a lot of advice from people who don't want you to quit. I could leave more advice but you probably have enough. You have heard it many times, Don't Quit. Maybe it would be helpful if you cut down the time you spend with this and so you wouldn't resent the market for taking so much of your time. Only you know what works for you. Just a thought. Hope you stay with it.
Brent

Mike and to anyone else,

The question I have to ask you: Is trading pattern breakouts with options your trading niche? There are so many different strategies, but maybe you haven't found the one that fits your trading style and that is why you having trouble. Have you traded intraday or longer term (5 year charts)? Mechanical or discretionary systems? Have you traded currencies, stocks, or futures? How about spread trading? If you haven't traded all these different ways, then how do you know that breakouts are your niche??? The good thing is you can paper trade all these strategies and then go towards what your feels good to you. This takes a lot of time, but it is so worth it, instead of burning through your capital trading a way that doesn't fit you. Another good blog you can read is Trader's Feed, by Brett Steenbarger (no disrespect to Jeff's blog). He talks a lot about finding your trading niche instead of trying to perfect trading rules that don't fit your style. Once you have your niche then perfecting the system can begin to take place...hope this helps, I know it helped me on my journey, and remember trading should always have a fun factor.

Marc in Asheville

Mike,
Hang in there buddy. As you can see by the flooding comments, you are not alone. The one thing that stuck out to me as i read your trading rules was the fact that you use mental stops. I myself was using mental stops and they did me no good when i was at work as the market fell farther and farther into the red. I do not know who you use as a broker, but you may want to check into Think or Swim. You are able to set a sell /stop order for your options based on where the price of the stock is. Even if you still use a mental stop, but place a hard stop order in a little lower than your mental stop (to allow for daily price swings) it would prevent another large lost like the one we had on Tues. This is just an idea. Keep your mental stop if you like, but put in a hard "in case there is an emergency drop" stop. This will act as a blanket to catch you as you fall, before you hit the ground. Hope this helps
Tonya
daytona beach

Mike,

I completely understand how you feel. I still struggle with it sometimes. I just hit my 1 year anniversary and my trades break even at best. In the last 3 weeks I went to Orlando(mega event,Advanced Technicals,and Advanced options. At Orlando I spoke with Stacey Acevado and told her how I was about to quit and she said" don't quit,just get right back at it and reach out to your support team. It will come. Be patient."(Jeff says the same).After talking to many successful students and instructors, it seems after about the 1 year mark things begin to come together. the pieces of the puzzle come together faster. It felt a little more realistic and not so much pressure. Taking all that we've learned and focusing on a few strategedies. So the key maybe patience and persistence. My feeling is if it takes 2 years or 10 years I'm going to succeed and so will you.

Good luck.

Sarah

Oops," strategies". I need spell check.

Sarah

Hi Jeff & Mike

We(also)are having trouble with our trades. We need to regroup and re-focus. Going to try and learn from everyone here on the blog. Just had our 1 year anniv. and thought things would be going better at this point. We paid for two years of learning so we will continue taking advantage of all available classes on investools. My husband and I are doing this together - so it has been a great experience in that respect. Thanks to everyone for their ideas.

Jeff - I have been trying to print some articles on your blog and I keep getting thrown out. Am I doing something wrong? I am using internet explorer if you need to know...

Kay and Bill

Mike, I agree with some of the earlier remarks on not trading based on the price of the option unless you are trading way out of the money options and you have to add a time factor. I also suggest finding a trend study such as the RSI and becoming familiar with it. I find this helps the most when an up(or down) trending stock is weakening and getting ready to turn around. Divergences in RSI and volume itself have helped me a lot for I had an uncanny knack for getting into long standing trends that fell apart as soon as I got on board. I hope this helps.
Rene

Mike,

Take a look at ATW today for a low-risk entry. You've got a short-term (3 week) ascending triangle wrapped up in an intermediate term (3 month) cup-and-handle formation. Both breaking out today over $52. Keep in mind volume is low, but if you use the trendline on the triangle as your exit (around $51), this could be a safe idea to get you back in the game.

Please keep in mind that i'm not trying to sell you on a trade. I have found that it takes a couple of really good trades to get your confidence back and really train your brain to look for what i call 'multiple setup' trades.

Anyway, stick with us. This is a special group.

Mike,

I've been burned on tons of trades, but I love options and refuse to quit. I too am not as profitable as I'd want to be. But I know this is a great vehicle to make money, just need to learn how to drive it better. This blog has been a tremendous help, I consider myself lucky that Jeff and others here are this generous with their time and knowledge. The only thing that would be even better would be to actually watch the pros place trades, dates, entry points, exits, basically hand holding telling you when to get in and when to get out. I tried that with another investment firm, but I was not learning. Hang in their, this blog is too valuable to quit just yet.

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...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT... ...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...

About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
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