Stevenbhorse, another TradeKing Leaderboard hero, gave us some secrets of his trading success:
1. Steven risks no more than 10% of account equity per trade. Setting trading and investment guidelines for yourself is a great thing to do in ANY market. This helps traders keep a handle on risk management and can be similar to a household budget. Risk management is designed to keep you in the “game” of trading.
After all, trading is not about one or even a few trades. It’s about the long haul and many, many trades. Reducing and capping the size of your trades makes the impact of each trade less. Since we don’t know beforehand which trades will return profits and which trades will give us losses, keeping their impact to a minimum is important. To borrow from sports as we often do, if you consistently go for singles, you’ll eventually make it to home base, and also minimize the number of strikeouts (your losers won’t deplete your trading capital too quickly).
2. Steven uses far out-of-the-money options. Stevenbhorse looks for 6-8% drops in precious metal and mining-sector stocks he’s bullish on (he works full-time in this sector and knows its fundamentals well). Then he buys far out-of-the-money calls (OTM), zeroing in on whatever options series has had the greatest decline, usually a month or two out in time. In my book, this is a move reserved for seasoned veterans only and here’s why.
Usually far OTM calls are very cheap dollar-wise, which helps keep the capital commitment down. However, you must also have the first guideline in mind. The low prices of these options may cause less experienced traders to buy too many. This can result in overleveraging a position and may result in taking bigger losses than one had anticipated. Yes, these options are cheap, but remember they are cheap for a reason – because the likelihood of them paying off is quite low. The flip side of that is if they do in fact make a profit, it is possible for this profit to be quite large on a percentage basis. So in summary, your odds of making a profit are low, but if you make one it may pay off big.
To contrast these with in-the-money (ITM) an options, ITM options move more in-step with the underlying stock. Far OTM options, on the other hand, move very little unless the stock makes a significant change. Stevenbhorse points to a trade in TRA (Terra Industries), a mining stock he traded with great success in early January. The underlying stock was trading around $14 per share when he bought March 25 calls for $0.20 per contract. Three days later, TRA rose about $7, and Steven sold his options for $1.50, for a large profit of 650%. (Assuming a one contract trade, there would be total commission costs of $11.20 to enter and exit this trade: $4.95 per leg plus 65 cents per contract traded).
While it is true that if he’d purchased ITM calls (such as the March 10 strike), he would’ve paid a lot more upfront and netted a much lower percentage gain, it is also true that if the stock had moved against him, the ITM trade would have likely resulted in a smaller percentage loss than the OTM trade.
Right now Steven is hoping to ride a similar upward move with Northern Dynasty Minerals (NAK) – his Trade Note lays out the plan.
3. Steven loves gold. Stevenbhorse watches kitco.com and financialsense.com to find precious-metal stocks on the move, and he’s definitely bullish on the sector in this bear’s-heaven of a market. With the Fed buying long-dated Treasuries, i.e. funding its current activities with direct debt, Stevenbhorse sees inflation in the offing with even more bullish effect on precious metals. He points to negative real interest rates as another factor boosting gold.
As demand for precious metals increases, Steven likes how the mining sector’s supply story has improved since last year, plus how crude oil’s collapse has increased miners’ operating leverage. Finally, he urges goldbugs to stay open to silver, “the poor man’s gold”, as a more affordable, yet viable alternative to capitalize on these sector trends.
Nice work, Steven – thanks for sharing your tips with our Trader Network. Here’s hoping all that glitters IS gold for you in the future!
Regards,
--Nicole Wachs
Director of Education
All-Star Commentator
Nicole’s previous blog posts: AMEDS: oil pairs trading and cash-secured put selling on value stocks and Uracowman eyes the “shorting opportunity of a decade”
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.