Perfecting Your Trading And Investing Strategy



Devising And Perfecting Your Trading And Investing Strategy

Our trading and investing strategy will depend to a large degree on technical analysis with the use of fundamental analysis to choose unquestionably solid stocks to trade in.

Before we start to design our trading and investing strategy, lets just define a few terms used in these writings.

  • Options: These are trading instruments which give you the right but not the obligation to buy or sell a stock.

  • There are 2 types of options: Call Options and Put Options.
  • Call Options make money if the stock is increasing in price.
  • Put Options make money if the stock is decreasing in price.
  • Covered Call: Selling a Call to initiate a position. You must own the underlying stock before you can sell a covered call. Be aware that your upside is limited. You gain from covered calls by squeezing out the time value and volatility values.
  • Shorting a Stock: Selling a stock you do not own (big players do) or for our purpose, buying Puts.
  • Bullish: Believing or betting on the market to go up.
  • Bearish: The opposite of Bullish.
  • Bull trap: Stock gives a bullish signal causing many traders to buy, only to sharply reverse position and turn down causing them to scamper to get out of their position or lose money.
  • Bear Trap: Opposite of Bull Trap. Gives a sell signal only to reverse position shortly after.
  • Short Trading Strategies: Although in general stocks tend to go up longer than they go down, the downward move is usually more rapid and violent than the move up. Can one tell when a stock is ready to pull back? Many times yes but only when it signals a reversal.

    Many professionals use short trading strategies very effectively. Short Trading Strategies are adopted by aggressive investors in their investing strategy.

  • “Shorting a Stock” means selling a stock one does not own. This is usually a big boy’s game but the small player can still play it with options - Put Options.
  • Hedge Strategy To Consider:
    1) When you buy a stock, you buy a Put Option. If your stock moves up, you make money on the stock and lose on the put option.
    2) You buy a stock position and sell a covered call. You have to have 100 shares for every covered call you want to sell. You only want to do this with volatile and heavily traded stocks.
    Also, when selling a Covered Call, the Option must have a big part, or all of its value as time value and volatility value. This amount loses it’s value over time and goes to zero upon expiration.
    3) Diversification (more on that later)

Although this is not a lesson about Options(that’s for another time), just be aware than they are counted among the tools that aggressive traders and investors use in their strategies for trading.

Ok, Lets Continue To The Good Stuff, The Real McCoy

The following are the actual steps you will take in developing your trading and investment strategy. This is the process you will use in formulating your plan. An example of the result will be listed at the end of the last Part.

The Steps you will take in developing your Trading And Investing Strategy are the following:

Step 1: State Your Definition of Success

  • What do you want? Is it to Protect, Preserve and/or Grow Your Capital?

  • How much do you want to make per year? Would it be 10%, 12%, 24% per year (put in the number you want to make but be realistic).
  • Do you want to mimic the performance of the S&P 500? Or do you want to beat it?

Note: If you are a conservative investor, for instance, and you set your goal at 6% per year, aim to make at least 1.5% per quarter(every 3 months), i.e., one quarter of 6% every 3 months.

You will actually make more than 6% per year because of compounding. Compounding is a powerful concept in investing as you will learn later.

6% per annum is not difficult and you really should set it higher even if you are conservative. A recommended place to start to find companies that meet your criteria is to research good companies that are paying high dividends of 6% or more per annum.

Buy the stock and sell covered calls. For every 100 shares, you can sell 1 Covered Call.

If you are a conservative investor and you use Options as an investing strategy, the Options you should mainly use are Covered Calls. At least in the beginning.

Options are referred to as “wasting assets” because a big chunk of their value is attributed to volatility and time duration to expiration. The longer the time to expiration, the more time value that is built in.

Also, the more volatile the stock is, the more volatility value that is built in. In other words volatile stocks with longer duration would have higher premiums than non volatile ones with shorter durations.

Volatility value and Time Value go to zero at expiration. The buyer loses those values. The seller gains on those values.

To check volatility of a stock, look at its Beta. The Beta is a coefficient that measures volatility compared to the S& P 500.

A Beta of 1 means that the stock has similar volatility as the S&P 500.
A Beta of less than 1, e.g., .90, or .80 means than the stock is not as volatile as the S&P 500.
A Beta of more than 1, e.g., 2, 3, means that the stock is more volatile than the S&P 500. The higher the number, the more volatile the stock is.

Also, if you intend to play with options, make sure that there is plenty of liquidity in the underlying stock as well as the Option. Liquidity ensures the ability to get in and out at reasonable prices.

Additionally, stay away from Options that have wide spreads between bid and ask. Wide spreads mean that you lose both ways. You lose going in and you lose coming out.

Enough said on options here, lets move on.

You should track your performance quarterly, whether or not you are a conservative or aggressive investor, to ensure that you are sticking to and meeting you goals.

If you are a more aggressive trader, more aggressive strategies are listed below.

Step 2: Trend Trading


Continue To:
  • Trend Trading
  • Entry Rules: Know How And When To Enter A Position
  • Know when to exit a position
  • Risk Management and More..


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