Editors Note: This is an excerpt from the February 2nd Weekend Update that went out to subscribers on Saturday. I've omitted the "Big Picture Update" and our current open option positions. If you trade stock options, this is an eye opener trade management strategy, one that completely slipped by us in the creation of the Blue Line Trend following trading system. Since we first introduced this strategy on January 26th, the system has already generated numerous 35% winning trades in both the Standard and Premium trading services.
Betting with the House
Trading stock options is akin to gambling, only it's our own game, our own rules, and there is no house to compete against other than ourselves. Much like the house advantage in Vegas, the edge in this system is that the trading signals are based upon statistical probabilities derived from a proprietary mix of algebra and geometry. It is up to us to carefully base the bets and know when to take our chips off the table.
35/75 Exit Strategy
We have described a few different profit-taking/stop exit ideas to make the most of the trading signals under the observation that one size does not fit all when it comes to the psychology of trading. The use of profit-taking targets and stops has been somewhat of a moving target because so much of it is personal: Comfort zones, risk vs. reward, active or passive trade management, bunt singles or home runs, home runs vs. grand slam home runs.
Last weekend I introduced a new trade management strategy, the 35/75 exits, and this weekend I am putting an exclamation point after it. Winning small and often has an appeal well beyond the adrenaline rush of that occasional grand slam home run...in the end it adds up, it takes a lot of risk off the table, and a lot of angst out of trading the market.
Since the inception of the system in May 2018, there have been 142 trade signals sent out to subscribers Of those 142 trades, we have come up with the following profit taking statistics:
Total Trades (Standard Service): 142
Number and percentage of trades that went up at least 35%: 114 = 80.28%
Number and percentage of trades that went up at least 40%: 112 = 78.87%
Number and percentage of trades that went up at least 45%: 105 = 73.94%
Number and percentage of trades that went up at least 50%: 103 = 72.54%
The downside of trading small, trading often is that of those 142 trades there were about 50 that went up 200% or more. Trading for small profits would have missed every one of those 200% winners.
FAQ: If 50 out of 200 trades (1 out of 4) triple in gains, why not just set the target at 200%, surely that is a very profitable trading system?
A: Risk of ruin. At a 200% target, there could be as many as 5-10 trades in a row that miss 200% and even using a 75% stop, that is a hefty drawdown of trading capital. I doubt that there are any option traders who are reading this right now who haven't at some point learned the hard way the lesson of risk of ruin, including yours truly. By taking frequent gains of 35% the risk of ruin goes to about as close to zero as it can get for this system. Every incremental profit-taking target up from 35% raises the risk of ruin probability in two ways: (1) a series of consecutive failures to reach the higher target, and (2) the chance that even though the trade eventually goes to the profit target, it first takes a detour south and hits the stop. Options are volatile, it happens, but it happens a whole lot less when the target is 35% than when it is 200%, or 100%, or even 50%.
FAQ: Why do you keep adding all of these changes to the system?
A: If you are doing well with the system as is, there is no compelling reason to adopt the, "Trade small/trade often," trade management philosophy. This is not a change to the system so much as it is an alternative way of taking advantage of what has been some very good trading signals. Can you make money in the stock market gaining 35% on 8 out of 10 trades, while 2 out of 10 lose 75%? It may not be the best and most profitable way to to trade the signals, but it may very well be the easiest.
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Past results are not a guarantee of future performance.
Option trading involves risk, big time risk...along with big time reward.