Select A Strategy

When we do our Market Analysis routine, we select a posture which is the basis of any strategies we employ over the next few days.  This will direct the focus of our efforts in planning trades and selecting issues for trade.  As stated elsewhere about 75% of issues will move with the market and, in general, it is best to trade with the market than to get in its way.

One thing we learned from the old Options Planet education was that floor traders and market makers consider their own risk management based on 5 market directions.  Normally we think of 3, but seeing it this way you can see that risk mitigation really requires dealing with the floor traders 5 market directions:

The Stongly Moving outliars might not be part of a normal trading plan, but should probably be part of a contingency plan for any trade or at least for the portfolio on the whole.

With the market posture we will select from a variety of strategies for new trades and adjustments to work with what the market is giving us.  Any strategy can work in its own area of the market posture but may require adjustment if the market changes:

We almost always enter a trade with short term rules.  We will change the rules for the trade if a trend develops.  We try to adopt strategies to support both a Get Rich and Stay Rich pile of money in our portfolio.  The Stay Rich will be generally long ETFs for diversification in major markets or market sectors which are performing well in longer term trends.

We mostly trade long Stocks and ETFs, long options, and long and short futures.  We rarely day trade, and for us a day trade is an entry signal which reversed and hit its stop in the same day.

When the market takes a breather we will often make trades to hedge some of our longer term trades.  Instead of adjusting stops we may buy protective puts, for example; this allows us to benefit from price action in the long term trade if the trend continues, but locks in a possible exit point if the market rolls over.  We expect to lose money in most hedging strategies, they are counter-trend trades.

The problem with options trading is that you are really stuck with the open market hours, but often a crisis begins to brew while the market is closed.  By the time the market opens much of the damage may already be done and you can do nothing but pick up the pieces.  If the market begins to make a strong move against our portfolio while the market is closed we will make hedge trades with futures.  This allows us to counteract most of the harmful price action with a trading vehicle which operates essentially 24-5.  We can adjust the portfolio delta in one trade.  Sure, the existing portfolio is still being damaged by the market action against it, but the futures trade is benefiting from the same action and if sized properly will allow you to enter a more neutral state until the market opens and you can make adjustments on individual positions.

We'll cover more specific hedging strategies on the web pages devoted to specific base strategies.  The list above, though, gives you a general idea of what kind of trades to take in varying market conditions.

Most 401K accounts only permit you to be long fund positions.  If the market is going down there are usually only 3 things you can do:

  1. Cash IS a valid position, use stops and get out when they are met.
  2. Some issues are likely to be going up against the market, find them and trade them with caution.
  3. Some plans allow you to trade inverse funds which benefit from adverse market conditions.

If you are have most of your retirement in a self-directed IRA there is another option:  Learn complex options strategies to benefit from any market conditions.

When you are restricted to a limited numbe of changes in a month or quarter you must make your moves carefully - you may be stuck in the consequences for weeks to come...  This makes actual retirement plans a field where you might make decisions based on weekly or even monthly charts instead of daily.  Often the same decision process applies, just made more slowly.

Rules and Guidelines

Perhaps someone here is looking for specific rules.  Let me unburden you of this expectation.  There will come a point when you need to make some decisions on your own and it is coming soon.

We will share guidelines and ideas, but it is up to you to make these into rules you will back test and determine for yourself when to enter and exit trades.  We are somewhat discretionary in our own rules, we will adjust the rules on the go, based on market conditions and our own experience.

Don't be disappointed, though.  The strategies we will outline are sound, the only thing we are leaving out is the exact decision point, which we leave to you with suggestions.  Some of our suggestions may be pretty clear, the others are areas where discretion may enter your own rules.

Honestly, what fun would it be if you did not participate in at least the smallest way in your own success.  You can be great at this, at least pick up the spoon and feed yourself a bit.

All Good Rules Should:

Any set of well defined rules should cover the following 6 elements:

What is Above and Below?

In basically every strategy we will use the words above and below.  We tend to use them in pretty common ways.  Generally as a standoff from a trigger price to introduce hysteresis and prevent churn.

Some strategies we have read use a fixed price like $0.25 regardless of the underlying price.  Others use 1% or 3% as a standoff.  Mostly it just depends on your risk tolerance.

Another idea we have come to like is a multiple of the Average True Range, like 0.3 ATR which is often around 1%.  This automatically adjusts for Volatility and Price.  Another formulaic base for this kind of decision would be the Standard Deviation, basically using a Bollinger Band standoff from your trigger price.

You may choose to use different values for different purposes.