• If previous trend is too strong, never trade counter trend.
• Watch out for magnets nearby.
• If a candle largely overlaps with prior candles, it is not a valid signal.

1. Magnets nearby
   Before initiating a position, check if there’s any other price zone that may attract price to gravitate towards it. For instance, when selling, check if there’s any other resistance nearby. If there is, bulls may attempt to break that resistance, resulting in your position being stopped out at a loss before reversing.
2. Strength of prior trend
   Never initiate a reversal trade if the prior trend was strong (e.g. Do not sell if 8 out of the previous 10 candles were strong bull candles)
3. Ignore price action if the candle overlaps with most of its prior candles

I need to remind myself that

• it is impossible for me to catch all trends
• a single good trade a week is enough for me to meet my target
• a bad trade avoided is equivalent to a good trade made (negative * negative = positive)

He argued that everybody can be a successful trader, as long as they find the correct niche for themselves… Some traders are suitable for discretionary trading, others prefer a mechanical system… some need to day trade, others prefer to do lots of fundamental research and only trade once or twice a month…

This is not a new concept to me… It’s something that I always believed in… But he mentioned something else that struck me.. He said that if we have problems being disciplined in our trading, it may be because that trading style is not suitable for us… He gave an example of an army officer who had problems with spread trading, because deep down, he considers hedging to be a coward’s behavior…  Thus, he argued that if we find ourselves repeatedly breaking our rules when trading, working on our self-discipline may not be the solution… Instead, we should consider if the strategy is suitable for our personality…. He argued that there’s lots of trading strategies available… and any of them can be profitable as long as it suits you…

That was kind of an ‘aha’ moment for me… I realize I was wasting my time all along trying to figure out which trading strategy is more profitable… I wrote lots of EAs to compare trend trading, breakout strategies, candlesticks, arbitrage strategies etc… Maybe all of them are equally profitable… Come on, for every trading strategy out there, there are people who make a fortune from it, while others bust their accounts using the exact same strategy…

So, it is not about the strategy at all… It is about a match between the trader and the strategy… If the strategy is suitable for you… you’ll ‘resonate’ when trading it… You wouldn’t have problems following the rules.. because you are just being yourself… That’s when you know it’s the right one for you…

I thought I am a person that needs stability… even though I am self-employed, can’t stand the routine of a 9 to 5 job, and was very miserable when I was bonded for 5 years in my previous job….

I thought I am good at following rules and a mechanical system suits me best… even though when I was a Math student, I never focused on the “How”, but focused more on the “Why”s… I always tried to memorize as few formulae as possible… but rather seeked to understand the concept behind the formulae and derived them myself….

Anyway, I’ve come to some conclusions about myself:

1. Analytical but emotional at times
2. Seeks stimulation
3. Extremely risk averse
4. Likes the challenge and mental stimulation of solving a problem
5. Strong need for freedom

I am not sure what trading style suits me best… though I have a vague idea… well, at least I know what does not suit me…

Let’s start with an example… Suppose you are a big iPhone fan and are extremely bullish about Apple (AAPL). You looked at the chart and identified strong support at $148.28. You believe that there is no way AAPL is going to fall below $148.28. In that case, you can choose to sell the nearest OTM Put, which is the $145 Put. In order to protect yourself from any unexpected plunge in the stock, you buy an even lower OTM Put, which is the $140 Put.

Example of a AAPL Bull Put Spread

Let’s just suppose you sold the $145 Put for $2.70 and bought the $140 Put for $1.20. What you’ve done is you’ve just sold a Bull Put Spread. Since the $145 Put that you sold is more expensive than the $140 Put, this spread is actually a credit spread; you earn premium upfront (($2.70 – $1.20)*100 = $150 per lot in this case).

If you are right and AAPL never trades below $145 for the entire period till expiry day, both the $145 and $140 Put options will expire worthless and you are a few hundred bucks richer.

However, if you are wrong (say Steve Jobs is suddenly ousted from AAPL again) and the stock price plunges to $100 on expiry date, your lose is limited. This is because although you will be forced to buy AAPL stock at $145 now, you can turn around and sell that same stock at $140, since you bought a $140 Put to protect yourself. Thus, your loss is only limited to $500 for every Put you sold.

But wait! Remember you earned a premium of $150 on that fateful day when you decided to sell the spread? This means your loss is actually $500 – $150 = $350 per lot (excluding commissions). That’s not half as bad as if you had not bought the $140 Put. In which case you would have lost ($145 – $100)*100 per lot… Even after deducting the premium that you earned, you would still have lost $4500 – $270 = $4230 per lot…

That’s the merit of doing a credit spread, as opposed to selling a naked option (i.e. selling an option without buying another to protect yourself)… Better safe than sorry.

So, the million dollars question (no pun intended) here is: How to grow your money at 5% per month…

My answer? SELL IRON CONDORS….

What are Iron Condors?

An iron condor is a limited risk, non-directional option trading strategy that is designed to have a large probability of earning a small limited profit. It consists of a combination of a bull put spread and a bear call spread*. It is best used when one predicts that the underlying asset (e.g. a company’s stock) will not move beyond a certain price range.

For instance, let’s consider an actual iron condor position in GS (Goldman Sachs) that I had in the month of August.

Using options expiring on the same expiration month (August in this case), I created an iron condor by selling a lower strike OTM Put ($145), buying an even lower strike OTM Put ($140), selling a higher strike OTM Call ($175) and buying another even higher strike OTM Call ($180). This results in a net credit of $131 per lot (before commission).

Notice that an Iron Condor ONLY involves OTM options. Since I sold a OTM Put and a OTM Call, I have no risk of being assigned as long as GS trades within $145 to $175. That’s a pretty wide range for a stock to move within a month. In addition, the 50% and 61.8% Fibonanci levels of GS was at $149.14 and $173.35 respectively. So I was pretty confident when putting on this trade. Eventually, the trade went well and all the options expired worthless.

(How I view Iron Condors….)

Why do I love Iron Condors?

Limited Risk

Maximum loss for the iron condor spread is limited, although significantly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.

For instance, in the example above, if GS does not stay within the $145 to $175 range, I will start to lose money.

Case 1 (GS stock price is $178 on expiry date)

If GS goes above $175 and continues to rise to $178 on expiry date, I will lose ($178 – $175)*100 = $300 per lot (1 option lot = 100 shares). This is because the buyer who bought the $175 CALL option from me will now exercise his option and ‘demand’ that I sell the GS stock to him at $175. Since I do not own any GS stock, I’ll have to buy it from the market at the market price of $178, resulting in a loss of $300. However, since I received a premium of $131 when I sold my Iron Condor, my final loss is actually $300 – $131 = $169 per lot (still a very ugly loss).

Case 2 (GS stock price is $20000 on expiry date)
If GS starts a mad rally and suddenly shoots above $175 to $20000 on expiry date, my loss, fortunately, is not going to explode through the roof. Since I bought a $180 CALL to protect myself, I’m not gonna lose my pants… I do not need to buy the GS stock at the market rate of $20000. I can exercise my CALL and buy the stock at $180, resulting in a net loss of $500 – $131 = $369. Good luck to the seller who sold me the $180 CALL ;p.

But seriously, although my loss in this transaction is capped at $369, I’ll freak out if I really lose such an amount… (well, not really, but I really don’t consider it worthwhile losing $369 when I could have reduced the loss if I acted earlier)…

I am extremely risk-averse… which explains why I never busted my account… Therefore, I will never allow my Iron condor positions to go against me to such extent… I’ll probably close the position at breakeven or a small profit once the stock gets too close to my “defense lines”… I’ll talk more about my exit strategies next time…

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* If you are totally new to options, do check out my “Options Trading 101” guide. It’s largely incomplete at the moment, but I’m working on it…