Trading in stock markets is a high risk and high reward activity. It is extremely important for an investor or trader to fully understand the repercussions of trading in stock markets. Derivatives or options are leveraged products and hence the associated risk and reward also gets multiplied. Options trading on one side, provide an excellent hedging or risk mitigation opportunity and on other hand can itself be pretty fast in losing or making money.
An experienced trader would definitely or should definitely answer these questions before entering the trade. Answering these questions, before entering the trade is important because otherwise casually initiated trade will not give you an opportunity to be in control, rather, the trade will guide your actions , and more often than not , it will take you towards loses and not profits.
What are those important questions?
- What is the maximum downside of this trade ?
Even if you have analysed everything, markets will always surprise you! And you do not want to be on mercy of market surprises. Must find out the total risk involved in the option trading strategy you are trying to implement.
- What is my expected profit form this trade?
Like it or not, most of the traders trade blindly. They do not know what is the expected profit from the trade they have entered. Whether that kind of profit is possible form this trade, is it realistic or not. If you are clear about the expected profit, you know when to square off your position. Otherwise, profits will come and go but we will stick to our trade without booking the profits! Happened with you? You were in good profits at one point in time and just after few ours or few days, position is in loss!
- What percentage of my capital is allocated for this trade?
If trade is safe, obviously higher allocation can be done , but if trade is very aggressive with good amount of risk, allocation has to be really small. I do not want to get out of business with one trade! In any case, allocating more than 20% to one trade or one option trading setup is not very advisable.
- What are the points at which I need to do some adjustment in trade?
Options trading without adjustment is like driving a car without a steering! You need some sort of adjustment in your option trading strategy at some point in the series. We must be clear about these points well in advance. Once markets start making moves, it becomes really difficult to think. So let us finish the thinking part, before entering the trade.
- What will be the adjustment at adjustment point?
Ok, we have decided the adjustment points and levels, but what will be the exact action. When the stock touches those levels, will I buy put at that level or will I sell a call at that particular level? This will help me in taking control of overall broad set up of my trade.
These are five simple questions , if answered before every trade will ensure that you are not trading under undue stress(due stress you have to take !) and almost all your trades end up in profit and only profit.(READ MORE:- profit or zero loss strategy http://masterstrategy.in/245/ )