Day Trading, Option Writing and Developing a Winning Strategy
JC: Hello Ward, how has your trading been since we last spoke?
WC: My trading has been trending upwards. Markets have generally been stuck in a trading range for several weeks now. In fact I’ve had to scale back in order to protect profits. Many times there were no clean signals during the New York/Chicago trading sessions. I knew it was time to bring in another tool from the toolbox.
JC: What do you mean by that comment?
WC: If you rely too heavily on one approach and the market goes through a transitional phase, your approach might not be as effective as it was when the market was trending in a clear direction. The market always tells you how to approach it so you can make money. You just need to listen carefully for the messages it sends. For example, I’ve been using my Retracement Matrix very successfully for a few years now, but since mid-February, the currencies have been posting most of their major moves overnight. Since I do like to sleep, I’ve missed a lot of those moves. I believe that my Matrix will be a staple for me again, but I need to listen to the market and adapt my approach.
JC: I like that idea of listening for the market. The Retracement Matrix you mentioned is used for day trades, correct?
WC: Yes, I’ve been using it primarily for day trades, but it also can be adapted for option writing and position trading.
JC: Overall, what is your view on day trading? Is it feasible for most traders to expect to make money day trading?
WC: That’s a tough question to answer. I have to honestly say that most traders should not day trade. The casualty rate is too high, and you’re working with small moves and hiccups just trying to harvest a few points. If you’re able to do it that’s great, but the majority of traders would be better served taking position trades or learning how to write options properly and effectively.
JC: Why do you say that? Statistics show that between 60% and 80% of all traders want to day trade, and you’re saying they should NOT day trade?
WC: That’s 100% correct. Trading success is all about finding out what your strengths are. Day trading is frustrating. You study the charts, wait for your signals, and get ready to execute a trade. As you’re waiting, doubt creeps into your mind and you ignore the signals, only to watch the market move in the direction you initially thought. You then resolve to “take that trade the next time the signals line up.” The signals line up again and you pull the trigger; then the market turns and moves against you! Of course you want to limit your loss so you jump out of the trade, crystallizing your loss. Once more you watch the market turn around and make the move you thought it would in the first place. I guarantee you will either go grey or pull your hair out in frustration, unless you are able to deal with the emotional roller coaster day trading puts you on.
JC: But you’re not supposed to trade with emotion as a factor.
WC: For most people it is very difficult to separate themselves from their emotions when they trade. You’re not supposed to do a lot of things, but this is your hard-earned money and it’s a pursuit that you want as profitable as possible. Nobody starts trading with the objective of losing money. It’s natural for emotions to become involved at some point.
JC: Okay, how do you deal with emotions?
WC: I limit myself to a maximum of two trades a day and I will not allow my losses to go over $350 a day. Even then, after two or three days I scale back my day trading until the market shows me a glaring opportunity.
JC: Why don’t you use one of the software packages available?
WC: The brutally honest reason is because I haven’t yet found one that works consistently over a long period of time. As markets grow and become far more complex, the current batch of software is in serious danger of becoming obsolete. I’m in the planning stages of putting together a predictive software package, but I don’t see that as ready for another 4 – 6 months at best. Until then I’ll keep working with my clients to help them develop their skills.
JC: I like your style. What does work for day trading then?
WC: If you seriously want to succeed as a day trader, you need to have a well-defined trading plan. You also need to stick to your strategy and avoid chasing the market as much as possible. Successful day traders are able to steel themselves against the negative effects of small losses and focus on reaching their weekly and monthly profit goals.
JC: What about using technical indicators, Fibonacci numbers or other chart analyses?
WC: Let me address each one. Firstly, technical indicators only give you an edge if three criteria are met. The first one is that you have to be able to interpret the signal before other traders, and the second is that the indicator needs to have a verifiable track record of success. The third and last criterion is that the indicator needs to be predictive. In other words, the indicator needs to be able to predict where the market will most likely move and make those predictions with over 60% accuracy. The one I use the most is a modified exponential moving average. I change the defaults to 5, 9, and 15 as a “workhorse” setting, and then I use the EMA to help determine where my exit point is. I find these numbers useful for currencies, bonds, and indexes.
JC:What about Fibonacci?
WC: Well, as for Fibonacci numbers, in my experience it’s really easy to get confused trying to figure out the exact time frame to apply the retracement values. Even when you do get it right, Fibonacci can be cumbersome for most traders to use effectively. I do use a modified sequence of Fib numbers in order to generate more “real world” trading levels, but I am always adjusting my algorithm to make sure it applies to current market conditions. If you want to use Fibonacci, Elliot Wave, or Gann, I suggest you work with a really good mentor who can help you avoid some of the pitfalls with those tools.
JC: Okay, what about chart analysis?
WC: Alright –lastly, chart analysis. All I have to offer here is some good common sense for chart analysis: focus on the right side of the chart. I see lots of people who are great at picking chart formations, support and resistance points, and technical analysis who still lose their shirts. What happens on the left side of the chart does matter, but it’s what happens on the right side that makes you money.
JC: What do you recommend traders who are losing money do to become profitable?
WC: I used to think that working with a good strategist was all traders needed to do if they wanted to make money in the market, but I’ve had to rethink my position. Traders need to understand the strategy, why it works, and when to use it. The only way to do that is by working with a professional trader and a good mentor at the same time. They may not necessarily be the same person, but good mentors tend to know good traders, and good traders tend to know good mentors.
JC: And you feel that option writing is a valuable strategy?
WC: Yes. I’ve always thought option writing is an excellent approach that helps traders build their accounts. The problem with option writing is the fact that the profits are taken in up front –it’s so easy to become complacent when you’re selling options. The people in my mentoring program have to prove they can properly pick profitable option selling strategies for at least 3 months before they have my blessing to go off on their own. Even then, I still assign them a trader to work with, and I am never more than a phone call away.
JC: How does option selling work?
WC: It’s fairly straight forward. You simply sell an option and you collect the premium. Insurance companies have been collecting premium from us for years using the same principles. The tricky part is picking the best option to sell so you get the highest premium with the smallest chance of the option being exercised. To give an example of a recent trade, on March 13 we sold the May crude oil 53.50 put and the May crude oil 71.00 call. In effect we feel the market will stay above $53.50 per barrel and below $71.00 per barrel until mid-April. Depending on the time of day, traders received between $900 and $1100 for writing those two positions. If the market stays in the expected band, anyone who wrote that position also will keep that premium.
JC: It seems so simple. There must be some risks . . .
WC: There is a lot of risk if you are not prepared to review the position on a daily basis and if you don’t have proper risk management strategies in place before entering the trade. For example, if oil should spike by $4 or $5 over a few days, the margin required to hold the calls would go up, sharply, which could put you in a losing position rather quickly. Before my clients went into the position, they had a predetermined exit strategy that focused on limiting any potential losses.
JC: Which approach is better, selling options or day trading? For that matter, why not just take a position and wait things out? What should a trader who is losing money do to turn things around?
WC: Position trades tend to keep too many people up at night. Last year the Euro required a full 3-cent stop loss to trade that market if you took a long-term position. I’d have a hard time sleeping if I knew that I could wake up and be down between $3000 and $4000. Some people might be just fine with that possibility. There is no single approach that will work for every trader. Each one has different skills and temperaments that need to be taken into account when they trade.
JC. So what you’re suggesting is?
WC: What I’m saying is that traders need to find their strengths and then learn to fully exploit them. By working with a mentor/strategist and an experienced professional trader, working traders can find their areas of core strength and focus on developing them. Some people will be excellent day traders, some top-notch option writers; some will become amazing position traders. There are even some people who should not be trading at all. You owe it to yourself to find a good professional and work together to identify what you’re good at.
JC. Thank you, Ward. Talking with you has been informative and enjoyable.
WC: You’re welcome, Janice. It’s been a pleasure.