This post was originally written for r/RealDayTrading Mar 28, 2021
I have been trading options for over 30 years and I am frequently asked, “Where Can I Learn To Trade Options?” Here is my 3 step process. Most of you are already mastering the first two steps and if you are proficient at those, the options part is pretty easy.
All of your trading has to start with market analysis. That means getting your bearings from a technical perspective (moving averages, volume, trendlines, momentum) and also being aware of the fundamental backdrop (earnings, interest rates, economic data, political policies). I spend three hours each morning conducting market analysis. This is the most critical step and it is the biggest piece of the puzzle. More than 75% of all stocks follow the market. If you get this wrong there is a 75% likelihood you will lose money. I always have a 5-minute chart of the SPY up when I am trading and I never take my eye off of it. Once you have your market bearings, you are ready for the next step.
Let’s say that you have concluded that the market is bullish for the next few days and that the uptrend should continue. There are not any speedbumps (economic events) ahead and the downside risk is minimal. Now it is time to zero in on the best stock.
I look for stocks that are moving higher when the market is moving lower. I call this relative strength (RS). Do NOT confuse this with the RSI indicator that compares the stock’s current move to its recent price movement (I find little value in RSI). Find stocks with relative strength that are moving higher on heavy volume and that have broken through technical resistance. These will be your best prospects.
If you get the market right and the stock right, options are easy. They are simply a way for you to increase your leverage. Here’s the rub: I am not saying that getting the first two steps is easy. It is very difficult and until you hone your skills with steps one and two you should not trade options. You will simply lose your money faster.
Basic options buying strategies and vertical spreads are all you need to trade any market scenario. Your opinion of the market and your confidence in that forecast determine the best options trading strategy along with your opinion of the magnitude and the duration of the expected stock move. Keep your strategies basic and the positions will be much easier to manage.
Options are not the starting point, they are the icing on the cake. Market first, stock second, and options last.
I went through the entire process and it culminated with a trade example.
Read Part 3 with the trade details.
Good luck with your trading.
