Three weeks ago we had our Option Strategies class and a week before that Ryan held a webcast on earnings season trading. It paid off. This week Amazon reported, and initially, we had no insight to how to trade it. In fact, we broke the rules trading it the day before but how do you know when you can break them?
It's Risk Management.
Trading is like running a business, in fact, it is a business. I'd venture to say that before taking any trading class most should read a book on business basics. When we trade earnings it's usually a week ahead of the event so that we can structure our trades ahead of time in anticipation of the event. What most do is buy calls or puts the day before then close their eyes and do the hope and pray strategy: Hoping and praying it goes your direction.
It start's with trading the right stocks. We use a set of 50 stocks and ETF's in our Core Foundations of Trading program that students track and follow and it just so happens that Amazon is one of those. Four times a year we get earnings and usually, you get large, outsized moves on them because of how they report on earnings. So those situations create opportunity to make a lot of money. Be it pre-earnings or post earnings (we teach both in Option Strategies).
Do these moves miss at times? Yes, I have taken trades where I had a great PTA for a long only to see the stock go the opposite way. Does it bother me to lose money? Sure, but we're managing risk here, not the emotions on each trade. So when you look at the set up you have to justify A) If you have enough capital to do this and B) If the reward justifies the risk.
For me, this is why I like options as an additive to portfolios. I despise Forex but love futures. Options give you the opportunity to 'knock it out of the park' like this where other asset classes are usually standard moves.
If we're talking risk/reward here let's do some math. How do most stock day traders trade? I've done this 10 + years now, I've seen every prop firm, strategy, indicator you can think of. So let me show you how 99% of stock day traders trade then fail, every time.
Trader has $5,000 in their account, they use margin to get them to $10,000. Trader buys $6,000 worth of XYZ stock at $5.50.
That's 1000 shares. Trader puts a stop at $5.30 for risk of $200. The stop is typically 'too tight' and stops them out. Why is the stop too tight? Because they're too levered, too many shares to make too small of a gain. So what happens? They take 5-10 trades a day for small penny gains.
Let's take Cory's example on the Amazon options trade above.
Cory buys 1 AMZN Call for $280. If Amazon went lower his max loss is $280, but his gain was over $2,000. So there's a few things here to take note of. One, the risk is minimal. Second, and arguably most important, he's not nail biting watching a 1 minute chart hoping it goes in his direction because his risk is defined.
If you want to know why there are so many schools out there that promote stock day trading it's simple: Day trades like that are a brokers dream. More trades = more commissions. This is the same conflict of interest financial advisors have with clients for money management.
I hope this article helped.