Trading Psychology Part #1: When to Buy/Sell
How I overcame the buy/sell issue most traders have
Have you ever bought a stock and wondered about an exit strategy? When should I sell? Only to find out what the experts tell you really doesn’t work?
Timing the market is almost impossible. There are several pundits who will tell you to sell when the ‘red’ arrow shows up or buy when the ‘green’ arrow appears on the chart. Although there may be some merit to trading systems which use charting studies, or a combination, it is still very hard to trade this way. For one, the reversal can be quick and hard (either way!). Any small profits may be decimated in a matter of minutes.
What can be done? Instead of trying to improve your charting skills, could there be another answer? Maybe take the decisions away from yourself? You could still use charting to decide when to enter the market, but for me, I have found a better answer.
Since I trade options, most options trading involves probabilities. Probability of touch; probability of profit; standard deviations and the like.
So, if you have a trading system which only factors in probabilities, is there a way to take the buy/sell decision away and profit? Many options traders utilize a ‘delta neutral’ trade, where the direction is less important. For example, a “Iron Condor” is a common trade, where you sell a put and call, out-of-the-money (OTM), then buy a put and call further out-of-the-money. This generally is a great way to trade until it is not. If you have trades on the same underlying stock, ETF, or Index, then the price can go through one side or the other and ruin the trade. A solution to this issue is to trade across numerous underlying stocks, numerous timeframes, and numerous strikes. Although this can be done and is fairly easy to manage, there is still a lot of ‘moving parts.’ When the markets are ‘fast’, meaning they’re more volatile than normal, many can lose sight and make bad decisions, similar to that of a buy/sell decision.
Before we get into better option choices, we also have to ask, what’s an appropriate annualized Return on Investment (ROI). If the average ROI is about 9% over 20 years in the S&P 500 ($SPX, $SPY), can that be improved upon?
I think I’ve found a way. It takes some of the psychological problems traders face out of the equation.
If I proposed the question, “Would you like to trade in a way where you could make 20% year after year, consistently or would you rather make 30% per year, with a risk of a 50% loss in random years?”
If you look at risk-of-ruin or monte carlo scenarios regarding this, it can be devastating if there are two 30% drawdowns in the first two or three years. For this reason alone, I would probably look for 20% in a safer trading system.
Better Solution
The better solution I am talking about involves looking at probabilities, structure of the trade, and entry. That’s it. Want to learn more? Consider joining our paid subscription and learn how we trade with consistent profits.