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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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A target exit point is an option price that would result in a substantial, yet attainable, profitIMPORTANCE OF TARGETED EXIT POINTS One of the most important decisions a trader must make when entering a position is determining when to sell or close out the trade. It is imperative to set a target exit point for each trade. A target exit point is an option price that would result in a substantial, yet attainable, profit. By setting your profit objectives in advance and determining your target exit point before you trade or at the time you make your option purchase, you avoid the consequences of one of the major stumbling blocks to achieving trading profits: greed. It is very hard for most investors to set reasonable profit goals once an option has jumped substantially in price. That extra point becomes a moving target with each advance in the options price. Therefore, it is not surprising that a reasonable profit is not achieved when the investor is forced to bail out because of tumbling prices. Although setting profit goals in advance may be simplistic and not the most flexible approach to option trading, the target exit point approach to taking profits is a necessary compromise. This is especially true for the options trader who has neither the savvy nor the emotional control to know when to hold and when to fold in the heat of battle, and who is also unable to stay tuned to the markets throughout the trading day. Note also that the profit objective should be substantial, meaning at least 100 percent, or double your initial investment, so you will not be walking away with small profits by using this approach. With this approach, you will miss out on those 1,000 percent gains that are the options equivalent of hitting the jackpot; but much more important, you will minimize the instances of solid profits becoming painful losses and you will regularly be taking respectable gains off the table. Once you have entered the heat of battle, the tendency will be to base your decisions upon emotion, and therefore your decisions will tend to be incorrect. To avoid this pitfall, set a closeout date based on the amount of time you expect the option needs to reach its target exit point. If that profit level has not been reached by the closeout date, exit the position on that date. Closeout dates should be set so that there is still enough time until expiration to salvage some time value from the option if the underlying stock has failed to move. Resist the temptation to sell at a small loss prior to your closeout date. You will be yielding to fear, robbing yourself of some potential gains. Also, resist the temptation to raise your profit objective as the price of the option nears your target exit point. You will then be yielding to greed, and your profits will slip away. Another important question that needs to be addressed is when should you not sell? You should not sell a position the instant it moves against you. There is never a need to engage in panic selling if it is assumed that your original conditions for opening the position still hold true (e.g., your market outlook and your outlook for the stock on which you own options have not changed); also, that you are not committing an excess amount of trading capital and you are still operating within your own risk tolerance. As option traders we create option positions for their huge profit potential, which can be fully realized only by allowing positions to remain open for a reasonable period of time. Setting predefined exit points goes a long way to facilitate this task. TIPS FOR SPOTTING AN EMERGING BULL MARKET Although no two bulls or bears are exactly alike, and sometimes their signals may be a bit obscure, eventually the indicators will pile up and a trend will become evident. As you analyze the stock market for signs of shifting trends, be cautious. Each market is different from its previous cousins, so not all the warning signs will be present each time. If you notice only one or two of the telltale clues, some fleeting business or economic event temporarily may be tilting the market. However, if you detect four, five, or more of these signs appearing all at once, youve probably discovered a major new market phase. Before the bull begins to charge ahead, you will find six major signs that the bear has retreated into hibernation. Most of these signs apply to stocks, but often they readily relate to other investment markets as well. One of the signs is that the market has undergone a mature decline. Naturally, if you want to determine whether a new market is on its way up, one of the first things youll do is determine what activity has come before. If the market has undergone a mature decline then a bull may not be far off. Second, look for a market that is dull and boring. Historically, bear markets generally storm onto the market scene, but they depart extremely quietly. This kind of lackluster activity is one of the most common signs that a bear market is losing strength. Such sluggishness may go on for weeks or even months, but stock prices do not necessarily tumble along with trading volumes. When this scenario occurs, professional investors might say the market has been seized by a complacent attitude. The next possible sign is when the market resists bad news. Generally, financial and even some sociopolitical news has a marked effect on the markets. When the markets refuse to budge, despite significant developments, you definitely should take notice. Another sign is when the gloom is so deep that even the top-quality investments are sold. As a severe bear market grinds on for what seems like forever, stock investors, for example, often sell their blue-chip securities in one last brief selling period. These probably are the last stocks to go, as investors will have unloaded their lower-quality holdings at the start of the bear. When the market has fallen to an uncomfortable degree, and investors believe hope for a quick recovery is gone, blue chips hit the market with a sudden decline. Not surprisingly, that tends to reinforce the bleak market mood, as investors begin to think that if even the best stocks are acting this way, then something really must be wrong with the market. Next, as a bear market begins to fade, stocks that once sold at priceearnings ratios of, say, 18 to 20 times earnings often are selling at unusually low P/Es, perhaps less than half their former figures. When those stocks once regarded as must-have securities lose all their appeal, the change from the normal situation should cause investors to take notice. Those who have a chance to purchase bargain stocks before the next bull market should swing into gear. Finally, high dividend yields offer a key signal. Like low price-earnings ratios, the often high-dividend yields to be found at the tail end of a bear market represent a market reversal in market psychology. Although yields in a bear market typically are higher than those for the same stock at the peak of a bull market, you can look for this phenomenon to alert you that a bear market has run its course. What does it mean when you can identify several of these indicators? Obviously, the bear market has begun to fade and the bull market slowly is taking shape. More and more trading occurs daily, and the number of advances, the upward movements in the prices of the individual investments, outpace the declines. The volume of trading and the number of advances and declines indicates the market breadth. To summarize, be aware of the following key signals that a bear market is approaching a bottom. First, market prices have been declining for more than 12 months. Second, the volume of trading declines and you start to observe a very boring market. Third, bad news makes no impression on the markets. Fourth, investors start unloading top-quality investments by heavily selling many of the blue chips. Fifth, investments that once were stars are now on the skids, selling at undervalued prices. With stocks, price-earnings ratios are unusually low. And finally, sixth, stock dividend yields rise abruptly. The bottom line is if you observe most or all of these signs, the bear market is probably coming to an end and a new bull may not be far behind. TAKE A LOOK BEHIND THE ANALYST CURTAIN How many times have you placed a trade that you thought was perfectly set up only to have an unforeseen or unexpected event cause the trade to go bad? The technicals all looked good; maybe even the fundamentals were all in place. To all intents and purposes, the trade looked like a winner. Then all of a sudden out of nowhere comes a comment from one of the guru goons (my term for analysts), the company announces an acquisition that the Street doesnt like, or maybe even a bizarre incident like an earthquake in Taiwan! The underlying then reverses and the trade moves against you. Lets look behind the scenes of how analysts and institutions really work. Its amazing how many individual investors and traders still live and die by analysts recommendations. Many people actually still think that analysts make recommendations for the good of investors. Think about it, who do the analysts work for? They work for the institutions. Why do analysts continue to rate a stock a strong buy while the underlying is bleeding a slow death? Why do the same analysts raise a stocks rating that has clearly been in an extended uptrend? Institutions build inventories in stocks that they then allocate to their brokers to sell to investors. In some cases, it is nothing more than a quota that the broker is expected to sell. The analyst from the institution will then focus on some piece of positive data regarding the stock and raise the ratings on the same. This causes a short-term buying interest in the stock by retail investors and usually a bump up in the price as well. Who are the retail investors buying from? Their institution! The institution has been accumulating inventory in a stock, so then it manufactures a buying spurt and depletes its inventory at a higher price. Many times this occurs as the stock is showing signs of topping out. The institution makes money, and who is left holding the bag or stock? Institutions are in the business to make money, and that consists of more than just broker commissions. If the investors make money, then thats okay, too, but its not the priority. In fact, in some cases your own institution will actually take a position against your trade! It goes even deeper. If an institution is dumping an inventory and you have purchased the stock and later decide that you want to sell, the institution wont buy your stock back! It will execute your trade only after it finds some other patsy to take it off your hands. Have you ever wondered why analysts always seem to be a step behind? When a company announces something negative, if its a stock that the institutions are interested in, the analysts all jump on the bandwagon with downgrades. As retail investors are dumping the stock based on the downgrades, the institutions are sitting back and waiting for the downdraft to subside and then they begin to start accumulating again. The whole process starts all over again. How about raising a stock to a strong buy once it appears ready to break out of a long-term consolidation or basing pattern? Wouldnt that be a novel idea? That would mean that analysts were really employed to help investors, however. Then there are all of the amazing abuses of investors by analysts regarding initial public offerings (IPOs). How many investors own Internet stocks that were priced at ridiculous price multiples due to continued upgrades by analysts as the stock prices went into the stratosphere? How many investors still own those stocks today under $10 a share? Do you think the institutions feel bad that they sold investors those stocks at ridiculous multiples? Believe me, they will only feel bad until they look at their bottom lines. Some of these longtime abuses are finally beginning to surface in the media, both on the television networks as well as in the print media. Some investors have even sued the analysts. Okay, so whats my point in all this? We are on our own out here and have only ourselves to hold accountable when investing our hard-earned money. Optionetics exists because no matter how much research we do, no matter how good a trade looks when we place it, things happen that are out of our control and can cause trades to go against us. Hedging all trades is crucial. When an unforeseen event does happen, we can employ a creative options strategy to take advantage of it. Even in our worst-case scenarios, our losses are minimal and we live to fight another day. Option strategies are designed not only to aid your research, but also to help hedge the trades you make, regardless of existing market conditions or directional bias. |
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