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This article will discuss how to profit from options trading and avoid the pitfalls of a lot of stock market advice. By the time you get stock tips, it is always too late to jump in because the price has already risen beyond the point where you can make a profit. Chances are that you will end up with a loss.
As a successful investor you will need the skills of a good doctor who investigates carefully and listens to the heartbeat of an investment. This is what options investing is all about. It’s about prevention, and acting before a big event happens. Unfortunately, most investors end up scrambling while the big event unfolds. I often hear my clients say: “It seems like the market is conspiring against me.”
Let’s look at a typical example of what happens to most investors at some time or other. Let’s assume something like this has happened to you:
You’ve been following a company by the name of NewBee for quite some time as an investment opportunity. However, as a trend-following investor, you are not ready to act because you are troubled by this new venture’s struggles with adequate funding and lack of a strong management team. The company is at a point where only a merger could save it.
One morning you wake up and read in the newspaper that NewBee is about to merge with a large corporation, BigBee. You race to your trading site and discover that the NewBee stock has already jumped 80% on the merger news. Millions of other investors have already acted and were willing to pay an 80% premium to buy a stake in NewBee. By the time your buy order is filled, you have paid an 85% premium – only to watch that stock price tumble as soon as you bought it. While earlier investors enjoyed a 60% profit over yesterday’s price, you ended up with a net loss of 13.5%.
What just happened is what we call as “emotional trend buying.” It’s the primary reason why investors loose money. Always remember that you are likely to be the last to know about company news. So, as a rule of thumb, never buy on news – even if it’s good news. In fact, good news is often associated with a drop in price, illogical as that sounds. To fully understand this concept, let’s take a step back.
In the real world, the big news that’s coming is already known to insiders and/or experts well before the time the big news breaks. These experts make their move and buy as much as they can get their hands on while the price is low. That’s the time to buy! When you learn option trading, you learn how to watch for a sudden unusual trading volume of an otherwise quiet stock. That is a clear signal that someone knows something that the rest of the world is unaware of. Now, as soon as the news hits, demand will rise rapidly, and so will the stock price. Once the price hits a certain threshold, these experts will start dumping their shares and take their profits. The stock price begins to tumble until it settles down at a steady rate.
In this scenario, the majority of investors will take a loss because they bought at a premium after the news hit. So, if it’s any consolation, you are not alone. The only ones walking away with a profit are the experts. Fortunately, every investor can use the tools and techniques of option trading to anticipate trends before they happen and weather this market’s volatility. Charting techniques and indicators, like Bollinger bands, can flag you on disproportionate buying and selling pressure, giving you an equal chance to profit from news before it breaks. Options trading strategies are not about predicting a direction, but about profiting from investors’ mass hysteria. That’s the most interesting part of options investing.
One of the Option trading strategy involves “contrarian theory”, meaning that you do the exact opposite of what everyone else is doing. When executed properly, using the appropriate tools, techniques and indicators, this strategy has a much better chance of profit success than using trend-following techniques.
As stated above, being a successful investor involves skills similar to those of a good doctor who diagnoses conditions in an unemotional and unbiased manner. Just like a doctor uses diagnostic tools, like a stethoscope, a successful investor also uses tools for correct diagnosis. Remember, never follow a stock tip. Millions of others are getting the same stock tip, and it creates a stampede that rapidly drives up prices and wipes out all chances for a profit.
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This is an article from our ‘Tactical Series’.
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