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7 effective rules for Smart

Options Trading

Complex Options. Simple Solutions.

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In today’s world, it is easy to test your trading idea before investing and then taking the risk in real market. The most important rule is that whenever we start with an option trading in derivatives market we should always startwith strategy testing. It is true that it might take some time, may be 1 month to 3-4 months and sometimes even more than that, but if we have our strategy written down along with a set of rules then it becomes very easy for us to trade in Options. Some of the rules to be set are like Entry point, Exit Point, Position shifting, Position to be hedge or not, if hedge then with Equity or Future, Options or Synthetic Futures, Quantity to trade, Margin to be used etc.Data Back testing means applying all strategic rules to historical data and check whether those strategies are favorable or not. One more important point to keep in mind is that strategies should be checked regularly for minimum 5 to 7 years which would enable you to cover almost all type of favorable and unfavorable events. You can then change or reverse the strategy whenever you don’t get a favorable outcome.

1. Strategy Back Data Testing

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Please note that the past testing results do not give us the guarantee of future results but it gives us an idea of how our strategy has performed in different time periods and market conditions.

1. Strategy Back Data Testing

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In today’s world, the problem is that no one thinks about how much money to invest in Option Trading or how to start working with an Option? So, here is the answer to it- there are many strategies applied during option’s trading and each strategy requires different fund planning. Let’s say one strategy might require a fund of Rs. 100 whereas the other strategy requires Rs. 200 and so on. Some strategies that are risky with high return profile requires higher fund than moderate strategies and low risk strategies. Moderate strategies or low risk strategies give lower returns than High Risk strategies and also the fund requirement is lower than High Risk strategies.

2. Planning for Fund Requirement

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There must be fixed time period to run the same strategy, which should be of minimum one year from the starting point. If a trader starts working on some strategy, like Butterfly, then this strategy needs to be run for at least one full year as strategies do not give benefits straight away. Sometimes a strategy is in favor of the trader for first 2 months but only gives nominal return of 1-2% and in the very next month it starts giving negative return of around 5-6%. If the trader stops his trading at this point, his account will show a loss but if he decides to continue with the same strategy for another 9 months then it might be possible that in few months’ strategy starts giving him some good return.

So, the trader should fix his minimum term (here 1 year) for the strategy to work properly.

3. Fixed Term for strategy to run

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Exchange’s expense and brokerage charged can seriously erode the returns earned. Therefore, a trader needs to keep notes of such expenses at the back testing time of the strategy.

4. Expense

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Trader should remain focused on learning more on daily basis. It is important to remember that understanding the market is an ongoing and a lifelong process. There are various factors that affect the market and the traders are needed to understand them.

Some of the factors that affect Market are world economy, Events like RBI Credit policy, Inflation Figures, IIP Figures, Rain figure in Rainy season, Election, Rail Budget, Finance Budget etc. It is very important to understand these Factors and their impact on the market, so that the trader can easily stand and trade in the market or else they can be pushed out of the market.

5. Knowledge Updating

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It is important to stay focused on the goals that were set. A losing trade or a winning trade should not surprise you as it is a part of trading. It is the cumulative profits you should focus on that would make a difference in long term. Once a trader accepts that profit and losses a part of trading, it will start having lesser effect on the emotions of the trader and thus ultimately improving the trading performance. Setting realistic goal should be an essential part of your strategy.

6. Trading Perception

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If your trading plan is ineffective, you will have to stop trading. If your trading account shows losses more than your historical strategy testing, then it can happen that the markets might have changed or the volatility within certain trading instrument might have become higher or lower. It is also possible that world economy or home economic factor had affected the market. At this point of time we should reassess the strategy with the required changes to stay in the market.

7. When to stop trading

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Thank You

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