Three Factors Determine if You Make Money in the Market
Target Your Wins and Losses
Last month I wrote a column for
Cabot Wealth Advisory
You Have to Treat Options Differently
. Afterward, I received an email from a reader who asked how you
can make money without winning at least 60-70% of the time. The
reader's question got me started on the topic for this article.
There are three factors that determine your level of success as an
options investor or a trader: your average win, your average loss
and your winning percentage.
You need to know these three factors in order to make an informed
decision about a trading style--whether it's stocks or
options. Let me give you three scenarios and you'll see what
This table is based on 10 trades with equal-dollar amounts in each
trade. As you can see, it isn't necessary to win all the
time, nor is it necessary to have huge wins.
The lesson here is that the relationship between your winning and
losing trades, along with your winning percentage, will determine
whether or not you make money.
Scenario A would likely be an aggressive options-trading strategy
where you're swinging for the fence. It would likely involve
front-month, out of the money options. When you swing for the
fence, you also strike out more. You could call this the Babe Ruth
strategy. Sure Babe Ruth was the greatest home run hitter of his
time, but he also set the record for strikeouts in a career and
both of his records stood for a long time.
Scenario C would likely be an option writing strategy with a high
winning percentage and smaller wins, but bigger losses. A credit
spread strategy would likely have higher average losses than
average wins, but would also have a high winning percentage.
Scenario B is what I strive for with
Cabot Options Trader
. Using options that are in the money by a strike or two and using
options that are more than a month from expiring, you will have a
better chance of a higher winning percentage. With this safer
approach you will have a smaller average win than you would have
with Scenario A but your average win will be higher than your
average loss, unlike Scenario C.
Good luck and good investing,
Cabot Options Trader