Successful trading often hinges on identifying the point of a market reversal. While it may seem ideal to pinpoint the exact moment of a downturn or an upswing to maximize profits, this is an improbable feat. Instead, aligning with the trend is a more reliable approach to secure consistent gains. As a proponent of probability and success rates, I advocate for trading with the chart’s momentum, not against it.
Rule #1: Trade with the Trend
To start with this strategy, the first and most critical rule is to always trade in line with the prevailing trend. But how do you determine whether a chart is trending upwards or downwards?
Here’s a simple method:
- Use a platform like TradingView.
- Adjust the settings to a 200-day moving average and make the line visually distinct (e.g., red).
In this strategy, you only enter a trade if the price is above the 200-day moving average, signifying an uptrend. If the price is below this line, no trade should be initiated. This foundational rule ensures you’re trading with the market’s natural direction.
Rule #2: Incorporating the RSI with a Twist
The second rule involves using a customized version of the RSI (Relative Strength Index) indicator to gauge market momentum. To apply this:
- Search for “RSI Divergence” in the indicators tab.
- Adjust its settings by unchecking unnecessary options and ensuring the middle line is clear (e.g., white).
Traditionally, the RSI is used to identify overbought or oversold conditions. However, in this strategy, the focus is on momentum. Enter a trade only when the RSI line is above the middle white line. If the RSI is below the line, no trade should be executed.
Additionally, this customized RSI indicator highlights divergence, which occurs when the price moves in the opposite direction to the indicator. While bullish divergence isn’t a mandatory condition for entering a trade, it’s a strong confirmation signal.
Rule #3: Identifying Momentum with Engulfing Candles
Momentum candles are crucial for identifying the start of a new trend. Specifically, this strategy relies on bullish engulfing candles, which occur when:
- A green (bullish) candle’s body fully engulfs the previous red (bearish) candle.
- The green candle closes above the prior red candle’s open.
To simplify the process, use an indicator that automatically identifies these candles:
- Search for “Engulfing Candle” in the indicators tab.
- Focus on the green arrows (bullish signals) while disregarding the red arrows.
You should only enter a trade when a green arrow appears and the corresponding candle has closed. Entering before the candle closes can lead to false signals if the pattern doesn’t fully form.
Practical Application of the Strategy
Let’s put these rules together to illustrate a successful trade:
- Confirm the price is above the 200-day moving average (uptrend).
- Check that the RSI is above the middle white line.
- Look for a green arrow indicating a bullish engulfing candle.
- Enter the trade only after the candle with the green arrow closes.
Once the trade is initiated:
- Establish a take-profit target with a 2:1 reward-to-risk ratio.
By adhering to these rules, you can take the emotion out of trading. Set your parameters, close your computer, and let the market do the work.
Dealing with Market Inactivity
It’s important to note that you won’t find trading opportunities every day. Since this strategy relies on trends, there will be periods when the market is stagnant or moving against your criteria. Recognizing when to stay out of the market is just as critical as knowing when to trade.
Another Example of the Strategy in Action
For additional clarity, here’s another example:
- Confirm the price is above the 200-day moving average.
- Verify the RSI is above the middle line, with a possible bullish divergence (a bonus signal).
- Identify a green arrow signaling a bullish engulfing candle.
- Wait for the candle to close before entering the trade.
Set the stop-loss and take-profit levels as described earlier and monitor the trade’s progress. Patience is key, as forcing trades in unsuitable market conditions can lead to losses.
Options trading offers a powerful way to capitalize on market opportunities, hedge risks, and amplify returns. While beginner strategies focus on basic concepts, advanced strategies allow experienced traders to unlock the full potential of options. Here are six advanced strategies to elevate your trading game and trade options like a pro.
- Mastering the Iron Condor Strategy
The Iron Condor is an advanced options strategy that benefits from low volatility and aims to generate steady income. It involves selling an out-of-the-money call and put while simultaneously buying further out-of-the-money options to limit potential losses.
How It Works
- Sell an out-of-the-money call
- Sell an out-of-the-money put
- Buy a further out-of-the-money call
- Buy a further out-of-the-money put
This creates two credit spreads: one on the call side and one on the put side. The maximum profit is earned if the stock price stays within the range of the two sold options until expiration.
When to Use It
This strategy works best in low-volatility environments when you expect the underlying asset to stay within a specific price range.
- Leveraging the Butterfly Spread for Precision
The Butterfly Spread is a neutral strategy ideal for traders who expect minimal movement in the underlying asset.
How It Works
- Buy one lower strike option
- Sell two at-the-money options
- Buy one higher strike option
The result is a limited risk, limited reward strategy that profits when the underlying price remains close to the middle strike price at expiration.
Key Advantages
Butterfly spreads are cost-effective and allow traders to benefit from precise price predictions without significant capital requirements.
- Rolling Options to Maximize Profit
Rolling an option involves closing an existing position and simultaneously opening a new one with a later expiration date or different strike price. This strategy allows traders to extend their trades or adjust to changing market conditions.
When to Roll Options
- Defensive Rolling: If the trade is moving against you, rolling to a later expiration or different strike can mitigate losses.
- Profit Maximization: If your trade is profitable but the option has more potential, rolling can help you capture additional gains.
Key Considerations
Rolling involves additional transaction costs, so it’s essential to calculate whether the potential benefit outweighs these costs.
- Capitalizing on Implied Volatility with Vega-Weighted Strategies
Implied volatility (IV) plays a critical role in options pricing. Advanced traders can take advantage of IV changes through vega-weighted strategies, such as straddles and strangles.
Using Straddles and Strangles
- Straddle: Buy a call and put at the same strike price and expiration.
- Strangle: Buy a call and put with different strike prices but the same expiration.
- When to Use Them
Straddles and strangles are ideal in high-IV environments, such as before earnings announcements or major economic events.
- Advanced Hedging with Collar Strategies
A collar strategy is a conservative approach to protect existing stock positions. It involves owning the underlying stock, buying a protective put, and selling a covered call.
How It Works
- Own the stock: Provides upside potential.
- Buy a put: Limits downside risk.
- Sell a call: Offsets the cost of the put.
This strategy locks in a profit range, ensuring limited downside while capping potential upside.
Ideal Scenarios
Collars are beneficial when you expect moderate price movement in the stock or during periods of uncertainty.
- Calendar Spreads for Time Decay Profits
A calendar spread, also known as a time spread, is an advanced options strategy that involves selling a near-term option and buying a longer-term option at the same strike price.
Benefits of Calendar Spreads
- Profits from time decay: The near-term option decays faster than the longer-term option.
- Capitalizes on IV changes: An increase in IV benefits the longer-term option more than the shorter-term one.
When to Use It
This strategy is effective when you expect minimal price movement in the underlying asset during the near term.
Tips for Trading Options Like a Pro
- Use a Trading Journal: Track your trades, strategies, and outcomes to refine your approach.
- Monitor Implied Volatility: Understand how IV affects options pricing and leverage it to your advantage.
- Diversify Strategies: Use a mix of strategies to adapt to different market conditions.
- Master Risk Management: Allocate capital wisely and never overexpose your portfolio.
- Stay Educated: Continuously learn and practice to stay ahead in the fast-paced options market.
By mastering these advanced strategies and incorporating disciplined trading practices, you can trade options like a seasoned professional and achieve consistent success in the market.