How To Evaluate A Stock Option Trading System
By Ultimate Trading
What Is The Best Stock Option Trading System For You?
Once youve set your trading objective, and picked the market you
want to focus on, you need to develop a
option trading system. Hundreds of different systems already
exist, and you can certainly learn about them, and even purchase one
if you like. Or you can develop your own. Whats important is that
you should be able to objectively evaluate the stock option trading
system to make sure it meets your needs and that it performs well.
There are several criteria you can use to evaluate a stock option
trading system. Ive listed some important ones here.
The first criteria to consider is whether or not the stock option
trading system preserves your capital. This is critical. If you
dont have money to trade, you cant make profits. Your stock option
trading system must preserve your capital or youll fail. This also
means you cant risk everything. As a trader, you should be looking
for small, repeated successes. Your focus should be on consistently
making profitable trades and limiting your losses on bad trades. A
stock option trading system that does not preserve your capital will
quickly put you out of business.
Next, look at how the stock option trading system has performed
historically. Historical performance is important since your goal is
to make profits over the long-term. Evaluating past performance is
the only way to determine if a stock option trading system, or if
your stock option trading system, is successful. Its not important
how successful a system might be; whats important is how successful
Success is determined by real profits, not by percentages alone. So
ask yourself how much this
option trading system has actually put in your pocket. Of
course, your percentage of gain is important, but only if it
measures your true profits or losses. Money in your pocket is the
only real measurement of success. Heres how you should calculate
success: at the end of the day, week, month, or year, do you have
more actual money than you started with? By actual, I mean money
that is liquid and can be accessed immediately. And if you do have
more, what is your percentage gain? The only way to truly show
profit or loss is if percentage gains (or losses) are based on the
amount of money invested.
Lets say youre a day trader. You start the day with $10,000, and
when youre done trading for the day, after closing out all your
positions, you have $10,400 in your trading account. Youve made
$400. Your percentage gain for the day is 4%. Thats real,
measurable success. If you measure historical performance in any
other way you might not get a true picture of your success.
Your stock option trading system should also be mechanical in
nature. A good stock option trading system should have you making
decisions that are based on rules and parameters, not on emotion. A
mechanical stock option trading system is not one thats based on
buying every IPO that becomes available. A mechanical stock option
trading system could be a direction to buy stocks with a maximum
price earnings ratio two weeks before the ex-dividend date, with a
5% stop-loss set.
Trading on your system should always take place in liquid markets.
An effective stock option trading system should be aimed at liquid
markets where sufficient daily volume exists to easily and
consistently execute orders. For example, the S&P 500 Index Futures
Market is highly liquid, whereas the Orange Juice Futures market is
far less liquid. You want to be able to make trades as quickly as
possible, and as close to the intended price as possible. While the
market should be liquid, it could be moving up or down. A good stock
option trading system will work in all kinds of markets. It should
have the potential to generate successful trading performance in
every market; bull, bear, and sideways trading range.
Also consider whether the maximum drawdown of your stock option
trading system fits your personal requirements and situation. An
inherent characteristic of investing in general and of trading
systems in particular is the maximum drawdown potential in account
value from the most recent peak. No stock option trading system is
perfect; youll make some trades that are great, and some that will
be bad. If the potential loss on bad trades in your system exceeds
your tolerance for risk, and puts your capital in jeopardy, then
its not the right stock option trading system for you.
The system should also fit the capital you have available to invest.
You have to be able to feel comfortable with your stock option
trading system, and if most of your capital is at risk, or the risk
levels are too high for your comfort, youll make emotional
decisions instead of logical ones. If a stock option trading system
meets all of these criteria, and your own trading objectives, it
will be a good
option trading system for you to use. Using this system
consistently, with the right trading mind-set and good money
management skills will ensure that your trading profits far exceed
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