How To Evaluate A Stock Option Trading System

Provided By Ultimate Trading Systems

What Is The Best Stock Option Trading System For You?

Once you’ve set your trading objective, and picked the market you want to focus on, you need to develop a stock 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. What’s 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. I’ve 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 don’t have money to trade, you can’t make profits. Your stock option trading system must preserve your capital or you’ll fail. This also means you can’t 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. It’s not important how successful a system might be; what’s important is how successful it is.

Success is determined by real profits, not by percentages alone. So ask yourself how much this stock 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. Here’s 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.

Let’s say you’re a day trader. You start the day with $10,000, and when you’re done trading for the day, after closing out all your positions, you have $10,400 in your trading account. You’ve made $400. Your percentage gain for the day is 4%. That’s 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 that’s 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; you’ll 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 it’s 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, you’ll 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 stock 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 any losses.
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