Trading rules are part of the
game for seasoned traders. Even
long-term investors can benefit by having rules in place. Those trading rules cover many aspects of
trading, some of which are appropriate for option traders while others apply
only to specific markets (stock, forex etc.).
Because I believe that becoming a successful investor/trader over the
long term requires the ability to avoid taking large losses, any rule that helps
you exit a trade that’s not working well is at the top of my list of ‘most
important’ rules. But when to take a
loss, and move on, is not today’s topic.
How important is an equivalent
rule for profitable trades? Do successful
traders use such rules,
including exiting a position once a specific profit level is achieved? Or, are the rules more flexible? Today’s blog begins a discussion of whether ‘profit
taking rules’ are a good idea. Please
share your opinion or experience.
For those readers who are new
to investing, let me be clear. No laws
are involved. These ‘rules’ are
self-imposed and no one (except yourself) is going to punish you for breaking
I’ve discussed the trading of
iron condors frequently
in this blog, but there are some questions not previously considered:
buying iron condors, do you think in terms of earning a specific profit from
the trade? Or do you always plan to hold
the iron condor through expiration, hoping to earn the maximum possible profit
– when all options expire worthless?
you have a rule that tells you to exit when a specific amount (or percentage of
the money at risk) has been earned, regardless of how attractive the current position
looks? Or is it more efficient and
profitable for you to manage positions by making decisions (including whether
to close) on an ongoing basis?
you have an exit ‘rule’ and stick to it? Or should there be some soft rule that tells
you when to cover the profitable iron condor – perhaps when you can close by
paying $0.20 or $0.30?
you have a method that’s been working for you, there’s no need to make any
changes. But you may want to think about
establishing an exit rule. That’s where
I sit – working on that decision.
always relied on a current analysis
of my portfolio to make decisions. I
feel I ‘know’ when to hold em’ and when to ‘fold ‘em – based on the current
risk/reward potential. I’m wondering whether
it would be better to take specific profits when achieved – to remove all risk
of losing those gains. I believe this is
another ‘comfort zone decision.’
Let’s consider a trader who
decides that earning $1,000 per month (substitute any number that’s suitable
for you) is the goal. The strategy: buy iron
condors on the Russell 2000 Index (RUT).
If it’s easier to think in terms of percentages, then consider that this
trader has $10,000 at risk (i.e., that’s the maximum loss) and the goal is to
earn 10% per month. If that feels too
aggressive, then perhaps the account can risk $20,000 with a goal of earning
5%. The principles are the same, and you
can choose an account size, position size, portfolio value at risk, and profit
objectives to suit your individual comfort zone.
The account is large enough
to handle the alternatives listed below, and margin requirements are not an
Contrary to the hype of Internet
scammers, buying iron condors is not a guaranteed path to a making
fortune. But when played carefully, your
chances of making good money over time, are excellent.
When buying iron
condors, is the goal to earn $1,000 this
month, or is the goal to average $1,000 per month (ignoring any attempt to
compound those earnings) over an extended period?
How do you
correct for the fact that you know you cannot meet your target every month? In fact, part of the time you will lose money. Should your monthly target be raised to compensate
for those losses? Should you increase size (trade more contracts) only after a
loss, in an attempt to make up for that loss?
There is no best answer for every trader, but I strongly suggest NOT
increasing size after a loss. A consistent
approach is better, and a higher monthly target ($1,200?) may enable you to meet your annual profit target.
How do you choose
which iron condor to trade, to meet your
goal on a consistent basis? Without a rigorous mathematical analysis, I
don’t believe it’s easy to decide. That's
where I believe ‘comfort zone’ comes into play.
My gut tells me to select the iron condor that’s most comfortable for me
to trade – and that’s what I already do.
The only change in methodology under consideration is to take profits early and trade the
correct size for the desired profit.
your iron condor, it’s basically a compromise between
iron condors that
have the highest probability of success (far OTM options), but which offer
smaller profits; or
iron condors with
a lower probability of success (options are less far OTM), but with less
money at risk.