Stock Picker’s Market?


I think I may be missing something as it relates to trading options. I've read The Rookies Guide and one thing that I don't understand is how do I pick the options to trade?

Do I need a background in stock picking?



Stock-picking history

A background in stock picking is not nearly good enough.  You must have a proven track record of earning money when picking stocks. 

However, If willing to adopt a less aggressive approach and try to find some stocks that will not fall significantly, then the selection task is much easier. Being forced to pick stocks that move higher is the norm for investors, and most cannot do it.  Picking stocks that either mover higher, remain essentially unchanged, or decline by a small amount – that's much easier. 

It's not foolproof.  Nor is it guaranteed to return big profits.  But your chances of earning money are much higher.  In return for that 'good stuff' profits are limited and there are no killings to be made.  The goal is to earn steady money.  As I said, it's not guaranteed, but you have a better chance to succeed that the person whose stock picks must move higher to earn a profit.

Part of your question may be how to pick the specific options to trade.  I recommend the credit spread strategy (Chapter 18) with one warning.  Understand that losing is part of the story, and you must practice good discipline and not sell too many spreads at one time.  Risk management is essential when you adopt this method.

When choosing specific options, you will have choices.  If it's difficult to decide, open practice trades and see how they feel.  Are you comfortable with risk and reward?  Option trading involves a constant trade-off between risk and potential reward and a bit of experience goes a long way in helping you find the right choice.

Talking heads

Talking heads on TV tell viewers that 'it's a stock picker's market,'  suggesting that investors cannot just buy index funds.  Instead, they are to seek out the best stocks and buy only those.  The missing piece of the puzzle is how to pick the best stocks.

The same problem exists when trading options with a directional bias., bullish or bearish. The truth is that most investors and professional money managers cannot beat the market averages.  There is no reason to believe you can do any better.  In my opinion, it is very difficult to generate profits consistently by adopting simple strategies, such as buying options.

I believe it's easier to find market neutral trades, but even then, picking stocks that are not going to undergo significant rallies or declines is not as easy as it may appear.


Indexes: less risky for premium sellers

If you lack confidence as a stock picker, then one alternative is to play the broader market by trading options on an ETF (such as SPY or IWM or QQQQ) or an index, such as SPX, NDX, RUT.

For the premium-selling, market neutral trader, index trading avoids the need to be concerned with the performance of a single stock. 

Practice and practice some more

Take another look at the chapters on credit spreads.  If you are new to this type of trade, and especially if you are new to options, begin by paper trading.  Have patience.  Be certain that you understand how these positions make/lose money.  Determine how well you manage risk.   Why does your position profit one day, or lose money on another day?  Follow the trades using your broker's risk management tools.  The purpose of this exercise is to understand why option prices change and to get some experience making trade decisions. 


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5 Responses to Stock Picker’s Market?

  1. Steve B 09/29/2010 at 11:21 AM #

    Do you think it is easier to find a handful of stocks you are comfortable with and adjust your option strategies depending on the behavior of the stock? Or to have a couple of strategies you excel at and then search more for setups than specific stocks? Does that make sense?

  2. Mark Wolfinger 09/29/2010 at 11:31 AM #

    Steve B,
    Yes, it makes sense.
    If you have a good feel for a small set of stocks and have traded them well in the past, I would give that top priority.
    That means choosing the stock at the appropriate time is far more important than the strategy. Choose one of several strategies that suits your opinion on stock movement.
    But – if you are asking before you have such a group of stocks, then no. I do not believe it’s easier. I don’t know where your trading talents lie. So, if you believe you can build that small list, I recommend doing so. My warning is the same as always: I don’t believe that is a realistic goal for the vast majority.
    I prefer to choose the strategy and then find the setup.
    Steve, I don’t want to sidestep the question. It depends on your talents. Unless you have proved to yourself that you can pick stock direction, I strongly suggest going with the strategy as priority and the stock as secondary.
    Good question

  3. Steve B 09/29/2010 at 11:37 AM #

    Thanks Mark! As a beginner, I too find it easier to gain confidence with a strategy and find the setups necessary for success in that strategy than to pick a handfull of stocks.
    Maybe once I have 2-3 different strategies under my belt it would be more feasible to find a group of 5-10 stocks/ETF’s that you just trade over and over again depending on what they do. But if I tried to do that now, I’d be on the sideline 67% of the time.

  4. Mark Wolfinger 09/29/2010 at 12:11 PM #

    Steve B,
    As a beginner, the odds are stacked against your ability to know how stocks are going to move. You can try to develop that skill, but let’s be smart about this and assume you have no chance to succeed as a stock picker at this time.
    To place your cash on the line, don’t you want proof that you are doing more than guessing? Proof means opening hudreds of trades at the appropriate time (by whatever your system is) and following the trades. It means keeping honest records. It does not mean holding positions until the turn positive to increase your win/loss record.
    Steve, this is next to impossible in my opinion. To learn how to be a stock picker, you must spend your time on developing trading skills. And that’s far different from the skills needed to adopt option strategies.
    If you attempt to do too much too soon, you will be overwhelmed and doomed. Make a choice: learn a couple of option strategies first and then work on stock-picking education. Or vice versa.
    Being on the sidelines until it’s right to be in the action is he sign of a GOOD trader. There is nothing wrong with sitting it out.

  5. Steve 09/29/2010 at 1:09 PM #

    I totally agree. That is why I am only trading a paper account right now working on a few strategies, entries, exits, risk management etc…
    When I meant being on the sideline, if I only know how to buy stocks, I only win if they go up. I agree, a good trader knows when to trade and when not too. Making a trade for the sake of making a trade is a bad idea.