Many of us traders are trained to look for tops and bottoms and game the markets accordingly. Though it makes sense on the surface, these are not smart options trading strategies. Playing “tops and bottoms” is generally a loser’s game (more on this below); following through after seeing a top or bottom take place can be the most lucrative profit opportunity.
While the stock market rewards these opportunities, in the long run we have to be aware of time frames. For example, there is a greater chance of market volatility in the short run, and that can confuse many who are not focused on the bigger picture.
Let’s take a look at long-term and a short-term options trading strategies I rely on – and that are proven to work:
Long-term strategy: Fed Policy analysis
I make it a habit to look at the big picture, so every December, I do an analysis of where Fed Policy is and where it is likely to be over the following twelve months. A highly accommodative Fed Policy tells me the stock market has backing and support, which means we can look forward to a good year (while fully expecting some volatility whips). A hawkish policy says we need to pull back some on our risk and tread carefully.
My yearly Fed assessment gives me a good read on how the stock market may perform over the next year, but it’s just a guide post. I know there are an unlimited number of uncertainties that can derail my hypothesis, but a year is a longer term plan for me, and I will stick to it unless the information I am getting from the markets changes midstream.
Short-term strategy: Stock trends
One short term guide post I use is stock charts, which guide my decision to start or end an option play. However, I will not stab at a bottom or attempt to pick a top. An oversold or overbought stock or market can stay that way for a long time, but when it turns and follows through with some volume and commitment, then a trend may be established.
I want to stay on top of those trends, because the odds of using them to bank a profit are far better than guessing at a top or bottom. If you choose to go with the latter approach, here’s what happens: You’ll keep picking various points for the top or bottom as a stock climbs or declines, but you’ll find yourself so often that when you finally do get it right, you’ll be far in the hole – and your emotional state will have just taken a beating.
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Trading is often compared to gambling for a reason. If you play blackjack and lose, say, seven hands in a row, you just know you’ll eventually win, right? But are you going to keep raising the bet for each hand? Perhaps that winning hand will finally come when you are down to your last few chips, and while that win may come with some relief, you are still probably in the red.
The better approach is to keep your eye on Fed Policy over the long-term. During the short-term, wait for a trend to develop, be patient for the confirmation and follow through, and then play it accordingly. Taken together, those are winning options trading strategies.
