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Today I would like to discuss a vital trading concept, ranking your trades. Not all trades setups are created equal. Some setups and ideas have much more profit potential than your run-of-the-mill bread and butter setups.

On these particular setups, I want to be risking more than usual. Sometimes if you don’t take enough risk, you take too much risk. When I see a good pitch, I like to size into my position to take advantage of the opportunity the market has made available.

Thus I have a system in place for how I go about taking different trades that I have different levels of conviction. We will discuss that system for ranking trades today.

Risk Management

Risk management is key to surviving in this game. It might sound simple, but the reality for most is that your winners must be more significant than your losers to be a profitable trader. Sometimes even the best traders forget this and run into trouble when they refuse to cut a loser early because they think it “must” pullback when the trade continues to go against them.

It is why I prefer to use options to structure my trade ideas. My risk is always defined before I enter a trade, and I can avoid issues such as trading on tilt and fighting a stock. Psychological options can make it easier to overcome these issues.

Ranking Your Trades

Now not all trading setups are created equal. I have developed the experience and intuition throughout my trading career to understand when I should bet more because the odds are much more in my favor than usual. Sometimes if you don’t take enough risk, you take too much risk because when the fat pitch arrives, you need to try to hit it out of the park.

Here is how I structure my trades based on my conviction:

Low Conviction Trades

In a low conviction trade or when I begin to size into my position on a trade I want to get long, I will sell put spreads. It involves selling a put option at a price I don’t think the stock will go below closer to the money, and to control my risk, I will buy a put below this price so that if I am wrong I can lose less. This way, if the stock goes sideways, I can profit by taking advantage of time decay or as the pro’s call it Theta. If this happens, I will pocket the difference in the premium I received to sell the first put and buy the second. However, I will lose out on potential gains if the stock goes higher.

Medium Conviction Trades

If I have more conviction on a trade, I want to get long. I will buy call spreads. It involves buying a call at a price I think a stock will go above. To pay for the cost of some of this trade and reduce my risk if I am wrong, I will sell a call at an even higher price. In this case, if the stock goes higher, I can profit more than if I had sold a put spread, but my risk is also higher if I am wrong on my timing and the stock goes sideways or down.

High Conviction Trades

When I see my best long setups, I will buy outright calls. For the most part, however, on my very best ideas, I will use a combination of all three strategies. I first will scale into my position with put spreads. When it begins to work, I will add to the position and buy call spreads. Then I will buy outright lotto calls so that I have the potential to profit if the stock explodes. I will also trade with at least three times the size I usually trade with or even 5 times.

Bottom Line

The great setups are rare and need to be taken advantage of. For this reason, I have a ranking system with which I take defined risk using options strategies. This flexibility allows me to take advantage of bread and butter setups I see daily and go for it when I see a high conviction setup that does not come around often. It is these opportunities and being able to take advantage of them to make a trader’s month or year.

 

Author:
Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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