In our last blog post we discussed the reasons that options traders should take it slowly when adopting a new income strategy. Here are some simple steps you can take to assure that your adoption of a new options strategy is sound:
- Communicate with the developer of the strategy and see if he or she is still actively trading the strategy: it sounds silly, but if the inventor has bailed on the strategy, that should tell you something. Also, if the developer is in fact still trading the strategy, he or she will often have modified the strategy since it was originally developed and you can learn about those changes and fold them into your own approach.
- Back test the strategy for at least three years: back testing can be very helpful in terms of creating your “muscle memory” for a new strategy. By repetitively performing the entry, adjustment and exit rules on a trade, it allows you to internalize the dynamics of the trade and more importantly prepare you for the different situations that will confront the trader during the course of the trade, in many different market conditions. That will be very helpful practice when trading live. It will also surface important trade issues which may provoke you to modify trade rules to suit your trading personality better.
- Paper trade the strategy for at least two months: Back testing is very helpful, but until you trade utilizing your broker platform during market hours and experience the true speed of the market, you will not have rounded out your preparation for live trading. Once you have paper traded the strategy for at least one month, you may be ready for very cautious live trading.
- Trade the strategy utilizing the minimum number of lots possible in month one: most strategies have a minimum number of lots below which you do not have the flexibility to make the trade. Using live capital introduces emotion into trading and until you know how you will react to risky low capital situations you will not have a clue as to how you will react in larger capital situations, where overreacting to any situation can be expensive. So start small. Very small.
- Don’t increase your capital level until you have experienced a loss using the strategy: this is the acid test. Are you so comfortable with the strategy that a loss does not cause you to lose faith in its merits? If you are ready to move up to the next level of capital even after a loss, that should tell you something about your confidence level in the strategy. Increase your capital level very gradually once you do so, of course.
If you follow these simple rules, you should be able to build a successful playbook of trades that fit your trading style and stand the test of time.
