For sure, should be the case anyway in my opinion but especially with news.
The vast majority of this concept is not my original idea/theory. All credit goes to Tom Sosnoff @ TastyTrade.
The derivatives market is intentionally configured to scare people away. Complex mathematical equations, greek terminology (delta, gamma, theta, vega, rho), big words like “implied volatility”, “volatility skew”, seemingly complex “multi-legged strategies” with crazy names (iron butterfly, jade lizard, iron condor, bull put spread, etc). All of this is designed to deter would-be traders away from learning.
Not a single measure within the entire “trading universe” better captures human emotion than implied volatility. It is the single most important factor when it comes to trading options, and, pricing expected moves for underlying assets (stocks, bonds, futures…anything). Fear became an asset class, that could be traded, with the invent of the VIX. As the derivatives market evolved, traders became more savvy in understanding the relationship between implied volatility and realized volatility. The former is almost always over-stated. That is the beginning of your edge.
Not only is it overstated, but, it is mean reverting. In fact, it is the only trade-able asset class on the planet that is truly mean-reverting. I’ll challenge anyone on this site to prove me wrong. Mostly all human beings do not live in a constant state of fear. Those that do are suffering and life is horrible. For most of us, fear is a cyclical experience.
The VIX has long stood as the “fear gauge” of the market. It’s nothing more than a simple numerical representation of the at-the-money implied volatility of the SPY. When it’s low, traders are complacent and not wary of big price swings. When it’s high, traders can be fearful and starting to price in bigger price swings. This is an oversimplification, but, is a high level definition of pure volatility. VOL typically goes down while markets go up, and the inverse when markets go down.
The real edge comes when using analysis called IV PERCENTILE. You can actually plot implied volatility against itself, to determine whether or not option premiums are cheap or expensive, relative to a lookback period (typically 252 days- which is the trading year). If you’re still w/ me, I’d hope you see the true edge at this very point.
When implied VOL is expensive relative to itself (I shoot for the upper 80th percentile) then there is an edge in selling premium in anticipation of a mean reversion (aka short vega). When implied VOL is cheap relative to itself, typically the bottom 20th percentile, the edge lies is buying options in anticipation of an increase in VOL (aka “going long vega”). Vega is just a measure of your position and how pricing would change based on a 1% move in the underlying’s volatility.
So, layering all of the above, you can see where the professional’s edge lies.
But, we’re not done.
If you stick to a strategy where you’re selling premium more often than not, say 9 out of 10 trades, you’re also exploiting another greek called Theta (or, time decay). All options have expiration dates. If you’re long an option, you’re short theta. As days go by, your position is going to lose value simply because it’s moving toward an expiration date. When you’re selling premium (going short an option), you’re actually long theta. So, the obligation that you sold to someone else is actually paying you (like an insurance premium) as each day goes by.
Implied volatility is the truest measure of human emotion in the market- primarily fear.
Fear is mean reverting.
Implied volatility is mean reverting.
Edge exists selling premium, when IV is “high”.
To me, selling strangles (1 naked short put + 1 naked short call) @ 16 delta is the name of the game.
This strategy can be further enhanced by delta hedging.
Strangles are delta neutral. So, say goodbye to picking A DIRECTION!
Yes, you read that right-- this strategy is purely directionless. It doesn’t matter what the market does.
If the underling starts to move, you can delta hedge by beta-weighting your book to the SPY and picking up SPY calls/puts to offset risk. This is how professionals trade.
If the market makes a big move against your position…> 1 STD DEV, then you can almost ALWAYS keep rolling the position out into the future, til the end of time, and wait for the underlying to mean revert. As long as you’re rolling for a credit, you can keep the dream alive for however long your capital can support.
This doesn’t take into account one of my favorite strategies, selling premium before an earnings announcement. Look up “vol crush” if you’re interested in that.
Get in early, get out early. Bag those profits
When to exit the trade is always remained a question and something very hard to estimate. I follow price action and decide my entries and exits while I am entering the trades. I follow the rule of strictly following my trading plan and that is how I do it.
Set a stop loss and a take profit point before you ever make a trade. When you are 80% of hitting either target, adjust accordingly.
The best way to avoid exiting trades too early is to have a trading plan that lays out your trade exit strategy and then sticking to it, no matter what.
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Well, it comes to controlling your emotions. If you can control your emotions, you can do anything in the forex market.
Exactly, a trade plan will help you control your emotions a bit since you’ll know when to exit the position, plus thats how you bring discipline as well.
Keep a TP in mind and stick to it. Maybe move SL into profit to secure the bag if you are worried about getting stopped at BE and not making anything, or take partials half way to TP.
The best way to avoid exiting trades too early is to have a trading plan that lays out your trade exit strategy and then sticking to it, no matter what.
It clearly shows that you have issues controlling your emotions that can have a bad impact on your trades in the long run. By closing trades early, you are restricting yourself and not making the most of the market opportunities that you could have otherwise. Keep the fear of losing aside and focus on what it actually is and see how it impacts your trades. I am sure you will do well.
Hi Beverly,
You are exactly right, since posting this the key thing I have worked on is my psychology and it’s made a world of difference.
We must see the current Trends before closing the trades.
It is all about discipline and patience. It is also good to have a trading plan with exit strategies properly laid out. All that is left to do is, stick to it.
There is no harm in closing trades early, just the returns will be less but with that risk too. Better trading strategy with carefully examining the support levels can help you to set SL slightly better.
Generally, it’s very risky to hold day trades overnight. Even with a losing trade, it’s usually better to close out and start fresh with new trades the next day. Several factors can affect a stock overnight, meaning that the risk of significant loss is as high as the chance of a big gain.
It is better to close trade earlier than never.
My best tip on it would be setting TP and SL for your trade so you can avoid checking it frequently, the more frequent you look at it, the more likely you gonna be tempted to trade early
the basic indicators are repackaged moving averages.
a moving average is a memory of the past, not an indicator of the future.
the basic indicators will never predict the future, but instead they are a memory of the past.
Some traders are afraid of huge losses and then they are tend to close positions to early. In my opinion, it isn’t a huge mistake but it resticts your ptential income. If you have set the stop loss ordered, then you shouldn’t be afrai of huge losses. Another option, when you don’t use stop loss orders and are tend to trade on your own. It’s not recommended fo r traders as I think, because it can easily devastate your deposit, as well as trading with high leverages. I sometimes prefer close the position early, because I’m not sure in its liquidity. Fortunately, it hapenns rarely in my trading activity.