Intro to Understanding the Market

One question I am frequently asked regarding trading is, what is the difference between stock and options trading?

This question is a bit loaded because to me they are very connected. What you choose to trade will likely depend on how much you have to invest and how long you intend to be in the market. Are you day trading or are you investing for retirement? Styles of trading and the financial instruments used to profit vary greatly but the interesting thing options provide that equities don’t is LEVERAGE!

So, what does this mean? Well put simply when you buy 1 option contract it gives the option buyer control over 100 shares of the underlying equity. You may notice I put the word contract in bold. That is because the owner of the option does NOT own the underlying equity but merely has bought rights to buy or sell that equity at a specified price. This contract will gain or lose value as the price of the equity moves.

Call options give the option buyer the right to buy the underlying at our specified price known as the strike price. As the price of an equity rises the right to purchase the equity at a lower price increase.

Put options give the option buyer the right to sell the underlying equity at the strike price. As the price of an equity falls the right to sell the equity at a higher price increase.

These options have an expiration date meaning that at the time they expire they need to be considered in the money. The strike price must be inside the range the equity is currently trading otherwise you have no deal with the option seller as the equity is not trading at your price anywhere on the chart.

Since options are contracts that give the buyer AND seller of the contract certain rights these options provide very unique ways to make money! You can essentially buy stock at a fraction of the cost, you can purchase an equity at costs lower than it’s trading, and you can even make your investments produce weekly/monthly income.

How much money can you make in the markets?

Well the stock markets are the largest financial instrument in the world where literally more wealth exists than anywhere else. There is $66,800,000,000,000.00 moving dollars in these markets every day! That’s a LOT of zeros! How many zeros would you need to take from that number each day to be satisfied? I’d argue it’s a number so small and insignificant the market wouldn’t even notice! That’s what traders do! That’s what I do! $2000/day is nothing in the big scheme of things!

When learning to trade it’s very important to identify your trade goals and the style you will use to accomplish your goals. What type of trader do you want to be? Day trader? Swing trader? Long-term investor? Each style will require a different approach. Perhaps in both the way you look at the market and which instruments you purchase to profit.

Once you have decided the style of trading you will be doing it’s important to identify these 3 VERY important details before entering ANY trade.

1. Reason for entry - Why do you think price will move up/down?
2. Stop Loss –  When the reason for entry no longer exists.
3. Price Targets – Where will you start locking in your profits?

Number 2 is especially difficult for new traders to understand but it’s probably the most important and makes the difference between successful traders and those who still take big losses. Trading is NOT about being right. Trading is about RISK MANAGEMENT!

When you take a trade for a certain reason, for example because the equity is trading above its 50 Day Simple Moving Average you decide to go long and buy. If the next day the equity is no longer trading above it’s 50 SMA and the reason you entered no longer exists then perhaps it’s best to cut your losses and move your money to a place where it will actually work for you.

There are many tools trader’s use to identify setups. Some of my favorite and most useful tools are moving averages. Particularly the 8 and 50 exponential moving averages. The 8 EMA identifies a strong trend. When price is consistently trading below the 8 EMA price is moving down, when price is trading above the 8 EMA it is moving up. The 50 EMA is what I call trend support. Unless price starts trending on the other side of the 50 EMA the recent trend is intact. Sounds too easy, right? Well, lets take a look!

Here’s what it looks like on /ES (S&P500 futures). As long as price is above the 8 EMA (yellow dots) the trend is strong and up. When price closes below both the 8 and 50 EMAs the trend changes to down until price closes above the 8 EMA again. When that happened here, the trend remained up as price stayed above the 8 and 50 EMAs and it was in the strongest trend when price is above the 8 EMA.

These are just a couple of the powerful tools I teach my student’s to use that I utilize to identify entries and exits for my positions. If you would like to learn more check out my Facebook page and group by clicking the link below. I post highly profitable trade setups every week, happy trading!