Sarah: Hi everybody, this is Sarah Potter from Shecantrade.com and this is the SCT podcast, we are at episode 40. Today’s discussion is going to be around adding a new trade set up or new trade strategy to your toolbox of trades and how do you actually evaluate that to make sure it’s really worthwhile to place those trades in the first place. So, I mean to kind of start off, I think it’s important to think about the context of all of these. We all want to be able to find the most amount of trade set ups that we can when we are trading options, we want to be able to take as much profit over the market as we can, we want to be able to reduce our risk, so I think everybody who is trading is always looking for something more, they are looking to able to make just a little bit more in the existing trades they are in or they are looking to have additional trade strategies to set up to trade, or set up based on how that market is moving. So, I have TJ here.
TJ: Good Afternoon
Sarah: and He and I will just have a little discussion back and forth about what we each do when we are testing new strategies or and/or give you some tips about how to do that yourselves and I think the first part of this discussion should really begin with when should you actually add a new set up to your existing trades, is there a time frame for you TJ when you are trading, when you think, yeah, now is the time, now I need to add in a new trade setup
TJ: Absolutely, right. I think what it is, it’s evaluating how the trades are working and a lot of times too, I think that you know, as you trade more and more, you can spot changes in the market more quickly and I think that’s what I really rely on, I look, you know, you guys had known me in the trading room and that know me, know that I spend a lot of time looking at the broad market and the S&P and I think you know, yes we are trading individual stocks but they are part of the broad market and also we have to remember too, that’s really, what’s really unique in that, the broad market trades on it’s own and trade the S&P the features that influence price as well as the price of the underlying, so you know, there is a push and pull, the chicken and egg, but what I like to do is I like to look at the market, are we consolidating, are we moving up, are we moving down, are we in a situation like we are right now, where you know, we are getting some big moves within during the day but when we look at the S &P at the end of a week or two weeks, you really haven’t moved that much because one day we are down 20 and the next two days, we are up 15 each day, so you know over the week, may be up 10 or 15, 20 points if that, so for example for trading, if you like to sell put credit spreads and the market is you know, you are in a nice up market, then it starts to reverse and it starts to trend down. Well that may be a time to reevaluate it and choose a different trade setup. For markets moving down, these big surprise days like we have had over the last two weeks, all of a sudden you are 5 points a day then you get a 40 points a day just thrown out, you know, just out of the blue, you know those put credits that you sell, those puts credit spreads or puts that you are selling, you know that is definitely going to affect that, so that would be something that I would look at, say when may be I should be looking at a different strategy. So I really like to look at the market first and you can really tell, you don’t even need to wait for 3,4,5,6 losing trades, you can just really look at the market and say, look you know what, we are going from a period of, we are moving up all the time to consolidation to moving down to a lot of volatility and I am going to be looking forward, I am going to change my trade set ups accordingly and I have, obviously, you know, I am sure this is the same that you do Sarah, is you know, what you have a set of trades you do for various market conditions and it’s about having that toolbox and matching the strategies or using to what the market looks like.
Sarah: Yeah, so when I am trading, my approach to finding trade set ups isn’t the fact that I say, I know how to trade let’s say 20 set ups, so I am going to look to trade each one of those today instead I go to the market and say what’s actually moving, what’s actually happening. Now, what strategy links up to what’s actually happening because I want to place the best strategy that I can and I just want to talk a little bit about people who let’s say, have a lot of success selling put credit spreads and then all of a sudden decide, no, I want to make some more money, so I am going to do the exact same thing and only this time I am going to sell the put, so they had taken the assumption that the naked put is going to behave the same way as the put credit spread, I mean if you read a book, technically it should, right, it’s the same idea you are choosing to sell a strike rate, I don’t think the price is going to be and you are collecting premium, both of those trades really are the same except for one you are buying back, so you are basically just reducing your margin and you are creating your spread versus the naked put is just selling the put. So, when you are thinking about that, because you want to make some more money on the same kind of trading assumption, let’s say the market is not moving around as much, so you think, well, I will just sell the same thing and sell the naked put and make it a bit more. It’s important to recognize that those are two difference trades set ups and if you are going to come in and test a new trade strategy and for this example you want to bring in the selling the naked put, I wouldn’t suggest that you start off in your real account trading the same amount of contracts as you already do when you have successfully traded put credit spreads, because the important piece there in the thinking about your trading plan and your response to trades is that, it’s going to be a different emotional reaction to trading the naked put, whether it’s just that you are uncomfortable with the undefined risk or the increased margin requirement, you are going to think about it and trade it in a different way than if you sell all the put credit spread. So it’s important when you are testing new strategies to start in a paper account and I think it’s important to just start testing things out on one contract, as opposed to using the existing contracts size that you might already use in a different one. So I basically say a new trade set up has to prove itself to me the works and it has to start out one, it’s not going to be where I am going to start trading with 10 contracts, let’s say and just expect that it’s going to do the same thing as my put credit spread. I don’t know, do you have any different rules for yourself when you are testing out a new strategy.
TJ: I think it’s writing down the strategy, I think a checklist steps, following the steps each time to make sure that I am doing something that’s repeatable, I find that any trades with futures is really easy to test because you are trading one market the S&P, say and you can just test, test, test . With options, we also have to keep in mind too that, you know, I may be testing the strategy this week in Apple and then next week, it might be in Tesla, then in CNG then in Google, then in Amazon and you have to remember too that we have to isolate the strategy from the stock we are trading, it becomes a little bit more different. Little bit more difficult and a little bit different than if you are just testing on one single market because there is no strategy that I want to sit and test, you know, 30 trades in a row on Apple because for Apple to be setting up for those trades, I mean that could, it’s just not something that’s really going to, you know, take place realistically, so I need to make sure that, I am keeping track of stock versus strategy and then writing down, what I am doing, I am keeping kind of a detailed journal and then I am giving it, you have to give enough trades to see whether it’s working but you also have to say that you know what, do it a few time and if it’s not working, you are not getting the results you want, may be it’s just not going to work and I think that’s a lot about, there was a lot of an attitude that comes with experience on how to test. One thing as a lot of people say you know, what I had backed that as a strategy and that’s it, they run it through some back testing software and then they take it out, they go live with it, we have to remember too that, you know, to back, that’s what’s happened in the past, the market going forward, may be similar but it may not be exactly the same and we might not get you know results that are close to the back testing. And that’s the same thing too as if we spend a lot of time developing a strategy based on historical data, when we go forward with it, it may not work as planned, so I think something are that I like to do obviously checklist, try that out on a paper account, see if that’s even close, once you kind of get it close, then you need to start trading real money, see how it works live trading, but yeah absolutely keep you contract size as small as possible one contract. Just keep detailed notes to see what’s really happening with that strategy and then it’s about fine tuning it but not spending too much time fine tuning, you need to really get that big picture first and once you are profitable with the big picture, then you can increase your profitability by fine tuning it.
Sarah: Ok, so let’s talk a little bit about back testing, because there is lots of platforms out there that do lot of sophisticated backtesting and your thoughts on it is that it’s not the same representation as if you are actually in the market live and testing the stuff in the moment as opposed to looking back, so why is it that you think that the real live testing is better, which I agree with by the way, but what are your thoughts.
TJ: I mean, the simplest thing is that, about fills, so we know options trading and it’s especially anyone who is in the room or does the room is that we know that, just because a appraise is traded doesn’t mean that, we are all going to get filled in the room and how many times do we see that where we sit there, we see the price, we get in the chat room oh, yeah, I got filled up filled, other people don’t, some people get filled, some people don’t get filled, but that price was really, that price was traded, we all saw it, some people got filled, some didn’t, so that’s the one thing with back testing, is there is no depth to the market. Yes, you may have accurate trade information that’s stored if it’s a sophisticated backtesting software but there is no depth for that market, it doesn’t tell you at that price whether a 100 people would have got filled or 5 people would have got filled. So that’s one thing, you know there can be slip edge that way, the other thing too is that, it’s kind of chicken and egg argument, it’s that most people, they don’t create a strategy and then back test it, what they do is, they create their strategy based on the back testing, so what they will do is they will start out and back test it, doesn’t look good and what they will do is, they will tweak the strategy so it looks awesome in back testing, well that’s great, that’s nice in high end side if your strategy would have worked 100%, well in the high end side, I can look at charts, I don’t need the back testing, I can get something to work really well too. It’s all about going forward and it’s about going forward and being able to, you know, the money isn’t made when the strategy is working, money is made when the market conditions change, how flexible, how fast can you adapt your strategy, so you don’t get a whole bunch of losing trades in a row that wipe out your previous profits. So I think that’s one thing about the backtesting, well the basic thing is that, you have to understand that it’s a simulation and you know, anything that simulated you know, may not be the same going forward and you won’t, definitely won’t be in the same market conditions with the same supply and demand on either side of the trade. But as I said, you know what, trading the S & Ps you know what, I can you know, most of the time, if you get that filled price, you know what, you are going to get filled out, it’s a deep, it’s a really deep contract and there’s a ton of people trading it, but if you are trading something like, Travelocity or Expedia and you know there is an option [inaudible] day one strike of 10 contracts, in a realistically easier 30 contract, what are you going to filled if there has only been 10. We have got to think about that really, that realism as well. So, what do you think Sarah, how else do you kind of go about both tweaking once you got your strategy established, how do you fine tune it?
Sarah: well, I agree that the first, I am always going to do is, checklists are very helpful, at least they are very helpful by tracking the information that I have used to not only place the trades, so I think about it in two concepts, one is I need to have steps that I am creating for the actual trade set up, but I also need a list of the evidence I have collected and what I want to look for, so if I think about Monday to Friday, do a five column chart and I have to rate down the evidence that I collected to use that trade set up and I am going to do that everyday for couple of weeks and when I need to go back then, when I review let’s say month’s worth of information here, about five column chart is what pieces of evidence have I continually gathered everyday and which one of those were actually very useful in helping me to make the decision about that trade set up, because you kind of have to test both, you have to figure out details of the trade set ups, so what are you going to use, what are you going to look for and then also in that evidence piece, so what made you decide place that trade, so it is important to gather information about both of those things and the more that you can find connections between the two, the better that’s going to be for you and generally that means the more successful the trade setup will be, because you are really identifying what are the pieces of information that you are finding and in the market, in the option chain to make the decisions that you are making and that’s also very important when it comes to thinking about trading in a psychological aspect of it. What you are doing is really your decisions and evidence and gathering information based on the evidence that creates the success in your trades as opposed to one feeling lucky or feeling I have a win or you know, just kind of hoping that those trades are going to work, so concrete evidence is very helpful and you can use that, especially over the long term, down the road, go back to these pieces of information to make sure that you actually are trading the trade set up the way that you tested it, being very good about going back to see to make sure that you actually have some good rules and you are following through on those rules down the road will also be very effective. So great talk, I think there was a lot of tips for everybody, I hope that’s helpful for all of you, please make sure to post a review whether you do that itunes or upon in testimonials, anywhere up on the internet is very helpful for us to give us a good review or any kind of review, a truthful review is very helpful. So for more information at shecantrade.com and happy trading everybody.