Option Investor

Covered-Calls 101

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Small Losses Equal Big Profits!

The past few months have provided some of the most productive periods since we began including the Covered-Call System as a regular part of the Option Investor Newsletter. The recent increase in share values has offered a glut of profitable opportunities for covered-call traders on a variety of issues across a range of favorable sectors.

Despite this bullish activity, many less-experienced investors have enjoyed little growth in the value of their portfolios. Even when their trading history reflects an abundance of viable prospects, it's not unusual to see instances where novice market participants have had difficulty maintaining a positive account balance. The most common trait in each of these cases is the failure to manage losses properly.

The facts are obvious! No one can successfully predict the market in every case so the key to success is to take small profits regularly and prevent losing plays from significantly eroding capital. Losses are bound to happen; they are inevitable. But that shouldn't keep you from profiting from stocks and options on a regular basis. The unfortunate truth is that most people find it very difficult to close out losing plays early. In contrast, successful traders understand there is no reason to hang on to a losing position when there are so many other profitable plays that deserve their time and money.

Emotion is the capital killer! Hope, greed, and fear all conspire to remove money from your account that you will never see again. What generally happens is the trader convinces himself that: "If I just hold on...I'll eventually break even" or "It can't go lower!", or "It's going to come back...it has to!" The reality is that it rarely does.

One of the best ways to avoid this trap is to use a trading plan with pre-determined exit points. Closing orders should be put in place as soon as the position is initiated. Then stop-loss orders can be used to remove on-the-spot decisions (about when to exit) from the equation and trailing stops, or similar profit-taking strategies, can be used to follow a position into greater gains and protect for trend reversals.

Next, if you are going to develop a plan, stick with it! Don't jump into trades on emotion; wait for the proper entry points. Study and identify trends and technical character within individual issues before opening a position. Use established support areas as buying opportunities and sell on rallies towards overhead supply or resistance. One of the oldest phrases is; "Buy on down days, sell on up days" and it is really not that difficult.

If you discover that your losses are consistently larger than your gains, stop trading! Step back, give yourself a break, and take a few days off from the rigors of the market. When you are ready to try again, evaluate your trading strategies and review each loss individually (so that you learn from previous mistakes), then move on!

Success will come when you create a favorable balance between hard work, sound judgment, and patience. Too many new participants give up after only a few losing plays, long before they have time to learn and absorb the various methods required for profitable trading.

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