The recent recovery in share values has created new interest in the stock market and brought some new subscribers to the Covered Calls System. Regardless of your level of trading experience or your knowledge of covered-calls, you can benefit from a review of the fundamental rules for success with this strategy.
The great thing about trading covered-calls is almost anyone can become an expert, even with very limited experience in options. On a relative basis it requires less time and effort than other popular techniques because once the trade has been initiated, an investor can place closing orders at key technical points in the price range of the underlying issue or watch the stock for changes in trend or character, using a mental stop to signal a timely exit. Of course losses will occur, despite the fact that the strategy is conservative, and a painful lesson will transpire the first time you delay the exit order in a losing position. After you become familiar with the options market youâ€™ll find that losses are simply part of the game and the key to success is learning how to keep those losers from putting you on the sidelines.
The toughest lesson new traders must learn is how to close losing plays early while the capital drawdown is still relatively small. The simple fact is there is no good reason to stay in a losing position when there are so many other viable plays that deserve your time and money. The best (and most profitable) solution is to accept your losses, learn from your mistakes (and evaluate each one critically), then move on! Success will not come immediately so you must have patience and continue to work hard, learning the basics of options pricing and gaining skills that other profitable traders exhibit on a daily basis. Indeed, too many new investors give up after a few bad plays, long before they have time to learn (and absorb) the various methods required for profitable trading. Once you understand that losses are simply part of doing business, you can move on to the "nuts and bolts" of position management. Again, the key to success is keeping losses to a minimum because there are never any big winners to offset the big losers. Although most covered-call investors can achieve a high ratio of winning trades the individual gains are relatively small on a percentage basis. That is main reason why correctly managing portfolio positions is so crucial for achieving consistent profits with this strategy.
Successful traders have a number of common traits and anyone who doesnâ€™t learn them will find it difficult to make money with options. The market will always prevent the uneducated masses from making money while consistently rewarding the astute professional minority. To be sure, the first prerequisite for long-term success is knowledge. Buying and selling stocks may be a simple technique but when you add options to the mix, the game becomes much more complex. An option trader must completely understand any strategy being used including its advantages and weaknesses.
Obviously, you can't make good decisions without absolute awareness of the mechanics of a specific technique and the best traders are those who are acutely aware of how best to overcome the shortcomings of their particular approach. Since limiting losses is the primary objective for covered-call writers, it stands to reason that every position should have a predetermined exit point. The majority of market professionals use protective stop-loss orders with their positions but the retail trader is far less proficient in this practice. Using stop-loss orders eliminates the risk of reaction-based judgments in difficult situations and removes emotions (fear, hope and greed) from the trading equation. The consistent use of stop-loss orders also provides a mechanical and disciplined method for achieving profits and allows the market to make the exit decision rather than relying on complex, biased human intuition.
Just as setting stop-loss orders on each individual position is an absolute must, a maximum allowable loss must be considered when managing portfolio positions. The rule is simple: Never trade with more money than you can reasonably afford to lose and always maintain a reasonable cash reserve. Also, when establishing position size and collateral requirements, investors should ensure that funds for active trades are not co-mingled with capital for other functions. In order to maintain a minimum portfolio balance, investors should set a total loss limit for all positions at the beginning of each month or option expiration period. When this level is breached, trading should be halted for the duration of that period. Of course, if your losses are consistently more than your gains, stop trading! Step back and take a few days off. When you are ready to try again, evaluate your current approach and review the steps that will be taken to avoid losses. When you begin to make money, put some of the profits in a reserve account just in case there are any unexpected developments in the future.