11 May 2007

Rules for speculation

1. Create a sound money-management strategy.

This one flies in the face of the conventional image of a speculator. But
believe me, all consistently successful speculators start with a plan. It
doesn't have to be anything too involved - just make sure you're clear on
your objectives, and set some guidelines for yourself. Figure out your entry
and exit strategy for each play, starting with how much to invest, how many
open positions you plan to have, how you will monitor positions, what kind of
stop-losses you will use to preserve capital, etc.

A sound money management strategy is the most important factor in successful
speculation and it allows you to stay in the game.

2. Know your broker and monitor your investment

When choosing a broker make sure to ask as many questions as necessary and
that you get the appropriate answers before simply giving over your money. If
you are a beginner, find out about the broker's history and references, and
speak to them frequently to establish a relationship. Make sure that either
your broker or you will be constantly monitoring your investment - today's
markets are very volatile and with options the price can shoot up 30% or more
in just a few hours...so it is necessary that your broker is able to see the
option is performing and be able to execute an order in a timely manner, to
ensure that your capital is protected.

With so many discount Internet brokers out there, it seems like more and more
people aren't doing their homework before opening an account. It's OK to try
and go it alone... unless you don't know what you're doing. In that case,
it's well worth the time and money to explore more experienced flesh-and- blood brokers.

3. Stick with your exit strategy if a trade goes against you

With a good money-management plan, there should never be any surprises. No
matter what price your trade is at, the action you need to take should be

That doesn't mean you have to be inflexible, however. Just because an option
has met your profit target, you don't have to automatically sell. But there
has to be a compelling reason to stick with the trade - something more than a
feeling that the trade will continue climbing above your target price. (After
all, you selected that target price for a reason.) And always use a stop-loss
or a trailing stop order to make sure you're ready for any reversal that
might pop up.

For a losing trade, however, you need to be a little more harsh. Options are
wasting instruments, and their value dies a little each day. Sometimes it's
better to stick to your strategy and settle for a loss than it is to wait it
out and hope for a miracle. That's money you could be plugging into another

4. Always, always, always, ask questions

The Internet age is creating a generation of independent investors. But some
are still too proud to admit that there are things they don't know. In the
speculation game, what you don't know can hurt you.

If you've taken my advice about finding a good broker, you've already got a
ready source of info to turn to. Dozens of Web sites also offer complete
details on options trading. So there's just no excuse for ignorance any
more... and losing money because of ignorance makes even less sense.

5. Learn from your mistakes

Find out what works for you. There will be losers along the way - but just
make sure you know what you did wrong in previous trades (e.g. you set a stop
loss of 15% and were stopped out too early and the option rebounded to 56%
profits). Take every trade as a lesson and use it to improve as you continue

6. Remember that knowledge is power

You can never know too much... strive to learn as much as you can about
options and their inner workings, strategies, fundamentals, everything... so
that you will be better equipped to profit with options trading.

As I've said in the past, options trading is more accessible than ever
before. And the profit potential hasn't diminished a single cent. Going out
of your way to learn the myriad of ways they can boost your bottom line is
the easiest way to discover what works for you.

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