Welcome back! Chris Burgess here with part 3 of our exploration of trading plans and how to design one that works for you. In this blog, we’re moving on to the third step of a trading plan: choosing strategies.
It’s vital that you’ve done the first two steps which you can review here and here, before moving on to this one. Many people want to jump right in and start learning strategies right away, and I admit, strategies are the fun part! But if you don’t know the broader context into which a strategy does or doesn’t fit, you run the risk of being the type of trader that jumps from strategy to strategy, always trying to find one “better.”
Instead, if you know exactly where you want to get, step 1, and you know the timeframe over which you want to trade, step 2, it becomes quite simple to focus on just the strategies that maximize your profits and minimize your losses over your chosen timeframe.
Let’s use Anna as an example. Remember back to Part 1 of this series; Anna is nearing retirement. She wants to use the nest egg that she has accumulated over her lifetime to generate monthly cash flow to pay her bills in retirement. That’s her “step 1”: she has determined exactly what she wants her trading account to accomplish.
Her “step 2” was figuring out the timeframe over which she wanted to trade. Now, there are several potential approaches here. For example, Anna could choose to invest in Real Estate Investment Trusts or REITs that pay a monthly dividend. Her work would then be to decide how she wants to allocate her capital across potential REIT investments based on criteria such as dividend payment frequency, dividend amount, payout ratio, geographical exposure, credit risk, and type of real estate holdings.
Another approach could be for Anna to use her knowledge of options to create monthly cash flow by selling options. Neither approach is right or wrong; it just depends on Anna’s personal preferences. Let’s say she goes with the second approach and decides to sell monthly options to generate cash flow. Immediately, Anna can narrow her choices down to just a select few strategies that fit her goals and trading timeframe.
For example, if she’s trying to generate consistent monthly cash flow and do it in a low-risk way, then she can immediately rule out trying to hit a big win buying meme stocks. Similarly, she’s not interested in any day-trading strategies or very long-term investments because those don’t fit her timeframe.
Instead, she will select only those options strategies that fit her goals and trading timeframe. There are a near-infinite number of strategies available to choose from. These might include monthly cash-secured puts and covered calls, vertical credit spreads, and iron condors, to name a few.
The goal of this section is not to try to list every available strategy and its pros and cons, but rather to help you think about strategies and how they categorize into archetypes. I consider an archetype to be a category of strategies that share similar characteristics, such as risk/reward, timeframe, desired outcome, probability, etc.
For example, the options strategies listed earlier that Anna might consider all have similar characteristics: they have well-defined risk, upfront reward, clear win/loss prices, and can all be done primarily with monthly options. All of these strategies fit Anna’s trading goals and timeframe.
A trader with different goals and/or different desired timeframe should consider different strategies. I can’t tell you which strategies to trade; that’s for you to decide. What I can do is help you think about whether a strategy fits your trading plan or not.
The first step to consider is whether the strategy can help fulfill your goal or not. For example, if you’re trying to double the size of a small account in two years or less, then a buy-and-hold approach on a dividend darling stock is simply the wrong approach because it is virtually guaranteed not to achieve your goal. Instead, you’d want to look for strategies that have low risk but relatively high reward should they succeed. An example of this strategy could be buying OTM call options on stocks that are likely to experience a short squeeze.
The next step is to consider whether the strategy can be reasonably repeated within your timeframe. To use dividend-paying stocks as an example yet again, buying and holding dividend stocks is just not going to fit the timeframe of a swing trader who doesn’t want to hold a position for longer than a week. Instead, he might look to trade volatility strategies such as Bollinger Band breakouts.
No matter what goal and timeframe you set for yourself, there are many different strategies to help you achieve that goal over that timeframe. Your job is to determine which strategies can best accomplish that goal within your desired timeframe and focus on just those strategies. In that way, you are much more likely to achieve your trading goals than the person who jumps around from strategy to strategy without an accurate understanding of how or even if any of the strategies fits their trading goals.
So always filter the strategies you choose to trade through the sieve of your trading goal and your desired timeframe. There will always be many strategies to choose from, so feel free to focus on even just a subset of those, and don’t worry about the rest.