This section is written specifically to help beginning investors and traders learn how to trade stock options online by describing the practical steps to use the concepts written about in ‘How to Trade‘ and ‘Winning Trading Strategies‘. It is meant to be a ‘how to’ chapter, and does not go into any theory.
Learning how to trade stock options successfully is not easy because most folks attempt to trade stock options the way they might trade stocks – ‘buy and hold’ or as some cynically say ‘buy and hope’. Most beginning investors and traders do not recognize that this is a bad practice until they have lost money in the markets. The main reason ‘buy and hold’ does not work in trading stock options is because options are ‘wasting assets’. This means that the value of the options decreases as time passes. To be successful in trading stock options one needs to both enter a trade and exit a trade at the right time. This usually requires a great deal of discipline for individuals to both control their feelings (of GREED and FEAR) as well as to monitor the markets to ensure that they ‘get out of the trade’ promptly when the opportunity presents itself. Both of these tasks are difficult!
Fortunately, if one learns how to trade stock options online and use the power of computerized brokerage systems, one not only does not have the above challenges, but also one has a great advantage over those who do not know how to trade stock options online successfully.
Here are the essential steps of how to trade stock options online in the 1, 2, 3 format:
- Only use limit orders to ‘open a trade’
- Only use GTC orders to ‘close a trade’
- Place the closing order shortly after the opening order is executed
THE WHYs OF THE ‘HOW TO TRADE STOCK OPTIONS ONLINE’ STEPS
1. Only use limit orders to ‘open a trade’
Opening a trade by ONLY using limit orders ensures that you never pay more than you intend to pay. Remember, the lower the price you pay to open a trade, the more money you will have left in your account to open other trades. The lower the price you pay to open a trade, the higher will be your profits when you close the trade. As described in ‘Why Liquidity Matters’, one can see that the spread between the ‘bid’ and the ‘ask’ of individual options can be quite large, especially for stock options that are illiquid or in times of high volatility. If you place a ‘market order’ and/or do not ‘shave’ the ‘bid-ask spread’, it will be much more difficult for you to make a profit on your trade. It does not matter whether you are entering into a single leg option trade (‘buying a call’ or ‘buying a put’) or into a multi-leg trade (butterflies, broken wing butterflies, double calendars, etc), always use limit orders. With multi-leg trades, without using limit orders, it is easy to lose money fast as the losses from each leg quickly add up.
To learn how to trade stock options online well, you must begin by using a broker who has an online trading platform that you can understand well and navigate around easily. Most brokerages nowadays have online platforms, however some are more unwieldy to use, and can frustrate you; so, take the time to explore the site, and practice until you feel comfortable. If you don’t like the platform, change brokers!
2. Only use GTC orders to ‘close a trade’
Using GTC (Good till canceled) orders to ‘close a trade’ helps both beginning investors as well as seasoned traders overcome the two challenges mentioned above – namely, allowing our feelings (GREED and FEAR) sabotaging our trading, and having to monitor the stock markets constantly. By using GTC orders that are resting on the brokerage computers, one creates an automatic exit plan that will be executed irrespective of what one is doing at the time. While some might find sitting in front of a monitor interesting and even exciting, interviews with seasoned successful traders reveal that the more successful ones are the ones who can control their emotions when trading, and can ‘stick to their trading plan’. I personally relish having my freedom and do not wish to be tied to a computer. By way of example, my favorite trade was one that was closed ‘automatically’ when I was on vacation one summer when an intraday spike in stock price on an earnings announcement day triggered a GTC order to close one of my open positions (the stock was 20% higher for a brief period of time and closed about where it opened that day). When I later checked the time of the trade, I realized that I was in the water on a beach with my family! That trade made me a firm believer in the power of GTC orders. Those who do not know how to trade stock options online well will inevitably fare worse than those who use these sophisticated tools that are available to all traders.
3. Place the closing order shortly after the opening order is executed
When you learn how to trade stock options online efficiently, you will realize that the best way to execute step 2 above is to allow the computer to do it for you. Nowadays, computerized systems allow you to place an order to ‘open a trade’ in such a manner that when the trade is executed, it can trigger one or two (alternate) orders to be entered into the system to close the trade based on triggers that you set. The beauty of this powerful system is that it allows retail traders (individuals) to share in technology that has thus far been only available to institutional traders and professional money managers. This system thus allows you to place your trades into the system when the stock market is closed, and have the opening order executed only if the ‘limit’ you set is met (this may or may not be the next day) – once the opening order is executed, the system will automatically place GTC closing orders into the system to be triggered if and when your trigger criteria are met. If you happen to ‘open a trade’ when the stock market is open, you can place your GTC closing orders to wait in the system until the stock market moves in your favor. Again, these automated systems allow you the peace of mind of knowing that you won’t miss taking a profit if the stock market rallies and you are not at your computer screen to ‘close your trade’. A detailed description of the variety of these automated orders is beyond the scope of this page. However, a few examples that are fairly basic include the following:
- OTO – One triggers other – here, the system will execute the ‘opening order’, and then trigger a GTC closing order to be placed into the system to wait to be triggered when your profit target is met
- OCO – One cancels other – here, you place two orders into the system, one a profit target closing order, the other, a loss target closing order. If either the profit or loss target is met, the system will automatically cancel the other order. You use this one for trades that are already open, and you want to place a GTC closing order into the system
- OTT – One triggers two – this order combines the features of the above two. Here, the system will execute the ‘opening order’, and then trigger a GTC closing OCO order as above with both a profit target and a loss target. Thus, if either closing order is executed, the other will be canceled.
Below is a screen shot of an OptionsXpress ‘All-in-One’ Trade ticket that shows how you could place an automated order while the stock market is closed to open a call spread ONLY if the ‘limit’ debit is met, along with a closing order that will be placed in the system as a GTC order to be executed ONLY if your profit target is met. You can set your communication preferences into the brokerage system to inform you by phone, email, pager, etc if and when the orders are triggered. Alternatively, each night you can log into the system and decide if you want to keep or modify any orders that were not opened, if your outlook on the stock has changed.
Follow this link for a step-by-step Pictorial Guide to ‘How to Trade Stock Options Online’.