Cross the Bridge - Away from Illusion
There are literally hundreds of options strategies, many more if you include the vast array of complex strategy combinations. Why so many? Simple, it s because most options speculators can't figure out price direction. Instead, they rely on complex option strategies and a variety of standard pricing models that don t work and simply add illusion to a constant simple reality of all markets: supply (resistance) and demand (support).
When you filter out illusion and replace it with pure supply and demand analysis in options trading, you not only simplify the useless complexity of options, you discover endless low risk-high reward opportunity based on a set of objective rules. This opportunity is one in which the reality-based options speculator simply derives his or her profit from the illusion- or emotion-based options speculator.
I have been trading and providing trading education for many years. One of the most important lessons I have learned is that most people can t follow simple rules. I can hand someone high- quality trading tools and a mechanical set of rules on a silver platter, but if the foundation of the trading belief system is faulty, he or she will not be able to follow or execute the simple rules. The problem is that the trader succumbs to illusion filters he or she doesn t even know are present. These illusions come in the form of lagging indicators and oscillators, market or economic news, so- called professional opinions, green and red candles on price charts, complex option strategies and so on. These types of market factors can trip up many novice traders in "the illusion trap."
Options traders who repeatedly fall for this trap make two consistent mistakes. First, they buy call options after a period of buying. Second, they buy calls at or near price levels where supply exceeds demand. Conversely, they sell put options after a period of selling and at or near price levels where demand exceeds supply. The simple laws of supply and demand ensure that the buyer and seller of anything who consistently takes this action will lose over time. To not only avoid this trap but also take advantage of it, a trader needs to make a simple shift in perception. Crossing this bridge of truth can lead to a monumental move in options trading performance.
The Proper Foundation
In my opinion, the two most important tenets for a proper foundation in trading anything are the following:
- The movement of price in any and all free markets is a function of an ongoing supply and demand equation. Opportunity exists when this simple and straightforward relationship is out of balance. In other words, you want to enter a position in a market when price is at a level where supply and demand are out of balance and exit that market when price has moved back to a level where supply and demand are in equilibrium.
- Any and all influences on price are reflected in price. In other words, price charts alone give all the information you need.
As long as these two tenets are the foundation of your trading belief system, you are likely headed down a path of objective information that offers consistent low risk-high reward opportunity. When the novice market speculator turns to conventional technical or fundamental analysis for price direction answers, he or she can get stuck in illusion traps that may add more layers of questions instead of providing answers.
Quantify Demand Objectively
When you focus on identifying objective supply and demand levels in the options market, you first have to analyze the underlying market. For example see Figure 1. Area A represents temporary price stability that gives the appearance of supply and demand equilibrium. Once the rally in price occurs (B), you know that area A was really a price level where supply and demand were out of balance. B can only happen because there is much more demand than supply at price level A. News and other market noise that accompanies price action does not offer the trader any additional insight beyond simple price. Therefore, if and when price revisits level A for the first time as seen in C, you can conclude that price is revisiting a level where demand greatly exceeds supply. In any market, when price reaches a level where demand greatly exceeds supply, prices rise.