Simplification of Trading, A Boring Yet Effective Approach
Like many things in life we tend to over-complicate trading without just focusing on the end-goal, making money. There are thousands of different strategies and approaches to trading all trying to lead to the same outcome. I have long considered a more goal-oriented approach, though it is one that would take discipline because although it is extremely effective in realizing the goal, it is a lot less exciting. I would draw a comparison to the New England Patriots dynasty, outside of all the cheating and favorable calls, the outcome, championships, was realized many times via an approach that was extremely boring to watch. The Patriots utilized a dink and dunk approach to move the ball down the field and score points, rarely any exciting highlight-reel worthy plays, utilizing WR/RB screen passes, quick passes to tight-ends and a balanced ground attack. In essence, they broke the sport of Football down into its simplest form of needing to gain ten yards every three, or sometimes four, plays. They would run many of the same plays over and over again, a Defense not realizing the many paper-cuts of three to five yard gains would amount to a gash over the course of the same, and ultimately a loss. The approach also required having a strong defense, and during Tom Brady’s era with the Patriots the team had the best scoring Defense in the NFL allowing it to win games without the need to score thirty points or more.
A similar boring, yet effective, approach can be transitioned to the trading world. If we break down trading into its simplest form there are roughly 250 trading days in a year and if you take an annual income number you would be content achieving you can determine how much money to target for returns per day. These numbers will vary from person to person but for the sake of example and using a number that would satisfy most, let us say $1 million. After taxes this would amount to approximately $650,000 which should result in a very nice lifestyle for the majority of people. To get to that number a trader simply needs to earn $4000 in profits per day and we will use a $1M portfolio as a starting point, so this method is more for those that have already established themselves fairly well but depending on the return goal it can change at any given ratio.
I want to interject and note that the process is much more important than the goal, so this approach is under the assumption your trading plan/process has already been established and shown consistent success. Once you have a confident plan you can set goals.
Returning to the example, if we want to max-risk 5% of our portfolio on a trade, and this can be determined using the Kelly Criterion, that would put each trade at $50,000 at first. To earn the daily objective of $4000 this would mean you need to return 8% on your trade, which in the options world is very easy to accomplish and will detail my approach next. I would also note that as the account grows you will not need to adjust this approach if you want to keep the same risk-standards and will then be risking an even smaller percentage of your net portfolio per trade, or the other option is to continue at the 5% risk factor and then it would reduce the percentage return on the trade necessity (at $80,000 per trade you only need to hit a 5% return).
I realize at this point some reading this may think I am making some wild assumptions, and although there are some that may seem wild at first, if you have participated in our Trading Hub, you know these are not all that wild at all. The main assumption that is a bit misleading is that there is a 100% win-rate on these trades, which will not be the case, as sometimes things happen in the market out of our control, but I have been able to use my approach I will detail next around an 85% win-rate and that was often aiming for 20-30% returns per trade, so at an 8% goal the win-rate undoubtedly would move higher, and I have forced some sub-optimal trades and realize improving discipline is a continuous learning experience. A lot of the time you can capture more than 8% as well which offsets potential losing trades.
There are likely many ways to accomplish what I have laid out, though at 8% daily returns on a single trade using options is likely the only means. There could be an equity approach utilizing larger capital positions with stricter risk controls and looking at making multiple trades per day. I have covered many examples of my scalping approach in other blog posts but will try and define it in more detail below.
My process starts with a list of around 110 stocks that have ample liquidity in weekly options to be able to trade size and get in and out without much slippage. Since I am looking for short-term move I use short-term charts, the 65-minute is my preferred, while being mindful of key levels on the daily timeframe as well. I can the charts of these names nightly looking to identify key breakout/breakdown points that align with volume pockets on the volume profile. I also utilize anchored VWAPs off key highs and lows for signal triggers. The preparation is the key to success. An optimal entry occurs when I get a technical trigger and check the early morning option flows and see heightened interest along with near-term Sigma’s moving up, an indication of increased buyer flow (demand). The other means of identification is early morning scans for hot flow, these names tend to run through the early afternoon, and even if there is not a technical trigger the opportunity is generally a high probability one for a profitable scalp. As I am targeting a short-term move we want to use front-weekly options to minimize the premium paid, though if it is a Thursday or Friday I will use the next week’s options to offset decay on a stalled move. My preference is to use 30-60 Deltas and often will target the one seeing the most volume (liquidity) or has notable open interest already in place. If using a targeted disciplined approach as defined earlier you simply need a $1 option contract to move to $1.10, or $2 to $2.20, and so forth and can put in the limit order immediately to avoid being lured into wanting more. If market breadth is showing early signs of a trend day you can hang onto positions with more confidence to capture further upside but otherwise it is best to take the gain and call it a day. The gains should tend to happen inside an hour, if it is not moving, your technical trigger was not as important as you may have thought and usually a sign to exit. In the case a position moves against I typically utilize a 5-minute candle that marked an opening 30-minute reversal and trade against that.
There are so many benefits to a disciplined and boring approach such as the one described above. For one I am generally making the trade in the opening hour and the day is over by Noon leaving plenty of time in a day to exercise, spend time with family, read, and put time into other hobbies. You also sleep well at night holding cash overnight and only utilizing capital during trading hours, no need to fear overnight gap risk.
I’ve been doing this approach in one of my portfolios more actively and it really is a great way to perform well in all market environments while being fairly stress-free with these short timeframes. I still am caught-up a bit in the desire to play for some bigger moves and try other strategies but the more I consider the value in this approach, the closer I am to just focusing solely on it and spending more time away from the computer while still earning more than I need.
It may not be the flashiest means of trading without having those “monster wins”, but like the Patriots, it reaches the desired outcome.