A:  The quick answer is that the rule applies to both trades as well as investments. However, there are some investments that will outperform the market but may take longer to do so. A stock that returns 5% for the first 3 years and then doubles in the 4th year may underperform the market on the short term but ultimately outperform the market. Your goal is to determine the lifespan of your investment as best as possible. All the while, make sure your expectations are realistic and not based on “hope”. Holding a dog because there is a remote chance that your company may hit the 9th inning home run is not a solid investment strategy.

Thanks for your question!

AJ Monte

The Market Guys

A:  You can place your sell stop below the entry price in any increment – down to the penny.  Unlike options, which have specified strike prices, the stop order may be placed at any price.  Of course, remember that for a sell stop you want to place the order slightly below the stock’s support.

 
Q:  Can you put more than one type of order on a stock?

A:  You may place more than one type of order for a stock but you should do that as a conditional order.  For example, if you want to place a sell limit above your entry price and a sell stop below your price, then you would enter a conditional bracketed order.  This will cancel the open order that is left when the first order is triggered.

Q:  At what percent would a trailing stop be considered too tight? (Ron)

A:  The chart will have to give you that answer.  What is too tight for one stock may be too loose for another.  Evaluate the volatility of the stock you’re trading and allow for the normal daily fluctuations.  When in doubt, allow for more room but reduce your position size so that you don’t violate The Market Guys’ 1% Rule.
 

A:  We often trade in the last 15 min of the day. So if we see the pivot point holding, we will trade *that* day rather than waiting for the next trading session.  This assumes that the signal is one that doesn’t require confirmation.  An example would be a bullish engulfing pattern.  A doji is an example of a candle that does require confirmation from the next trading session.

Q:  In today’s climate and with so many stocks well below there 50 and 200 day moving averages, what can you take from the charts to give you confidence in future picks?  – Lee

A:  Well, for starters, you could include bear trading strategies such as put buying and short selling to profit from market downturns.  Then you would actually be searching for stocks that are below the 50 SMA and 200 SMA.  Beyond that, you can find short term buying opportunities and use the moving averages as profit targets as opposed to support levels.  Further, the candle patterns and role reversals that we identify are just as valid in downtrending stocks as they are in uptrending stocks. 

Q: Can you short sell and trade options in an IRA account?  – Ed

A:  Short sell – no.  But you have many options strategies available to you, including some that have similar profit scenarios as short selling.  All you need to do is submit an IRA Options Upgrade request to your E*Trade rep and you can begin trading options in your retirement account.

Q: So many 401K and retirement IRA’s do not permit individuals to invest directly into stocks other than the stock of the company which offers the plan. Most of these investments are limited to funds within certain selected mutual fund families. How do you advise clients on how to appropriately manage risk when limited to these investments?  – Brenda

A:  First, consider your overall portfolio.  In addition to your company plan, be sure to balance across your other savings.  Having done that, you need to do the best you can with the limited investments in your company plan.  Consider having a core of index funds and money market funds.  Index funds will follow the market and give you diversification with low expense.  In these volatile times, money market funds are good to temper the falling and volatile markets.  Don’t get carried away with many funds and switching too often – that usually results overall under-performance.  Finally, be sure your other investments balance the limitations of your company plan.  If you have a high balance in retirement index funds, don’t add more in your other accounts.

A:  You can trade for a living but you must be prepared to treat it like a real business.  You can’t just step in and start pulling cash out of the market.  You’ll have a period of learning where you will likely lose money. You also must have enough funds to keep you from trading scared – that is, feeling like you cannot lose any money.  When that happens, you will be much more prone to avoiding losses by letting them ride.  The best bet is to start trading on the side, while you have another income source.  Then you can make the switch when you’re confident in your ability to continue full-time.

Q: : Can you buy a put if you don’t own the stock and pocket difference if option is in the money at expiration? - J.H.

A:  You sure can!  You don’t need to own the underlying stock to trade options.  What you’re referring to is a long put trade which is similar to shorting the stock.  In both trades, you profit when the stock price drops.  You have to be careful about losing time value, though.  Consider subscribing to The Options Oracle to help you decide which option is the right one for your trade.

Q: If you sell to OPEN a PUT and you don’t want it to be a naked put, would you first buy the underlying stock or would you first short the underlying stock?  – D.D.

A:  Selling a put obligates you to buy the stock.  Therefore, in order to not be uncovered or naked, you would need to have the full amount of cash required to make the purchase in your account.  This is known as a cash secured put.  Shorting the stock does not hedge a short put position.  If the stock price rises, the short put will expire worthless but you continue to lose from the short stock position.

A:  You can choose to sell your option at any time prior to expiration.  When you sell that option, though, it isn’t necessarily matched back up with the original seller.  In other words, you don’t have to trade with the same person as the original trade.  The buys and sells are pooled and matched through the exchange.  As long as there is ANY buyer out there, you can sell your option.

Q: Explain again the relation of the stock price, strike price and the intrinsic value. – Bruce

A:  For the call option, the stock price minus the strike price is the intrinsic value.  For the put option, the strike price minus the stock price is the intrinsic value.

Q: What are your personal opinions on the down side to call options? Any? – Avi

A:  It depends on how you use it.  If you’re buying a call in place of buying the stock, one down side is that you have an expiration on the call option.  As such, there is time decay – or a drop in the value – as you get closer to the expiration date.  Also, just like buying a stock, you have the risk associated with a drop in the stock price.  If the stock price falls, the value of the call option falls.  However, there are benefits that can’t be forgotten.  These include more leverage and greater choices in managing the trade.

Q: If you sell the option before the expiration, do you sell at the stock price or the option price? – Geoff

A:  You don’t sell at the stock price – you sell for the current option premium.  Remember, you paid a premium to buy the option.  That premium is based on the intrinsic value and the time value.  When you sell the option later, there will likely be a new premium based on current intrinsic + time value.  If you bought a call option and the stock price goes up, you would have more intrinsic value.

Q: Is the premium price per contract or share? – Don

A:  Options chains list the price per share for an option.  Therefore, a quote of $3.55 for a particular option would cost you $355 for each contract you buy (plus commission).

Q: Why would you sell a call at a loss, rather than letting it just expire? – Jill

A:  If you let an option expire worthless, you lose the entire premium.  If the trade starts to move against you, it is better to sell the option at a loss since you still have some value in the premium.  That’s the objective of risk management – don’t give up the entire trade, but rather salvage your capital when you realize you’re wrong.

Q: I’ve heard that the potential for gain is greater with options trading than with just trading stocks. Is there truth to that and what makes options gains more lucrative, compared to trading common stock? – Ben

A:  There are two reasons why options can be more profitable than stocks.  The first is leverage. You can control the same stock for much less capital.  For example, you may be able to trade a $100 stock for a $40 option premium and still get almost the same profit.  An eighty cent profit on $40 is better than a $1 profit on $100.  Second, options give you more flexibility.  You can make money if the stock moves sideways – something you can’t do with the stock.  We teach these strategies through The Options Oracle every week!

Q: I just took your Options for Beginners webinar today. I wanted to say thank you, it was a good presentation. I also took your intro to trading webinar on Tuesday. Exciting!!! If you had a short position that wasn’t doing very well, could you buy an option with a strike price below your entry level for the short and then immediately turn around and exercise it to cover the short? (And thus make a profit…)? – Tim

A:  Think about the two parts of the trade. First, you have a short trade that is losing money because the stock price rose. Second, you buy a low strike call but you pay a premium for both intrinsic value and time value. If you exercise, you would realize intrinsic value but you would immediately lose time value. So the answer is “No” – you would actually lose more money in the scenario you described!

A:  It is always a good time for short trades.  We don’t consider a market – or parts of the market – to be good or bad.  There are uptrends and downtrends.  A down market is not bad if you know how to short or use other bear strategies.  With the current market weakness, we are certainly finding more short sale opportunities so consider adding this strategy if you’ve never used it before.

Q: What does P/E mean? How is it calculated and how can I use it to make decisions when buying stocks?    – Aprajita J.

A:  P/E is a fundamental measure that stands for Price to Earnings.  It is a ratio of the current stock price to the stock’s earnings.  P/E is best used as a comparative measure rather than an absolute measure.  Different industries have different levels of “high” or “low” P/E’s.  Most investors use P/E as one of the fundamental considerations while most short-term traders tend to ignore it.  A basic approach considers a low P/E relative to industry peers as a bullish signal.

Q: What is a good way to practice without risking my cash? – Tim L.

A:  The old method of paper trading is still a good start.  You could literally paper trade which means you follow the market and write down your buys and sells in a notebook and evaluate your results.  Some programs allow for simulator trading – it looks like the real thing until you shut down.  Then you get to start fresh the next time.  But there is no substitute for having real money in the market.  So consider real trading but with very small positions -  1 option contract or 50 shares.  Then you get the real trades with all of the emotional attachment but less capital at risk.