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Wanderer Buy or Sell Signal
Short-Term Moving Averages headed the right direction
Option Bid/Ask spread of 5% or less
3% Trade Size
At-The-Money Strike Price, Roughly 25-45 Days Until Expiration
Stop Loss at 25% Max
Sell First Half at 25% Profit
Sell Second Half on a 20% Trailing Stop
In Depth:
### Rule #1 - Wanderer Buy or Sell Signal
The Wanderer signal is a momentum indicator (see here for more info, and here to add it to your TradingView charts). When it triggers, we can feel pretty confident that the stock's momentum is headed our way. Obviously, this isn't the case with every trade, but by sticking to this, we increase our odds of at least some follow through of the current move.
### Rule #2 - Short-Term Moving Averages headed the right direction
This goes hand-in-hand with the Wanderer Signal. If there is a buy signal we want to see both a rising 20-DMA, and a rising 50-DMA. This is sort of added protection that what we are buying has the short-term momentum headed our way. With a sell signal, obviously then, we want to see a falling 20- and 50-DMA. Do not enter an option trade with the MAs headed the wrong way.
### Rule #3 - Option Bid/Ask spread of 5% or less
Switching gears now to the options side of the trade. When looking for an option to trade, you want to find a stock whose option bid/ask spread is under 5% wide. In an illiquid stock you'll find that an option market exists, but that the spread is very wide. This means you'll be losing both on the way into a trade, and the way out. The tighter the spread the better. An example of a good spread would be $4.00 Bid / $4.10 Ask. Ten cents wide, divided by $4.00 gives you a 2.5% spread. Not bad.
### Rule #4 - 3% Trade Size
This is a rule, but really just a rule-of-thumb. If you are totally new to options trading, a 1% portfolio size option trade is reasonable. I think 3% is a pretty good level for most traders. Occasionally you'll go on a run of losses. At 3% trade size, a long string of losses still won't be too damaging. But if you were trading 10% size, a string of losses could mean real trouble to the size of your account. Remember, 3% refers to the size of your portfolio. If you are trading a $100,000 portfolio, then you'd trade $3,000 worth of options on a trade. If the calls you were buying are $3.00 each ($300), you would buy 10 contracts.
### Rule #5 - At-The-Money Strike Price, Roughly 25-45 Days Until Expiration
You shouldn't need to spend any time agonizing over what strike price to buy. Simply pick the at-the-money strike. For expiration, keep it right around a month or a little more remaining. Do those two things and you won't have a lot of time decay to contend with.
### Rule #6 - Stop Loss at 25% Max
Now that you've made your trade, it's time to manage it. Number one rule in all of trading is to manage your risk. Our Wanderer method puts a hard cap of 25% on your trade. That's it. There is nothing else to think about. If the trade has gone against you 25% then clearly something wasn't right. End the trade and move on to the next. There are three ways to do this. One is simply to watch your trade. Two is to set an alert on your charts near where you calculate the risk to be ~20%, then go in and manage the trade if that alert triggers. Three is to set a stop loss order. In the past I haven't been a big fan of stop orders, and I'm still not, but I recognize that they can be useful. A couple of tips for using stops with options. Only use day orders, and don't place the order until after the market opens for the day. Also, use a stop limit order, with the stop one price and the limit a few cents lower. Lastly, set an alert on your charts about where you think that will trigger, and try to go in as soon as you can to double check that your stop has filled. If you can't be around to do any of these things, simply close out your options trade before you leave.
### Rule #7 – Sell First half at 25% Profit
Exactly like it sounds. When you've reached a profit of 25% you sell half of your position. Traders new to options often sell too early, or hold too long, forgetting that you don't have to close a trade all at once.
### Rule #8 – Sell Second Half on a 20% Trailing Stop
Once you have reached the 25% profit level you will sell your first half, and then use a stop at 5% profit. As your profit climbs, you move the stop higher. At 40% profit, move stop up to 20%. Do this continuously until the trade runs out of steam and stops you out. Over time we've found that this results in around half of our trade's second half stopping out for less than 25%. However, the profits from the trades that continue to run, result in an overall higher return.
These are the rules of the Wanderer Options Momentum Strategy. We've designed this to be as simple as possible to follow along with, and to be as hands-off as is possible with options trading. As with all of our trading at Wanderer, we consider risk management to be the most important aspect, and this system is no different. But, a system like this is not automated, which means that the trader himself is the automator. We suggest you follow the system robotically. When it is time to buy, you buy, when it is time to sell, you sell. Don't second guess. After you have a long history of trades, you can begin to tweak the system to suit your needs, and we'll list some possible ways to do that, but in the beginning, just follow the rules.
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