Incorporating Different Time Frames into Your Trading
By Phillip Wiegand, Optionetics,com
01/11/2001 5:00:00 PM
One of the separating factors between successful traders and the not so successful is a well thought out trading plan. The best plans will help allocate the appropriate amount of capital to the different strategies they implement. For example, you may choose to have a certain percentage of your portfolio invested in long-term "core" positions (i.e. collars) and then allocate the remainder of your risk capital to other limited risk strategies. This type of plan allows the trader to constantly be in the market without incurring much risk, yet have the flexibility to take advantage of short-term trading opportunities. A successful trader also has the ability to trade a security in multiple time frames. This is what I would like to focus on for the remainder of today's article.
One of my trading objectives is to constantly be financing the longer-term positions I have on the table at any given time. I want to pay for those longer-term positions with the profits made from other trades I have going in the stock. This is just another way to reduce the risks and increase the returns from your investments. There are many different ways to accomplish this. But the bottom line is that I want to use trades that have different objectives, depending on the time horizon that I am trading. It's very important here that you have a strong understanding of the various strategies at your disposal and which strategies work best under specific circumstances. My favorite strategies to combine with existing long-term positions are calendar spreads, credit spreads, ratio backspreads and butterfly spreads.
At first glance, this may seem like a very complicated process to figure out, let alone actually implement. However, if we break it down into simple components, you should have no problem incorporating this thinking into your own trading plan. First, it is important to break down the time frames that you want to trade. I like to separate my time horizons into three separate categories: long-term, intermediate-term and short-term. Generally, I like to take a long-term bullish position in sound, quality companies that lead their respective industries, and then use non-directional or bearish trades for the short-term/intermediate time frames. This way you have exposure to your long-term assumptions while being protected, in case the strategy doesn't pan out right away.
For example, Texas Instruments (TXN) is a great company (in my opinion) and I am bullish on this guy for the long-term. However, there is plenty of uncertainty in this stock (and the overall sector) that will cause this stock to trade flat to down for a while. The question is: When will it begin to take off? Since we have no way of knowing that, it makes sense to go ahead and get into a long-term bullish position for exposure. Long-term bull call spreads or collar spreads would certainly be potential candidates for getting your foot in the door. These trades give you enough time for the trade to workout, limit your risk and provide nice risk/reward scenarios. Next, we need to confront the intermediate-term, and I like to use ratio backspreads in this time frame. For example, it may make sense to use a put ratio backspread in conjunction with your long-term collar or long-term bull call spread. That way, you are protected and may even make money if the stock were to crater. Lastly, the short-term needs to be dealt with and, generally, I like to use calendar spreads in this time frame. These trades let you take advantage of the time decay characteristics of options and don't place the burden of choosing market direction. Additionally, if the stock that you're playing has a nice volatility skew, then calendar spreads can be particularly attractive. Now we have a position in TXN that has the potential to make money, no matter what the stock does. And the long-term position has the potential to be "paid off", depending on the results of the short-term and long-term trades.
The neat thing is that Optionetics.com's Platinum site will show you exactly what the risk profile of these three trades look like in combination. This way, you don't need to go through the cumbersome process of calculating all of the break-evens, maximum risk or maximum reward in your head. You actually have a visual aid to help determine the number of contracts to include in each individual position. Incorporating this process into your trading will definitely help you achieve the next level.
Good luck and enjoy the weekend! |
