Lessons from the Pros

Option Trading and Alert Setting

In my last article, in which I discussed my reasoning why I discourage directional trading with OTM (out-of-the-money) options, I also mentioned that I am a trader first and an instructor second. Since then I have received several emails touching on this very point. Just briefly about that point, all those who have been trading for a while know that "trading is a lonely existence." Trading requires concentration and isolation. It involves a lot of screen time, a lot. Having the capacity to teach helps me, for I know myself and I do know my trading weaknesses quite well. At times, I do tend to overtrade. Hence, instructing helps me to stay disciplined and true to my own trading plan. One of the Ten Rules of Trading from our Professional Trader class is the rule that clearly states: Do not overtrade.

Having said that, I should move on to my reply to an email that I have received from a trader who was asking me to clarify my use of alerts; I believe that any serious trader should make the best possible use of alerts. Rather than coming up with a hypothetical example such as when XYZ is at such-and-such a price then we could place the alert at such-and-such a level, I will look at what the general market is currently doing and elaborate on where I would place an alert as of writing of this article.

Figure 1 below shows the daily chart of the Standard and Poor’s Futures, the ticker for it on Trade Station is @ES. As you will observe, I have marked the Head and Shoulder formation on the chart that everyone is talking about, including CNBC. Often when everyone knows about a specific formation, that formation might not play out; whether this plays out or not remains to be seen.

Figure 1

On the chart the blue horizontal line is marking the two previous extreme lows. The zone of 865.56 is not necessarily the neckline of the (H & S) Head and Shoulder formation, but the lowest point that the ES has gone in recent history. For those unfamiliar with the H & S formation, the measurement which is used to project the target is the distance from the highest point of the head to the neckline. Once this distance is known, that specific number gets subtracted from the neckline to provide a possible target to the downside. As always, this article is for educational purposes only with the intent to illustrate how to place an alert on the underlying. This newsletter is not intended to be a trade suggestion of any kind.

Figure 2 below shows the Trade Station pop-up dialog box which comes up when a trader attempts to Format a Horizontal Line. In our case, the blue line will be used as the alert so when the price action crosses below 865.56, then the alert will go off. By the time this article gets published, this might already be true. When the Format Horizontal Line dialog box is pulled up, there are four choices given: Alerts, Style, Labels, and Data. The first one is the point of my focus. I have placed a check mark at the Enable Alert box and then have also selected Alert Continuously.

Figure 2: Format Horizontal Line

Figure 3 shows an additional 3 choices that a trader is given. Those choices are Audible (beep or sound), Visual (meaning the actual line that I have drawn on the chart – I could make it visible or invisible) and the final choice is to send the alert via email.

Figure 3: Notification Preferences

Having explained the alert set up, I will wrap up with an actual email from one of our readers. In order to distinguish my response to the reader I have utilized upper case lettering, while the reader’s words are in the lower case. "In your article (PLAN THE EXIT(S) BEFOREHAND) you subtract the amount of credit from the sold call to set your alert." YES AS ONE OF THE WAYS TO MONITOR MY POSITION. Should I take this as one of your lessons how not to lose $$? YES, BUT ALSO WHETHER YOU WILL LOSE OR MAKE MONEY MANY TIMES DEPENDS ON YOUR MIND SET. By setting your alert on the "wrong" side you protected yourself from losing $$. WHAT YOU ARE CALLING THE WRONG SIDE IS ACTUALLY THE CORRECT SIDE BECAUSE IF I LET THIS POSITION GO AGAINST ME TO THE POINT THAT IT IS EATING INTO MY PROFITS, THEN IT IS ALREADY TOO LATE AND THE PRICE IS AT THE WRONG SIDE/PLACE FOR MY POSITION. If you waited till the price came to BEP (BREAK EVEN POINT) you would close the trade with the small loss. IN THAT CASE, THE SMALL LOSS WOULD NOT BE THAT SMALL, BUT BIG BECAUSE THERE ARE OTHER COMPONENTS THAT NEED TO BE TAKEN INTO ACCOUNT. BESIDES THE PRICE ACTION THERE IS VOLATILITY AND ALSO THERE IS TIME TO EXPIRY. AFTER ALL, OPTIONS ARE 3 DIMENSIONAL PRODUCTS. Is this how you protect yourself with any trade or just sometimes depending on other things? THIS IS HOW I MONITOR MY POSITION, AND WHAT I SPECIFICALLY DO ON A CASE TO CASE SITUATION VARIES SOMEWHAT. Basically, you cannot have Maximum Loss by using the alerts. THAT IS CORRECT ONLY IF YOU TAKE THE ACTION AS SOON AS THE ALERT GOES OFF. REMEMBER THE LAST TIME PASSIVITY WORKED AGAINST YOU. NO PASSIVITY WHEN THE ALERT GOES OFF. Even if the trade goes wrong, you can still have a small profit, OR A SMALL LOSS that is your point, right? YES. You achieve this by having "alert" (cushion space) so you have time to react and end up with a small profit instead with a loss. THE ALERT IS THE LIFESAVER.

In conclusion, I have explained how to set up an alert using TradeStation. If you are using some other platform, make sure that you know how to make the best use of the alert on that platform. I personally find alerts very useful. I believe that any serious trader should make the best possible use of alerts. Have a good rest of the summer trading.

- Josip Causic