Traders Edge Blog

Ask the Crew:
Crew members tackle questions submitted by readers each month

Q: When you suggest placing a limit order so you get in at a good strike price on a butterfly, what is a good strike? I assume it means as close to the middle leg as possible. Am I correct?

A: You want a good fill price. I only do the trades when the stock is near a strike price. The limit order I send in is usually only slightly worse than the midpoint (mark) of the butterfly.

Q: I don’t have that butterfly entry functionality with my broker. Can I just enter each of the 3 legs individually and close them all out individually when ready?

A: You can usually put together some kind of “combo” order, but if not then you will simply need to do the Buying legs before the Selling legs. Otherwise your broker will think you are trying to sell naked calls and will most likely reject the order. When getting out you will have to close your sold positions first as well.

Q: What are the risks involved when you do an iron condor? Also, what do you need to be watching for in order to exit the trade before expiration date so that you don’t wind up buying any stock?

A: The risk in an iron condor would be the difference between the strikes minus the premium you received. So, if you took in a $1 credit for both sides and there was a $5 spread in your strike prices, you would have a $4 risk on the trade. To avoid buying any stock or having stock put to you, keep an eye on the time value of your sold options. If the time value is less than .10, keep a close watch on your position and consider closing it. I’ve only been exercised early a couple of times. Once was on a Thursday after a dividend had been paid out and I woke up to being short several hundred shares of stock – the call was exercised. The other time the stock had a dramatic drop and the time value was at 0 – I didn’t buy back the option and ended up with stock when the put was exercised.

 

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Coaches Corner:
The Role of Virtual Trading

At this point in your trading career you are probably at one of three levels: beginner, intermediate or advanced. Whatever the level, you’ve probably dabbled in some form of virtual trading, commonly referred to as simulated trading, allowing you to test strategies and track performance in a risk-free environment. There are certainly lots of opinions on simulated trading, ranging from negative to positive. While I tend to agree with arguments on both sides of the aisle, I do believe virtual trading has real merit and that most would benefit from incorporating some paper trading into their game plan.

First, let’s address those people who find virtual trading a complete waste of time. I have come to know several people during my coaching career that could probably make the next edition of Jack Schwager’s “Market Wizards,” if only their simulated results reflected live results. Unfortunately, they can’t begin to pull the trigger in their live accounts”a problem more prevalent then you might imagine. Thus, I do agree that virtual trading can become an impediment in your trading progress when you can’t escape its safety blanket.

Another common complaint with virtual trading is that trades and results are not completely accurate compared to live trades in real accounts. Yes, it is true that virtual trading does not represent every transaction in the live markets in a complete and accurate manner – this is to be expected given that it’s not an actual market with market makers, buyers and sellers. Additionally, trades in the virtual environment are delayed, which is another flaw.

Despite the issues though, virtual trading is not so far removed from the live markets that it can’t translate a good portion of your successes or failures into what your actual results would have been in the live markets.

Criticisms aside, to fairly assess the merit of virtual trading, we have to first understand what it is intended to do. Simply stated, virtual trading is meant to create a safe environment in which to practice. We all need practice when starting something new or when we want to improve at something we have some experience with.

To demonstrate that point in a relevant fashion, I like to compare simulated trading to hitting balls at the driving range. Now I really enjoy golfing, but it will be the death of me because my swing needs a lot of work. It would be foolish of me not to utilize the golf range to practice and improve my swing simply because it’s not being scored like an actual round of golf. The more I swing and focus on certain parts of the swing, the better I get, regardless of it being a live round of golf or not. The same holds true with trading. You can’t tackle a new concept and expect to nail it the first time without some practice. I always tell clients that if you can’t make money in a virtual environment then you have no business trading live yet because it will only get harder. Hence, practice of the mechanics is the first step in mastering a subject even if you’re doing it in an environment free of emotional attachment.

Now many people feel they can’t treat paper trading like the real thing because there is no risk involved. Fact is that’s purely an issue of discipline. Why risk and lose real dollars in the learning process when mistakes are inevitable? Making mistakes with real money serves little purpose, especially when you can learn to be disciplined in the virtual environment and then progress to trading live with small positions before eventually ramping to full-position sizing. Whether this process takes a month or six months, the key is using baby steps in the beginning to protect and preserve capital while you perfect your approach. Once you’ve done so, you have your entire life to trade and you can do so with confidence. It’s important to note that losing confidence is the number one reason traders fail in the beginning”and confidence is generally lost because of poor execution. Learning to properly execute trading strategies utilizing virtual trading is a good way to negate the issue of confidence loss.

When you do make the decision to use paper trading in your trading plans, you must treat it with the same respect you would in live market trading to gain the most from the experience. You should keep track of each trade’s outcome and your performance in the trade; take notes as to what went well and what didn’t. It’s important to remember that a good trading plan requires discipline”practicing that discipline in a virtual environment, although difficult, is critical when it comes to developing the skills to be a great trader.

In summary, paper trading is an important way to reinforce the concepts, techniques and strategies you’re learning about. Moreover, there’s a practical element to virtual trading that must be considered. Many people lack the funds and/or knowledge to trade every trade suggested by the likes of Preston or Karson. Paper trading allows a trader to engage in such trading – gaining critical experience not otherwise available.

Bottom line, virtual trading should be used as it’s intended to be – as a tool for practice, but not as a crutch. The amount of time you spend paper trading one technique to the next should be limited to the length of time you need to begin developing confidence in your skills. Ultimately, virtual trading provides traders with a means for gaining critical experience without putting dollars at risk until such time as it’s prudent to do so”when paper results can be easily translated into real profits in the live trading markets.

Beau Keenan

 

Beau Keenan has been an active trader for six years. He graduated from BYU’s Marriott School of Business with a degree in corporate finance, but found his passion in trading. During that time he’s traveled the country coaching individuals on the markets and how to trade equities, options, futures and foreign currencies. He enjoys teaching and since joining the Traders Edge Network has personally worked with hundreds of individuals. Beau is a husband and father of two young children. He enjoys the freedom he has to do lots of other activities, from traveling to building businesses.