Probability Based Trading is very simple to execute. I am constantly challenged by fellow traders about its’ simplicity. “If it is this easy to execute, how can it possibly work”. They find it impossible to believe that I don’t use charts, indicators, support/resistance, Fibonacci retracements and extensions, etc.
I must admit to the reader that it was extremely difficult to throw out over twenty years of studying so many methodologies, indicators and the like. And when I considered the huge investment in money and time it was even more challenging to just “chuck” it all.
Having become consistent trading the probabilities that are right in front of me has totally changed my outlook, my expectations and most importantly, my results. Upon embracing Probability Based Trading, refining your strategies and executions and proving the concept to yourself I trust you will not look back. Here are the steps that I take to successfully trade to put the odds on my side:
1. Assemble a list of the stocks and ETF’s that have high liquidity and tight bid/ask spreads.
This one step alone will free you to focus on trade strategy and executions. Like many of my clients I used to spend an inordinate amount of time doing all kinds of scans to find what underlying(s) present an opportunity for potential trades. I regularly talk with other traders who are consumed by trying to come up with the perfect scan or an aberration in option value. Forget it! Don’t waste time and energy trying to find trades when a good universe of 50 to 150 symbols will give you all of the trading opportunities you need. With this short vetted list I am sure you will find more trades than the amount of capital you want to put to work. I have provided a list of the stocks and ETF’s that I have in my database under the “Trading Resources” page. Feel free to start with this list. This is all you need.
2. Sort your list by Implied Volatility Percentile.
Don’t confuse the IV Percentile with Implied Volatility and/or Historical Volatility. I have my list of underlying symbols in an Excel spreadsheet. I have this spreadsheet linked to a live data source so all of my data is “real time”. I simply use the “Data Sort’ function in Excel to rank all of the symbols by Implied Volatility Percentile from largest to smallest. (you can find PDF’s of the list before and after sorting in the Trading Resources tab.
3. Evaluate the list for potential trades.
After the list has been sorted the symbols with the highest Implied Volatility Percentile are at the top. I am only interested in underlying stocks and ETF’s that have an IV Percentile of 50 or higher and 25 or lower. I know that if the IV Percentile is above 50 I will be looking for opportunities to sell volatility (premium). If the IV Percentile is below 25 I will only consider directional trades.
4. Quickly find potential trades that meet my criteria.
I quickly enter each symbol that has an IV Percentile over 50 into my options platform. Now simply looking at the options chain I am looking for trades that fall into the 70% +/- probability of success.
The 70% probability of success is my “wheelhouse”. Many traders prefer higher risk and higher reward while others like lower risk with lower returns. Each trader has to find his or her comfort area….and then remain consistent to allow the odds to work for you.
5. Confirm that there is not an imminent binary event (like earnings) and route the trade.
If I am filled on the trade it is on my terms and with the odds in my favor of a winning trade of 70% or more.
6. Rinse and repeat.
The key to successful Probability Based Trading is to trade a very large number of trades and keep the number of positions small while maintaining consistent risk.
7. Manage winners.
Contrary to everything that I was taught (translate “pounded into my head”) I manage my winners………and I don’t concern myself with the losers. I accepted the risk when I put the trade on and now I simply let the time and strategy work in my favor.
Compelling research and my experience has proven that it is materially more beneficial to manage winners and take winning trades off between 25% and 75% of maximum profit as opposed to letting the trades go to expiration. (This is what I did in the past). Taking the trades off prior to expiration and redeploying the capital yields far better results.