Increase Your Certainty Before Trading Forex Options
How to trade forex options objectively
Paul and my “Trading Forex with Options” ebook will be up for grabs tomorrow and I wanted to prep you for options trades before you learn the material. Paul sent me a copy of his trading planner that he uses for every single one of his trades so he can remain completely objective when putting on his trades and be certain about his decision. Would it be helpful to you to know how to gain this certainty and significantly reduce those feelings of doubt and frustration? Let’s walk through each of the components of the planner that he filled out recently:
Forex Option Trading Plan
Look at the chart
The first thing you should do is bring up a chart of the currency pair of interest and note what it’s been doing and the current price level/range it’s been in. This will give you a context of what’s been going on and will immediately show you the current sentiment. You should be answering, “Is sentiment positive, negative, or neutral right now?”
In this case price has tested lows and failed and is starting to develop a positive sentiment.
Weigh positive and negative factors for sentiment to decide on a direction
Ok when you first look at what’s filled out in the “supporting reasons” box, you may freak. But it’s actually not difficult if you can read. Like Paul said in his interview, he just goes to trusted financial sites like bloomberg.com or ft.com, or even investment bank reports and looks at what economic news is coming out and what the market cares about. You can follow the same strategy and simply list what you find here. After listing all of the reasons why a currency pair should increase in the “supporting reasons” box, you can list all of the opposing reasons in the box below it. If you have more strong reasons in the upper box, then you can put on a trade with the confidence that you are riding on a large fundamental driving force. How to do this is all covered specifically in the ebook, but if even after reading that you are still confused, reading Paul’s weekly briefing or reading certain investment bank analysis reports can help you decide on a direction supported by fundamentals.
In this case headlines indicate that stock market crashes are causing the Yen to benefit against the Dollar, but in the long term evidence is overwhelming that the Yen has to weaken (i.e. USD/JPY strengthen).
Decide what the best structure is for the current market environment
Sometimes price has been in a range and you want to profit from an explosion in one direction, or you may only expect it to increase weakly because sentiment is only weakly positive. Or, you may expect price to remain confined to a range. Each one of these possibilities requires a different options strategy. If this seems like greek to you right now, the book covers the basics of how to choose the right options for the right environment.
In this case, the call option is bought near the entry price to express a long view of the USD/JPY, and another call option is sold with a strike price way up at 100 to reduce the amount of money risked on this trade. For a similar reason, a put option is sold below the entry price and has the backing of strong technical support near the strike price.
Plan your exit and be prepared to deal with negative outcomes from the beginning
It’s amazing how most traders spot what they perceive to be an opportunity in the market and only see the positive outcomes that could occur, and think that risk management is as simple as putting a stop loss on.
But let’s think about it: if you went through all that work performing analysis to find an opportunity to profit, what makes you think that you don’t need to go through the same work to anticipate possible negative outcomes and plan your exit strategy?
VAR stands for “Value at Risk” and basically is a way of measuring the maximum likely movement of price within a given time frame and level of confidence given the volatility implied by the market. This is so we can give price plenty of room to “breathe” without risking too much.
In this case, analysis of past price action and words of experts in the media (regarding the Bank of Japan) seemed to both indicate that Japan would be happy with the USD/JPY around 98 or above, so we would be happy taking profits at 98. Using current volatility, with 95% confidence we can expect a maximum loss of $616.
I realize that this may be a lot of jargon for non options traders, but once you learn it you get used to it and really it’s just a matter of filling out each of these boxes every time you approach the market–Then you can forget about second guessing yourself or worrying about getting stopped out. Again, I didn’t explain every little detail here because I don’t have room, but I’ll be posting more strategies that you need to trade options profitably in the future. If you want to fast track your success with trading forex options, however you’ll want to get the “Trading Forex with Options” ebook when it comes out tomorrow.
