How To Best Calculate Risks In The Optionmarket (part 2)

There may be ground for a change of plan or opinion at the last moment; if a stop is on the floor it takes time to cancel or change it, hence there is a period of a few minutes when the operator does not know where he stands in the optionmarket. By using mental stops and optionmarket orders he always knows where he stands, except as regards the prices at which his orders are executed. The main consideration is, he knows whether he is in or out. The placing of stops is most effectual and scientific when indicated by the optionmarket itself. An example of this is as follows:

Here a option in the optionmarket, fluctuating between 128 and 129, gives a buying indication at 128 3/4. Obviously, if the indication is true, the price will not again break 128, having met buying sufficiently strong to turn it up twice from that figure and a third time from 128 1/8. The fact that it did not touch 128 on the last down swing forecasts a higher up swing; it shows that the downward pressure was not so strong and the demand slightly larger and more urgent. In other words, the point of resistance was raised 1/8.

Having bought at 128 3/4, the optionmarket stop is placed at 127 7/8, which is ¼ below the last point of resistance. The option goes above its previous top (129 1/8) and continues to 130 3/4. At any time after it has crossed 130 the trader may raise his stop to cost plus commission (129). The option reacts at 129 7/8, and then continues the advance to above 131. As soon as a new high point is reached the optionmarket stop is raised to 129 5/8, as 129 7/8 was the point of resistance on the dip.

In such a case the initial risk was 7/8 of a point plus commissions, etc… the optionmarket giving a well defined stop point, making an arbitrary stop not only unnecessary but expensive. The illustration is given in chart form, but the experienced tape reader generally carries these swings in his head. A series of higher tops and bottoms are made in a pronounced up swing and the reverse in a down swing.

Arbitrary optionmarket stops may, of course, be used at any time, especially if one wishes to clinch a substantial profit, but until a option gets away from the price at which it was entered into the optionmarket, it seems best to use the stops it develops for itself.

If the operator is shaken out of his trade immediately after entering the optionmarket, it does not prove his judgment was wrong. Some accident may have happened, some untoward development in a particular issue, of sufficient weight to affect the rest of the list. It is these unknown occurrences that make the limitation of losses most important.

In such a case it would be folly to change the optionmarket stop so that the risk is increased. This, while customary with the general investing public, is something a professional tape reader seldom does. Each optionmarket trade is made on its own basis, and for certain definite reasons. At the outset the amount of risk should be decided upon, and, except in very rare instances, should not be changed, except on the side of profit. The tape reader must eliminate, not increase, his risk. Averaging does not come within the province of the tape reader. Averaging is groping for the top or bottom. The tape reader must not grope. He must see and know, or he should not act.