ities with a small account, youshould trade in markets that have low margin requirements and good re-turn potential. You should stay away from the high-margin markets suchas the S&P 500 stock index futures.
No  matter  how  much  money  you  have  to  invest,  start  small.  I  havetaught a variety of people over the years with a very wide range of capitalavailable for investment. I advise them all to start by trading small untilthey ﬁgure out what they’re doing. Whether you have $1,000 or $1 million,you have to learn to walk before you can run. In the beginning, I recom-mend risking only 5 percent of your account on any one trade. In this way,you can afford to learn from your mistakes as a novice trader.
Often,  having  too  much  money  as  a  beginner  can  be  detrimental.The more money you have, the greater the chance of overinvesting andmaking costly mistakes. I ﬁnd that the best long-term investors are verycautious early on. However, they systematically increase the size of theirtrades based on the steady increase in capital in their accounts. For ex-ample, you may begin with $5,000 and choose to invest 100 shares at atime, then not increase to 200 shares until such time as your account hasdoubled to $10,000.
IMPORTANCE OF TARGETED EXIT POINTS
One of the most important decisions a trader must make when entering aposition is determining when to sell or close out the trade. It is imperativeto  set  a  target  exit  point  for  each  trade.  A  target  exit  point  is  an  optionprice that would result in a substantial, yet attainable, proﬁt.
By  setting  your  proﬁt  objectives  in  advance  and  determining  yourtarget exit point before you trade or at the time you make your optionpurchase,  you  avoid  the  consequences  of  one  of  the  major  stumblingblocks  to  achieving  trading  proﬁts:  greed.  It  is  very  hard  for  most  in-vestors  to  set  reasonable  proﬁt  goals  once  an  option  has  jumped  sub-stantially in price. That extra point becomes a moving target with eachadvance in the option’s price. Therefore, it is not surprising that a reason-able proﬁt is not achieved when the investor is forced to bail out becauseof tumbling prices.
Although setting proﬁt goals in advance may be simplistic and not themost ﬂexible approach to option trading, the target exit point approach to
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taking  proﬁts  is  a  necessary  compromise.  This  is  especially  true  for  theoptions  trader  who  has  neither  the  savvy  nor  the  emotional  control  toknow when to hold and when to fold in the heat of battle, and who is alsounable to stay tuned to the markets throughout the trading day.
Note also that the proﬁt objective should be substantial, meaning atleast  100  percent,  or  double  your  initial  investment,  so  you  will  not  bewalking  away  with  small  proﬁts  by  using  this  approach.  With  this  ap-proach, you will miss out on those 1,000 percent gains that are the optionsequivalent of hitting the jackpot; but much more important, you will mini-mize  the  instances  of  solid  proﬁts  becoming  painful  losses  and  you  willregularly be taking respectable gains off the table.
Once you have entered the heat of battle, the tendency will be to baseyour decisions upon emotion, and therefore your decisions will tend to beincorrect. To avoid this pitfall, set a closeout date based on the amount oftime  you  expect  the  option  needs  to  reach  its  target  exit  point.  If  thatproﬁt level has not been reached by the closeout date, exit the position onthat date. Closeout dates should be set so that there is still enough timeuntil expiration to salvage some time value from the option if the underly-ing stock has failed to move.
Resist  the  temptation  to  sell  at  a  small  loss  prior  to  your  closeoutdate. You will be yielding to fear, robbing yourself of some potential gains.Also, resist the temptation to raise your proﬁt objective as the price of theoption nears your target exit point. You will then be yielding to greed, andyour proﬁts will slip away.
Another  important  question  that  needs  to  be  addressed  is  whenshould  you  not  sell?  You  should  not  sell  a  position  the  instant  it  movesagainst  you.  There  is  never  a  need  to  engage  in  panic  selling  if  it  is  as-sumed that your original conditions for opening the position still hold true(e.g., your market outlook and your outlook for the stock on which youown options have not changed); also, that you are not committing an ex-cess amount of trading capital and you are still operating within your ownrisk tolerance.
As option traders we create option positions for their huge proﬁt po-tential,  which  can  be  fully  realized  only  by  allowing  positions  to  remainopen for a reasonable period of time. Setting predeﬁned exit points goes along way to facilitate this task.
TIPS FOR SPOTTING AN EMERGING BULL MARKET
Although no two bulls or bears are exactly alike, and sometimes their sig-nals  may  be  a  bit  obscure,  eventually  the  indicators  will  pile  up  and  a
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trend will become evident. As you analyze the stock market for signs ofshifting  trends,  be  cautious.  Each  market  is  different  from  its  previouscousins, so not all the warning signs will be present each time. If you no-tice  only  one  or  two  of  the  telltale  clues,  some  ﬂeeting  business  or  eco-nomic event temporarily may be tilting the market. However, if you detectfour,  ﬁve,  or  more  of  these  signs  appearing  all  at  once,  you’ve  probablydiscovered a major new market phase.
Before the bull begins to charge ahead, you will ﬁnd six major signsthat the bear has retreated into hibernation. Most of these signs apply tostocks, but often they readily relate to other investment markets as well.
One  of  the  signs  is  that  the  market  has  undergone  a  mature  decline.Naturally, if you want to determine whether a new market is on its way up,one of the ﬁrst things you’ll do is determine what activity has come before.If the market has undergone a mature decline then a bull may not be far off.Second,  look  for  a  market  that  is  dull  and  boring.  Historically,  bearmarkets generally storm onto the market scene, but they depart extremelyquietly. This kind of lackluster activity is one of the most common signsthat  a  bear  market  is  losing  strength.  Such  sluggishness  may  go  on  forweeks or even months, but stock prices do not necessarily tumble alongwith  trading  volumes.  When  this  scenario  occurs,  professional  investorsmight say the market has been seized by a complacent attitude.
The  next  possible  sign  is  when  the  market  resists  bad  news.  Gener-ally, ﬁnancial and even some sociopolitical news has a marked effect onthe markets. When the markets refuse to budge, despite signiﬁcant devel-opments, you deﬁnitely should take notice.
Another sign is when the gloom is so deep that even the top-qualityinvestments are sold. As a severe bear market grinds on for what seemslike forever, stock investors, for example, often sell their blue-chip secu-rities in one last brief selling period. These probably are the last stocks togo,  as  investors  will  have  unloaded  their  lower-quality  holdings  at  thestart of the bear.
When the market has fallen to an uncomfortable degree, and investorsbelieve hope for a quick recovery is gone, blue chips hit the market with asudden decline. Not surprisingly, that tends to reinforce the bleak marketmood, as investors begin to think that if even the best stocks are actingthis way, then something really must be wrong with the market.
Next, as a bear market begins to fade, stocks that once sold at price-earnings ratios of, say, 18 to 20 times earnings often are selling at unusu-ally  low  P/Es,  perhaps  less  than  half  their  former  ﬁgures.  When  thosestocks  once  regarded  as  must-have  securities  lose  all  their  appeal,  thechange from the normal situation should cause investors to take notice.Those who have a chance to purchase bargain stocks before the next bullmarket should swing into gear.
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Finally, high dividend yields offer a key signal. Like low price-earningsratios, the often high-dividend yields to be found at the tail end of a bearmarket represent a market reversal in market psychology. Although yieldsin a bear market typically are higher than those for the same stock at thepeak of a bull market, you can look for this phenomenon to alert you thata bear market has run its course.
What does it mean when you can identify several of these indicators?Obviously, the bear market has begun to fade and the bull market slowlyis taking shape. More and more trading occurs daily, and the number ofadvances,  the  upward  movements  in  the  prices  of  the  individual  invest-ments, outpace the declines. The volume of trading and the number ofadvances and declines indicates the market breadth.
To summarize, be aware of the following key signals that a bear mar-ket is approaching a bottom. First, market prices have been declining formore  than  12  months.  Second,  the  volume  of  trading  declines  and  youstart to observe a very boring market. Third, bad news makes no impres-sion on the markets. Fourth, investors start unloading top-quality invest-ments  by  heavily  selling  many  of  the  blue  chips.  Fifth,  investments  thatonce were stars are now on the skids, selling at undervalued prices. Withstocks,  price-earnings  ratios  are  unusually  low.  And  ﬁnally,  sixth,  stockdividend yields rise abruptly. The bottom line is if you observe most or allof these signs, the bear market is probably coming to an end and a newbull may not be far behind.
TAKE A LOOK BEHIND THE ANALYST CURTAIN
How many times have you placed a trade that you thought was perfectlyset up only to have an unforeseen or unexpected event cause the trade togo  bad?  The  technicals  all  looked  good;  maybe  even  the  fundamentalswere all in place. To all intents and purposes, the trade looked like a win-ner. Then all of a sudden out of nowhere comes a comment from one ofthe “guru goons” (my term for analysts), the company announces an ac-quisition that the Street doesn’t like, or maybe even a bizarre incident likean  earthquake  in  Taiwan!  The  underlying  then  reverses  and  the  trademoves against you. Let’s look behind the scenes of how analysts and insti-tutions really work.
It’s amazing how many individual investors and traders still live and dieby analysts’ recommendations. Many people actually still think that analystsmake recommendations for the good of investors. Think about it, who dothe analysts work for? They work for the institutions. Why do analysts con-tinue to rate a stock a “strong buy” while the underlying is bleeding a slow
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death? Why do the same analysts raise a stock’s rating that has clearly beenin  an  extended  uptrend?  Institutions  build  inventories  in  stocks  that  theythen allocate to their brokers to sell to investors. In some cases, it is nothingmore than a quota that the broker is expected to sell. The analyst from theinstitution  will  then  focus  on  some  piece  of  positive  data  regarding  thestock and raise the ratings on the same. This causes a short-term buying in-terest in the stock by retail investors and usually a bump up in the price aswell. Who are the retail investors buying from? Their institution! The institu-tion has been accumulating inventory in a stock, so then it manufactures abuying spurt and depletes its inventory at a higher price. Many times this oc-curs  as  the  stock  is  showing  signs  of  topping  out.  The  institution  makesmoney, and who is left holding the “bag” or stock?
Institutions are in the business to make money, and that consists ofmore  than  just  broker  commissions.  If  the  investors  make  money,  thenthat’s okay, too, but it’s not the priority. In fact, in some cases your own in-stitution  will  actually  take  a  position  against  your  trade!  It  goes  evendeeper. If an institution is dumping an inventory and you have purchasedthe stock and later decide that you want to sell, the institution won’t buyyour stock back! It will execute your trade only after it ﬁnds some otherpatsy to take it off your hands.
Have you ever wondered why analysts always seem to be a step be-hind? When a company announces something negative, if it’s a stock thatthe institutions are interested in, the analysts all jump on the bandwagonwith downgrades. As retail investors are dumping the stock based on thedowngrades,  the  institutions  are  sitting  back  and  waiting  for  the  down-draft  to  subside  and  then  they  begin  to  start  accumulating  again.  Thewhole process starts all over again. How about raising a stock to a “strongbuy”  once  it  appears  ready  to  break  out  of  a  long-term  consolidation  orbasing pattern? Wouldn’t that be a novel idea? That would mean that ana-lysts were really employed to help investors, however.
Then there are all of the amazing abuses of investors by analysts re-garding initial public offerings (IPOs). How many investors own Internetstocks that were priced at ridiculous price multiples due to continued up-grades  by  analysts  as  the  stock  prices  went  into  the  stratosphere?  Howmany  investors  still  own  those  stocks  today  under  $10  a  share?  Do  youthink  the  institutions  feel  bad  that  they  sold  investors  those  stocks  atridiculous multiples? Believe me, they will only feel bad until they look attheir bottom lines.
Some of these longtime abuses are ﬁnally beginning to surface in themedia, both on the television networks as well as in the print media. Someinvestors have even sued the analysts. Okay, so what’s my point in all this?We are on our own out here and have only ourselves to hold accountablewhen  investing  our  hard-earned  money.  Optionetics  exists  because  no
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matter how much research we do, no matter how good a trade looks whenwe place it, things happen that are out of our control and can cause tradesto go against us. Hedging all trades is crucial. When an unforeseen eventdoes happen, we can employ a creative options strategy to take advantageof it. Even in our worst-case scenarios, our losses are minimal and we liveto ﬁght another day. Option strategies are designed not only to aid your re-search, but also to help hedge the trades you make, regardless of existingmarket conditions or directional bias.
COMPUTERIZED TRADING SYSTEMS
Trading  systems  facilitate  trader  discipline.  Computerized  systems  offeradditional  advantages.  The  speed  and  efﬁciency  with  which  a  computeridentiﬁes patterns and generates signals is one obvious advantage. Com-puters can quickly achieve the number crunching necessary to recognizetrading signals. However, it is possible for a trader to calculate these sig-nals manually (in the time required), and the trader’s ability to evaluate acomplete rule-based system is limited as well. Computer systems offer di-rection and suggestions about what to do in a given market and help limitthe range of choices. This makes the trader’s task less overwhelming, be-cause the possibilities and opportunities become more clearly deﬁned.
Trading  systems  approach  the  market  consistently  and  objectively.Programs  are  designed  logically.  Rules  are  uniformly  applied  to  deﬁnedmarket  conditions.  Trading  systems  are  effective  since  rules  are  not  thevictims of trader judgment. The whimsical nature of a trader is diminishedby a system.
The emotional aspect of trading can be signiﬁcantly reduced as wellsince systems are void of emotion and judgment. Unfortunately, the emo-tional tendency of a trader is to outguess the system, even when it’s pro-ducing  proﬁtable  trades.  If  a  trader  can  discipline  himself  or  herself  tofollow  a  system  with  rigor,  emotions  will  not  rule  the  decision-makingprocess. Trading systems are designed to think, not to feel. Another posi-tive feature of trading systems is that they generally include money man-agement rules that help to facilitate trading discipline.
One of the more common arguments against trading systems is thatthey can become popular enough to inﬂuence the underlying price. Thisconcern has been voiced both by the market federal regulatory agenciesand by individual traders. The concern is that the similarity of computer-based systems used to manage large positions may cause large traders torespond in the same way at the same time, thereby causing distortion inthe markets.
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While  it  is  not  guaranteed  that  past  price  patterns  guarantee  futureprice patterns, it is also not true that markets are random. Another argu-ment against the use of trading systems is they deﬁne market behavior inlimited ways when the market can, in fact, behave in an inﬁnite number ofways. It is believed that because systems are mathematically or mechani-cally  deﬁned,  this  reduces  relationships  of  events  to  percentage  odds  ofwhat  could  happen  next.  While  the  criticism  is  valid  in  that  systems  docapture  a  very  limited  number  of  possibilities,  this  characteristic  is  alsowhat makes systems useful. The ability to reduce information to observ-able  patterns  gives  the  trader  some  semblance  of  order  and  direction.Without this, many traders feel overwhelmed and directionless.
One of the more controversial techniques to develop from computer-ized trading is the concept of optimization. Optimization is a process bywhich data is repeatedly tested to ﬁnd the best results. The best movingaverage size, point and ﬁgure method, or other parameters are made to ﬁtthe  raw  data.  It  is  important  to  understand  the  methods  of  optimizationand  to  provide  proper  precautions  regarding  optimized  trading  systems.Performed  properly,  extensive  testing  can  reveal  a  great  deal.  However,excessive optimizing can be misleading, deceptive, and costly.
Trading systems give the trader a way to interpret, quantify, and clas-sify market behavior. Since trading systems deﬁne potential opportunityand provide speciﬁc trading signals, following these signals can facilitatethe development of proﬁt-making trading skills as well as strong exit andentrance discipline.
Computerized trading systems have vastly expanded the scope of in-formation  available  to  today’s  traders.  Systems  can  now  be  thoroughlyback-tested  and  perfected  using  the  computer  to  test  many  if-then  sce-narios. Trading systems offer a way to deﬁne and categorize market be-havior by reducing information to patterns that generate trading signals.While systems are without emotion, traders are not and often try to out-guess a system. Misuse and lack of discipline are major causes of lossesin trading systems.
CONCLUSION
The investment elements mentioned in this chapter are designed to guideyou on the road to trading success. Trading can be a humbling experience.It can also be highly proﬁtable. Perhaps it is human nature to get a littleoverconﬁdent and cocky when the money starts rolling in. But that’s thetime  when  you  need  to  ﬁght  against  your  own  bravado.  Remember,  ittakes only one big mistake to send you back to ground zero. Start small
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and let your account grow consistently. There’s always more to be learnedand a better trade down the road.
In  addition,  there  a  number  of  things  you  can  do  to  protect  your account.  Use  the  following  six  guidelines  to  safeguard  your  share  ofmarket proﬁts:
1. Do  your  own  research  before  you  invest.  Don’t  invest  in  companiesthat minimize or avoid disclosure of their ﬁnancial condition. Alwaysread the ﬁne print in your information sources and avoid hot tips.2. Deal  with  major  brokerage  ﬁrms  and  reputable  brokers.  Know  yourbrokerage ﬁrm’s ﬁnancial condition and who owns the ﬁrm. Be sureyou know what your agreement speciﬁes.
3. Keep  a  written  record  of  all  trades.  Write  your  orders  in  advance.When you receive trading conﬁrmations, make sure to compare themwith your written records.
4. Put your broker to work. If trading conﬁrmations are slow in coming,complain  to  your  broker.  Balance  all  monthly  statements.  Ask  yourbroker to explain any discrepancies. If trouble persists, go to a super-visor. If it continues, change ﬁrms.
5. Change brokers who talk about sure winners. Resist all sales manipu-lation emphasizing double-digit rates of return, shares that will dou-ble, hot stocks, and guaranteed proﬁts.
6. Never put greed before safety. Sometimes you have to protect your-self against yourself, and that can be the most difﬁcult job of all. Re-member  the  market  will  be  here  tomorrow—but  to  use  it,  you  needinvestment capital.
Hopefully, this information will help you avoid or deal effectively withmany of the issues that you might experience. Investors who know how tochoose a good broker, how to analyze information, how to order skillfully,and how to protect themselves are investors who know how to make money.
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How to SpotExplosiveOpportunities
Locating  exceptional  investment  opportunities  is  the  key  to  suc-
cessful  trading.  The  main  objective  is  to  discover  opportunitiesthat:
• Meet all the criteria for a good investment.• Use your investment capital in the most efﬁcient manner.• Produce substantial returns in a relatively short period of time.
Throughout the years I have been investing and trading, I have thoughtof myself as being fairly successful, while in the eyes of others, I have beenperceived as extremely successful. However, contrary to popular belief, Iknow that deep down inside I still have more room to grow. Over the pastfew years, I have been able to accelerate my proﬁtability by being patient(as much as I could be) and by being selective when I made an investment.I have to admit that I love the day-to-day excitement and the ﬁnancialrewards of trading. However, I make a great deal more money by lookingfor opportunity intelligently. In other words, instead of being in the mar-kets just because I feel I need to be, now I wait like a cheetah in the jungle,looking for a wounded animal to pounce upon. Although the cheetah cancatch  any  animal,  wounded  or  not,  it  preys  on  the  sure  thing.  I  havelearned that this is the best way to trade—wait for everything to look right,then attack with speed and conﬁdence.
Initially it may not be easy for you to do the same. However, this conﬁ-dence and patience will come over time as you build up experience and in-crease your investment account through successful trades. How do you spotexplosive proﬁt opportunities? It’s an awareness that needs to be developed,
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and if done correctly will enable you to make 100 percent on your money,sometimes in minutes, hours, or days, instead of years.
How do you ﬁnd the growing money trees hidden deep within the in-formation forest? Simply use the vast amounts of information available toyou; learn to ﬁlter the data and ﬁnd the best investments. The problem isthat  there  is  so  much  information.  This  can  be  overwhelming  and  quiteconfusing. Many would-be investors pick up a newspaper, look at the ﬁ-nancial section, quickly decide that they can’t make heads or tails out ofthe information, and promptly give up. The general feeling is that anythingthis complicated must be extremely difﬁcult to succeed in.
What if you gave up the ﬁrst time you fell off a bicycle? What if yougave up the ﬁrst time you sat behind the wheel of a car to learn to drive?What  if  you  gave  up  on  anything  halfway  challenging?  You  wouldn’t  getanywhere—which is why many people never succeed. Successful individ-uals persevere. This also is true in learning the ﬁnancial markets. It mayseem difﬁcult at ﬁrst; but once you know the basics about how to ride thebike,  it  gets  easier.  After  a  while,  you’re  cruising  down  the  road  yelling,“Look, Mom—no hands!”
Recognizing an excellent trade when you see it is just half the battle.As a trader, you must know how to go about ﬁnding explosive proﬁt op-portunities. There are an overwhelming number of methods used by theinvestment  community  to  evaluate  trading  opportunities.  I  will  not  at-tempt to impart an exhaustive study of analysis techniques—there are fartoo many of them, and most do not work on a long-term basis. However,there  are  two  basic  categories  that  should  be  included  as  basic  compo-nents of a trader’s arsenal: fundamental analysis and technical analysis.
FUNDAMENTAL ANALYSIS
Fundamental  analysis  is  a  trading  approach  used  to  predict  the  futureprice movements of a market based on the careful analysis of an invest-ment’s true worth. Various economic data—including income statements,past records of earnings, sales, assets, management, and product develop-ment—assist  in  predicting  the  future  success  or  failure  of  the  company.Thus, a fundamental analyst studies the fundamentals of a business—itsproducts, customers, consumption, proﬁt outlook, management strength,and  supply  of  and  demand  for  outputs  (i.e.,  oil,  soybeans,  wheat,  etc.).Fundamental  analysts  use  this  data  to  anticipate  price  transitions.  Theysee a company or market as it is now in the present, and they attempt toforecast where it is going in the future.
Annual  reports  and  quarterly  ﬁnancial  statements  (and  their  close
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government-mandated  cousins  for  publicly  traded  companies,  the  10-Kand  10-Q,  respectively)  are  part  of  the  information  used  in  fundamentalanalysis. The ﬁrst question is, “Why should we be concerned about ﬁnan-cial statements?” They are, after all, simply a restatement of the past, not aroad map to the future. There are two primary reasons. The ﬁrst reasonfor looking at ﬁnancial statements is to determine how well managementhas handled the affairs of the company, because if you own shares or havea  bullish  position  on  the  stock  using  options,  these  people  are  handlingyour investments. Is management operating the company well or poorly?Is management efﬁcient or inefﬁcient? How is this ﬁrm’s management ascompared to its competitors?
The second reason for looking at ﬁnancial statements is to determineif  the  ﬁrm  is  positioned  to  carry  out  the  goals  of  management.  For  in-stance, if they are about to run out of cash, expansion projects are proba-bly not going to be realized.
The ﬁrst step in studying ﬁnancial statements is to get one’s hands onthe items from the annual or quarterly report. There are many sources foracquiring an annual report. The most direct way is to call or write the in-vestor  relations  department  of  the  ﬁrm  you  are  interested  in  analyzing,and  simply  ask  them  to  send  you  one.  If  you  already  own  one  or  moreshares in the ﬁrm, they will automatically send you both the annual reportand  the  quarterly  ﬁnancial  information.  Another  location  for  ﬁnancialinformation is the ﬁrm’s own web site.
Most  companies  will  post  at  least  the  numbers  from  their  ﬁnancialstatement  on  their  web  site.  Your  local  library  will  often  have  copies  ofﬁrms of local interest. In addition, there