Friday, February 8, 2013

How do you decide what to trade?

I know one question that I get frequently is how to find what to trade. Its a hard question to answer because the answer really depends on a lot of variables. But there is probably one universal rules to follow:

1) Make sure the stock is liquid. My rule of thumb is that the stock trades at least 1 million shares a day on average. You want a liquid stock because you want to make sure you can get in and out of the stock easily. But on top of the stock being liquid you are going to want to make sure the options are liquid as well. I like to look at open interest to gauge this. If you look at the 8 closest strikes you should see a couple thousand contracts in open interest.

Other than that the sky is the limit. There are so many sources of ideas out there. They range from free to paid services. It really depends how active you want to be and what you cash flow situation is like. I personally like to come up with my own ideas, and I honestly don't like to pay for trade ideas. So I navigate towards free tools for idea generation. But with the internet this is very easy. And if you follow our advice on this blog and get a think or swim account through TD Ameritrade, you will have more tools for idea generation than you know what to do with.

I think a great place to start is to look at companies that you know. What companies do you interact with in your personal life. Write down a list of those companies and look up there stock symbol on Do they pass the liquidity test? You might have some good trade ideas.

As I have blogged about a lot lately I have gravitated towards leap covered call positions on high yield dividend stocks. The first thing I do to identify a candidate to trade is use a free service called dividata ( Its a really great tool that allows you to set filters, see stocks that are going ex-dividend soon, high yielders...etc. I really like the dividend history and rankings that it provides. After I find some candidates that peak my interest I take those stocks over to the TOS platform and look at the price chart, to decide if it technically looks like a good entry point.

If the timing looks good to enter into the position from a technical standpoint I then precede to the options tab on the platform to scope out the nearest out of the money call option that I can sell against it. Typically I am looking 1 year out on this type of position. I am looking to collect about 7-10% of the current stock price as a "cushion" or a reduction to my cost basis. I should also point out that I am targeting dividend stocks yielding 5-10% (sometimes a little higher), that have a good stable payment history of at least 5 years (preferably 10). All in this sets me up with about 12-20% cushion.

Now this is for just one type of trade idea generation. I also like to look at the popular ETF's for trade ideas. One of my go to index ETF's is the SPY, which for those of you that are not familiar is the index that tracks the S&P 500. I typically look at trading this instrument from the short side when I think the market is a bit overdone.

Other places you can get trade ideas: Tasty Trade, Think Or Swim Scans,, CNBC,,,,

This is only a small list of the endless pool of opportunity that awaits you.

Good Luck Trading!

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