There is no secret sauce to control your trading psychology on ever single trade – but you can get better at it over time. More often than not it’s the impulsive trades that become destructive to our portfolio. You know the trades we make on a whim and hope with no more than 15 seconds of analysis.

Reminds me of those late night TV infomercials. We have all seen them and I’m sure at one point or another you bought something that you never really needed right? I just hope you never bought the Snuggie (come on people, it’s a blanket with cut holes in it.) But these impulse purchases are just the same for traders – and they CAN be avoided.

Ask Yourself These Questions Now

There are lots of great tips and tricks out there on avoiding impulsive trading. However, there are five key questions that I particularly think are helpful.  These questions, if asked ahead of time, help make sure logical thinking and planning are a part of the picture.

1.) When did you come up with the trading idea?

Is this a chart set-up you have been waiting to see for the last month or is this an idea you stole off a trading forum on yahoo? Avoid trades that seemingly “appear” on your radar without much analysis on your part. Off the cuff trades can be fun – but typically no profitable.

2.) What is your plan for entry/exit/adjustments?

Impulse traders don’t even think about these three elements – they just make trades and worry about the other parts later. Have a trading plan in place ahead of time and make sure that any trade you make fits that plan.

3.) What are the technical indicators showing?

Did you check to see if the technical indicators you are using show the same disposition for market direction? If everything is showing an over-bought market ready to top out then why go in and buy now? Just a few moments glance at indicators like MACD and Stochastics can go a long way in avoiding a disaster

4.) How much money are you risking?

Even if you go ahead and make the impulsive trade, determining a conservative position size can be a big step in the right direction. Don’t over invest on any one trade – ever. Take marginal positions in different securities, strike prices, and expiration months.

5.) Historically, are you profitable trading on a whim?

Carve out some time to do some homework on yourself. Find the trades that you have made before on your “gut feelings” and see just how profitable they were. Look, some people are good at spur-of-the-moment trading…you might not be though. Dig deep into your trading records and find out.

Overcoming “Trade and Pray”

If any of these questions make you second guess a trade it’s probably a good thing. We have just conquered the greedy side of your emotions with logical planning. The real benefit to going through this exercise is to avoid the “Trade and Pray” epidemic. Make a trade then Pray it goes right…

These 5 simple questions (if asked) will prevent you from wasting valuable money on trades that don’t have any consistency in the long run. By following this simple solution, you will control your trading psychology and your portfolio with thank you later.

This morning the European Debt Crisis got a little worse as Standard & Poor’s downgraded its rating on Italy last night to A from A+. The new report pointed out multiple problems with the Eurozone’s 2nd largest debtor including weak economic growth, rising borrowing costs and record levels of debt insurance.

Last month the European Central Bank was forced into buying Italian and Spanish bonds because their yields surged so high that they fear another looming bailout was near unless they came in a bought up the debt that nobody else wanted. Sound familiar US? Our own Federal Reserve has done the same thing twice already via the QE1 & QE2 programs.

Spaghetti Bowl of Debt

A great chart from the NYTimes was posted a couple months ago and shows just how inter-connected this problem is. If you thought Greece was the major problem, think again. The contagion risk that one default will lead to another, and another is very real.

Tough But Real Solutions?

Since most of the debt is inter-connected some analysts have pointed out that a lot of progress can be made but retiring and forgiving debt between countries. A study was even done by a European Business School and found the following results should interlinked debt be “cancelled” or “compressed.”

• The countries can reduce their total debt by 64% through cross cancellation of interlinked debt, taking total debt from 40.47% of GDP to 14.58%
• Six countries – Ireland, Italy, Spain, Britain, France and Germany – can write off more than 50% of their outstanding debt
• Three countries – Ireland, Italy, and Germany – can reduce their obligations such that they owe more than €1bn to only 2 other countries
• Ireland can reduce its debt from almost 130% of GDP to under 20% of GDP
• France can virtually eliminate its debt – reducing it to just 0.06% of GDP

September was another clean-up month as the market continue to head lower with big sell-off and volatility spikes. Kept the portfolio very light and most of our money in cash once it started – the only small loss we took was with our 1 credit spread position after rolling it lower to avoid bigger losses. I’m comfortable with how things shook out and sometimes losses are part of playing the game.

Credit Spread Strategy: -1.30%

To re-cap this month’s income, let’s look at what we made in premium vs. our required investments (in margin). Here are the positions we had with corresponding PROFIT/INVESTMENT and RETURN:

RUT 600/590 PUT SPREAD (Rolled Lower) – ($40)/$950 = -4.21% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $40 of loss after investing just $950 in margin. That means we saw a total portfolio return of -1.30% this month based on our model allocation.

Naked Puts/Calls Strategy: 0.74%

To re-cap this month’s income, let’s look at what we made in premium vs. our required investments (in margin). Here are the positions we had with corresponding PROFIT/INVESTMENT and RETURN:

IWM 55 PUT – $24/$550 = 4.36% Return

OIH 90 PUT – $40/$900 = 4.44% Return

DIA 101.75 PUT (Rolled Lower) – ($60)/$1,070 = -5.61% Return

With regard to TOTAL INCOME and RETURN, the portfolio produced $4 of income after investing just $2,520 in margin. That means we saw a total portfolio return of 0.74% this month based on our model portfolio allocation.

Iron Condors Strategy: 0.00%

Again this month we did not enter any positions for the Iron Condor strategy – and thankfully so with the volatility. All funds remained in cash.

Becoming a successful trader is a process. It doesn’t happen overnight or everyone and their mother would become traders. It’s a process of constant research and studying, which can actually be very mentally challenging (yet stimulating at the same time).

There are no successful traders who made a killing on the first day – myself included. It is the daily steps you take towards your financial goals that truly become your foundation for a long and profitable career. And with that there are 3 major, unbreakable laws of trading that you must obey to be successful in the long run.

1) Trading is a Process.

There is no magic key or system – by now you should know this. You have to undergo the process yourself and should look for guidance and help from other professionals. To think that you will be up and trading millions of dollars next week is a fantasy.

Remember that we all learned to crawl before walking and running. We learn how to fall and get back up in the process and it goes the same in trading the markets. Many people tend to jump ahead, skipping some of the most important parts in the process – mainly how to lose money and still survive.

Everything you do should be a well though out process- a series of steps, activities and education all leading towards your goals. Don’t skip steps.

2) The Law of Inertia.

“Every object stays at rest until is acted upon by an external force” is a famous quote we all have heard before. So how does it apply to trading stocks and options? Simply put, you need to break the internal force that prohibits you from letting learning lead action.

The law of process above will be useless if you fail to practice what you learn at some point. Paper trading is a great way to get started and you don’t even have to risk real capital. I still paper trade on a daily basis, testing new strategies and techniques.

You probably have attended conferences, workshops, seminars, and read books on everything by now right? But what good is all this education if you don’t put it to work. Some things you have to learn by doing, so start making trades already!

3) Law of Probability.

Experienced traders understand that trading is not more than a game of probability. Nothing is 100% certain about predicting the market, so more or less you are just making educated guesses. Beginners learn this the hard way but eventually get it down the road after losing money.

You must stop trading based on hunches, emotions and news headlines. Focus on using technical analysis tools and make sure that you have a solid risk management plan in place. If you understand the law of probability then you know you should position your trades according to their likelihood of making money – higher probabilities get more allocation.

The stock market (or any financial market for that part) is different from all other business environments. Trading has the appearance of being something that should very easy to do with the “right” tools – throw in the possibility of making a lot of money quickly and you can see why so many try and fail.

What is Your 1 Unbreakable Law?

Regardless of how long you have been trading, I’m sure you have learned at thing or two you could share with everyone. Add your 1 unbreakable law of trading you have learned over the years below.

Today we are opening the new position as follows:

Trade: Sell RUT October 480 Put AND Buy RUT October 470 Put

Premium: $35 (0.35) Net Credit or better per contract

Underlying Price: $691

Max Return: 3.61%

Break-Even Price: $479.65

Time Until Expiration: 36 Days

Probability of Loss: 5.11%

Trade Explanation: For the Credit Spread portfolio we are adding our 1st trade for the October portfolio. It’s been pretty quiet in this portfolio lately which has allowed us to let the market work through this recent volatility. I would have traded earlier as I’ve mentioned before BUT with volatility so high I wanted to get inside 35 days (or close to it) for our new positions.

With the VIX still near 40 there is still really great premium for options and no point in adding positions that are 45-50 days from expiration in this market…you can still make money with front month contracts.

I decided to go with the RUT as apposed to other major indexes for two major reasons:

1. The RUT has seen the biggest drop in the recent sell-off as we know. This has naturally swelled premium more so than say the NDX which is surprisingly making it’s way higher (the NDX actually would be a good CALL spread trade possibly later on this week).
   
2. Even if we see a drop similar in magnitude and timing to the flash crash our position would be safely away from the market.
   

The reason this all works out so nice is because of volatility. When volatility premiums are high, even in a market that I think could go lower, we can position ourselves EVEN FURTHER from the market and reduce risk.

For this trade we are only risking roughly $968 in margin requirement per contract to possibly make $35 in premium collected on this trade by expiration – making an solid gain of 3.61% overall. As always, if you are having trouble getting filled, try legging into the spread (i.e. buy the lower put first and then sell the higher put in separate orders).

Post your comments below if you have any questions about this trade, another trading idea, commentary, etc.

I was on a coaching call last night with another student and we were looking at Gold (GLD). I had noticed that it’s flashing a pretty large bearish divergence signal on the daily chart using a MACD Histogram.

Now, I’ll be the first to tell you that Gold is all over the media right now and has been in a parabolic state for the past year. But that doesn’t mean we won’t see a little correct here to keep this rally going.

As always, I’m a fan of sustainable trends. This gold “bubble” as some people are calling it still has legs, but not a the rate it was going in July. Corrections are healthy and needed for Gold right now.

What Are Your Thoughts On Gold?

I know a lot of you have traded gold and continue to make trades on Gold. What do you think the charts are saying and how are you positioned?

Bernanke’s possible QE3 program is back on the table and possibly coming to a printing press near you! Following his comments in Jackson hole, the Federal Reserve chairman made it clear that they would continue to help where needed – secret Fed code = QE3.

What is Quantitative Easing?

Everyone’s talking about it yet you may not even know what it means. So here’s the short and sweet answer…

• Central Banks set the price of money as an official interest rate. The lower the rate, the more attractive borrower is for the economy and thus people save less and borrower/spend more.
• Since rates cannot go below zero, once they have cut the target rate then they move onto Quantitative Easing as another way to stimulate the economy.
• The goal of QE is to bring down interest rates for businesses and household. But how exactly do they do this? Easy…
• The Central Banks print money and use that money to purchase assests. In our case, US Bonds.
• The purchase of US bonds drives the price higher and yields (interest) lower.
• As Government Bonds become less attractive at lower rates, then money is filtered to riskier assets classes (like corporate and municipal bonds) which in turn lowers rates.
• With lower rates, the HOPE is that companies will borrower more and spend more to stimulate the economy.

Let’s Be Realistic For A Second

We are heading into a possible 3rd round of QE. So will the Fed pumping more than $1 trillion dollars into the system really make a difference? Not enough I fear.

The country needs a fundamental boost to housing and the job market. Without these two keys, there will be no recovery – period end of story. Jobless claims and the unemployment rate in general have been stuck in a rut for months and it’s going to take more than marginal downticks to instill confidence.

Quantitative easing is intended to bring down interest rates, but my argument is that they are already at historic lows. Therefore, any additional impact of another round of QE would be modest.

Both the 10-Year Treasury Bonds and 30-Year Mortgage Rates are already at historic lows, and yet rather than borrowing and spending, many businesses and households are still scared to do anything. This is clearly evident in the most recent reading of consumer sentiment which is taking a nose-dive right now.

What’s The Point Of All This?

Believe me, I’m not naive enough to think that the stock market won’t get a boost from another round of QE because it will (and frankly already has enough though it hasn’t been officially announced yet). Each and every QE program thus far has correlated with huge gains for stocks – but that’s the market, I’m focusing on the economy.

GDP growth has slowed to less than 2%, which is down right pathetic for our third year of economic recovery wouldn’t you say?

I think we are in a modern “liquidity trap” where people are too afraid to invest and spend that cutting interest rates further doesn’t accomplish much. Sure QE came be great for American exports as the dollar slides it makes it more attractive to buy cheap American products, but even those numbers have been less than strong this year.

Ben Is A Student Of The Depression

Let’s stop beating the guy up for a second. He wouldn’t be the chairman of the central bank if he wasn’t well educated and really who are we to tell him what to do right? From what I’ve read Ben is a real student of the Great Depression and focused much of his attention on learning why, how, what happened. So I have to believe that he’s on our side and knows what the hell he is doing.

Do You Think Another Round of QE Will Help/Hurt?

As always, I’m interested to get your opinion on this. Add your comments below and share you thoughts/concerns about the possibility and impact of another QE program.