Directional Spreads - Part Two: Profile of a Loser

In the last segment I discussed the setup and analysis for executing directional spread trades. Of course, there are MANY ways to do this; I just use one that seems to work for me, given my style of trading and time constraints. Once I decide that I like the setup, the market conditions, how it fits into my portfolio, and the risk/reward profile I go about executing the trade. There are just a few quick steps that I go through:

· Position Sizing: Generally, I will risk ½% of my account size on each trade. Depending on how much I like the trade, I may risk all of that or only part. In the case of ISRG you might remember that I was risking $40 for each contract. If I was willing to risk up to $200, I just do 5 contracts… simple.
· Execute the Trade: One of the many things I like about the ThinkOrSwim platform is that I can go directly from my risk/reward analysis to an order in just a couple of clicks. Once I have the risk/reward picture the way I like it, as described in Part One, I can just send the trade off for execution… quick.
· Set Alerts: As you know, my style of trading is to minimize the time requirements, so I try and automate everything I can. The first step is to set an alert, or sometimes a conditional order, at my stop price. In this case it was $107. I want to make sure that if ISRG hits that number I am out, so this goes in immediately. In this case it hit the next day (which I didn’t know would happen at the time).
· Set Exit Orders: By the same reasoning, I want to exit profitable trades in the same automated fashion, so I also immediately enter my exit orders for my target price. In this case I sold it for $1.90 and wanted to buy it back for around 70 cents. This order goes in right away.

That’s it! It all takes about 2 minutes, and then I just wait. In this case I waited one day and had to exit. There was a buyout rumor that hit the news the following day and the price spiked up. I have reviewed my analysis and I still like the trade... some just don't work out.

Good Trading…