Many new traders want one thing: a set of rules they can follow without watching the market, that wins every time. Unfortunately, that’s not how trading works. In this segment from Go Ask A Trader, John Locke explains how professional traders build an options trading strategy, and why it starts with understanding, not with a back test.
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Start With Three Things: Goals, Risk Tolerance and Asset Behavior
According to John, building an options trading strategy is fairly simple once you are clear on three things:
- Your goals. What do you want this strategy to accomplish?
- Your risk tolerance. How much drawdown and loss can you realistically accept?
- Your asset’s behavior. How does the market you trade tend to move, and what are the strengths and weaknesses of the positions you plan to use?
Once you understand these, you can design a strategy that behaves the way you expect it to.
Build Rules That Match Your Goals
Next, you create three sets of rules: entry rules, exit rules and adjustment rules. Each one has its own conditions and triggers. The aim is to choose the rules that most closely match your goals, not the rules that produce the best-looking results on paper.
“I’m not coming in and back testing something and trying to make it fit. I’m understanding my asset.”
John Locke
No Options Trading Strategy Wins in Every Market
Here is the part many traders miss. You can build a strategy that does well when the market chops back and forth. Or you can build one that does well when the market drops, draws down and then takes off. However, you can’t build both into the same set of rules unless you add some judgment to how you trade.
That’s okay. A professional trader knows which conditions their strategy is built for, and accepts that it won’t perform well in the others.
How Professionals Use a Backtester
Backtesting still plays a role, but not the one most traders expect. John doesn’t use a backtester to maximize results. Instead, he uses it to observe. For example, after running a trade through many cycles, he might notice it rarely recovers from losses. That tells him he may need a new adjustment rule, or that he should simply accept that weakness.
The danger is using a backtest to filter out losses. If a strategy had one big loss, it’s tempting to add a trigger that would have avoided it. But the market won’t hit that exact trigger next time. As a result, the rule doesn’t fix the trade. It only hides the loss in the backtest, which becomes a problem when you trade it live.
Losses Are Part of Trading
Even skilled traders who use judgment will be wrong sometimes. The market can do the less likely thing. As John puts it, you have to learn to deal with being wrong and having losses. That’s being a trader.
Key Takeaways
- Build your options trading strategy around your goals, risk tolerance and asset behavior.
- Create entry, exit and adjustment rules that match your goals.
- Know which market conditions your strategy is built for, and which it isn’t.
- Use a back tester to observe and improve, not to filter out losses.
- Accept that losses are part of trading.
See More of This Video
Watch the extended video in our Explore More and Sustain membership on YouTube on this topic.
Or are you ready to learn options trading with up to 5 hours of live trader coaching every week? Explore the Locke In Your Success Trading Community membership. Basic membership is FREE!
Disclaimer: This content is for educational purposes only. We are not broker-dealers or financial advisors and are not making specific trade recommendations. Trading involves substantial risk, and past or hypothetical results do not guarantee future performance.
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