The Different Ways That Stocks Can Move
Most people think that to get the most success out of the stock market you simply need to have a good read on whether stocks will move up or down.
While determining that is the fundamental goal of trading, professional traders do a slightly more complicated analysis than that.
After a professional trader has figured out that they like a stock to the upside or downside they then need to think about how that stock might move. Depending on the direction of the move and how aggressive they think it could be there are a number of strategies they might choose to employ.
Below I will go over the different ways that a stock can move and how you can best approach these setups for maximum profit.
Different Ways a Stock Can Rally
Stocks can rally at a slow and steady pace or they can gap higher aggressively. While you can make money being long the stock in either case there are more nuanced ways to approach each setup.
Stock that you expect will gap – This is a setup that you want to approach with call options. You might expect a more aggressive move like this after a catalyst event like earnings or an announcement. You can make money being long the underlying stock but on an aggressive move your profit potential with options will be much greater. When evaluating a trade setup think about if a gap is a possibility, if it is, use options.
Stocks that you expect to grind higher – When you expect a stock to grind higher to the upside over a longer period of time options might not be the best approach. Longer dated options will be more expensive and as a stock grinds higher implied volatility moves lower. This will have a negative effect on options prices. Holding the stock over a longer period of time also gives you the chance to collect dividends, something the option buyer does not get.
These are ways to approach a stock that you expect to go up and keep going up. For stocks caught in a trading range you will want to approach them in a different way.
Stocks Caught in a Range
When stocks are caught in a trading range it can be difficult to approach the setup using the underlying stock.
Options give us the ability to setup credit spreads that will profits with little to no movement in the stock.
This is the best approach for a stock that is caught in a very tight trading range. If the range is broader and you can clearly identify the top and bottom of the range you could choose to trade it with the second approach above.
This gives you the opportunity to profit on shorter term moves in the stock.
More Than One Way to Trade a Setup
Any setup will have several valid approaches that you could use. What’s important is to think about how a stock might move and what the absolute best way to approach the setup would be using the advice above.
You should think about what strategy would squee the most out of the setup you are considering and then put that into play.
Trade smarter like this and you will be very happy with the results.
AKA, “The Alpha Shark”