When I was a child, my parents read me a bedtime story that gave me nightmares for years. It was called, “Rusty in Orchestraville.” It had no monsters, no witches, no violence of any kind, but it terrified me. It was the story of a boy who loved music, but could never decide which instrument he wanted to play. Every time he chose one; he started to worry that there was another, better instrument for him out there. He kept abandoning each choice to pick up something new. As an old man, he realized that although all his friends had become great musicians, he had let his opportunities slip away from him because he was unwilling to make a decision. I understand Rusty’s anxiety. In many areas of our lives, picking one thing feels like closing a door on so many other options. This phenomenon can trip up your trading just as easily as it can any other area of life.
The more alternatives there are, the more paralyzing it can be. As an Options Animal instructor, I often see this scenario played out when we asked students to create a limited watch list of equities and concentrate their trading on that small pool of companies. One of the most important tenants of the OA methodology is that students should develop and maintain a watch list of good companies that they analyze and become familiar with over time. We maintain that it is far easier to make money on a company whose fundamentals and technicals are familiar and whose typical behavior is known, then it is to profit from a random stock chosen from a sort or scan of the market. When you know how a company reacts to news and earnings, you are not taken by surprise. You can anticipate its movement and profit or protect yourself as needed. Moreover, when you are familiar with a company’s fundamentals, you are far less likely to panic with dips and downturns. You are far better equipped to interpret and make use of news when it comes out. The only way to know if a pull back is a danger sign or a buying opportunity is to really understand the company itself. For all these reasons and so many more, we encourage our students to build a watch list over time and concentrate the majority of their trading on those companies.
When students seek help building a watch list, their questions often seemed tinged with anxiety, as if they can’t bear the thought that in limiting their trading universe, they may be giving up some yet to be discovered, amazing opportunity. They obsess about getting the list “right.” What if the next great explosive stock is not on the list? I want to try to ease that lingering watchlist anxiety. The purpose of the watch list is not to forever limit your trading possibilities, but to narrow the range of equities that require monitoring and due diligence. It is a starting point, not an end point. My own watchlist continues to evolve over time. Some equities have come off the list as their characteristics have changed, or they no longer suit my trading style. New equities can join the list. I am happy to research companies suggested by my fellow coaches and students, as well as companies that I learn about through other means. If they have fundamentals I like and good option chains, I add them. I begin trading them in a small way at first, and as I become comfortable with them over time, I may increase my allocation. What I do not do, is scan the market for good chart patterns and place trades on companies I only know by ticker symbol.
Besides the fact that that kind of opportunistic trading never worked well for me, the style of trading that I practice and now teach, does not require me to catch the next explosive move. I can trade an equity up down or sideways as long as I understand it well enough to develop a reasonable expectation of its short and long term behavior. Some of my most profitable trades have come from stable and unglamorous stocks such as Walgreens, Proctor and Gamble, Microsoft and Ebay. Far from missing opportunities, by limiting my trading universe to a smaller number of stocks that I can really monitor, I am far better able to catch the opportunities when the arise.
Finally, and I cannot stress this strongly enough – students, whether at Options Animal or elsewhere, should paper trade as they learn. The watch list you develop as a student is for practice. Its purpose is to let you develop skills in fundamental and technical analysis and give you a pool of equities to practice new trade structures. Don’t let the idea of limiting your trading possibilities paralyze you. Start with a few companies you know. Try to pick a few with different volatilities so you can practice trades that work on calm and volatile companies. Take suggestions from your teachers and fellow students, from the news and headlines or just use the companies you interact with on a daily basis. Above all, remember that these are not final choices or set in stone.