Top 10 Option Trading Tips

Option Trading Tip #5

My top 10 call and put option trading tips that I have learned, and that you MUST know before you start trading calls and puts.

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Trading Options Tip #5:

When trading call and put options, the underlying stock's trend is your friend. Don't fight it!

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The Trend is Your Friend is a popular axiom that both stock traders and option traders live by. If the stock is in an uptrend, then don't fight it and expect the stock price to continue to go up. Likewise, if the stock is in a downtrend then don't try to pick the bottom--expect the stock price to keep going down. Because trading call and put options is all about guessing the direction of the underlying stock, option traders MUST identify the stock trend before trading options.

The saying The Trend is Your Friend is a guideline, and not a hard fast rule. What it means is that all other factors aside, expect the stock to continue moving in the direction that it has been moving. Just like a any moving object has momentum, stock prices have momentum too. Obviously, major news events and earnings releases can make the stock price move in the opposite direction instantly, but without insider information my bet is always with the trend.

I generally find it more successful to jump onboard the rallies and follow the crowd than to try to call the top of a price rally or try to call the bottom of a downtrend. When you see a stock is in an uptrend, most amateurs will think "the stock has gone up too fast and it must fall" but the reality is with stock price movements momentum is a wonderful thing. Don't try to pick the top of a rally or you will usually lose.

Likewise, when a stock is in a downtrend, most amateurs will think "the stock has fallen so much so fast that it must be ready for a bounce back up. But beware of trying to catch a falling knife, you will usually get cut and bloody. Follow the trend and buy puts on stock prices that are falling!

Remember that The Trend is Your Friend, resistance is futile, and momentum can be a powerful ally when you are trading options. I usually find it more profitable to follow the crowd then to swim upstream!