Increase Your Trading Profitability By Using the “Rule of 3″
One simple trading secret – known as the rule of three – could significantly increase the number of profitable trades you book. If you want to add this powerful strategy to your trading toolbox in 2010, I suggest you read on… I’ll tell you exactly what steps you need to take to implement the rule of three on your next trade.
When putting together a binary option portfolio strategy, we confront one of the most important factors for success: profit control. That is, how do we maximize our profits without exposing ourselves to maximum risk? That’s where the rule of three comes in.
The number three represents a universal idea of completeness. For example, one of the most stable structures is a tripod. The third leg gives it the stability it lacked with two legs. In trading and technical analysis, three points of confirmation are considered necessary to provide confidence for drawing a trend line or confirming an entry or exit.
Now let’s apply the rule of three to weekly binary option plays.
My rule is, put on three contracts for each binary position and assign a different profit target for each.
By entering three binary contracts for a trade, you automatically create a managed exit strategy. This is very important, because the returns in our binary plays can be substantial, but they are not linear. In many cases, our Monday entry becomes profitable on Tuesday or Wednesday because of a surprise news event.
Having three separate contracts gives you the ability to ride this surprise sentiment wave and lighten up automatically if the price hits the first lower profit target. In this case you have one or two binaries left to ride a bigger move. I think taking profits earlier on some of the positions is prudent since there is no guarantee that the rest of the move will continue our way.
Where should you set the profit target for each binary? I have two variations for you.
One strategy is to set the first binary’s profit target at 50%, the second at 100% and the third at 300%. In other words, sell if your first binary gains 50%… sell the next one if it doubles… and sell your remaining binary if the price jumps 300%.
The logic behind this is that once a binary option play goes through a 100% return, the sentiment momentum is very much in our favor and is likely to continue through expiration. These profit allocations also help you capture a big surprise without watching if the market makes a 300% move (which it can easily do in our five-day options).
A second strategy is to leave the third binary without a profit limit. It allows us to manage the last leg and fulfills a deep psychological desire to engage in the trade! It is important to remember that we can also close any or all of the positions at any time.
So, how can you put this plan to work for your own portfolio in the New Year?
If you haven’t already, take a look at my tutorial on binary options in the Penny Sleuth. In it, I break down exactly how these exciting investments work. I also tell you where you can go to open a demo trading account. Basically, this account lets you practice trading binary options without putting your real cash on the line prematurely.
When you place your first demo trade, aim to put on three trades – one where you sell at 50% gains, one where you sell at 100% gains, and one where you let your profits ride to 300% (or more, if you opt to take my alternative approach).
Obviously, it’ll take some practice before you’re able to consistently pick winning trades in the binary world. The good news is that you can practice with no risk – and the trades are short enough in duration (just a week) that you can keep working at it quickly.
I am back-testing a lot of variations of profit-taking strategies and will let you know if others are more promising!
December 23, 2010
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