Turning pattern recognition into a strategy

Recently I wrote a newsletter outlining the similarities fishing has to trading. I’ve linked the newsletter a little further down, but here’s a hint — it’s all about identifying high probability patterns and then executing with a strategy that fits.

We talked about the importance of learning and recognizing high probability patterns. But there are so many out there, so once you have one, you have to know which options strategy you want to use to trade it.

Here’s how to begin selecting the right strategy…

Selecting Your Strategy:

In options trading, it typically boils down to which options strategy you’ll use. Most traders begin by learning how to trade long calls, and then slowly gain expertise in others. Well-rounded traders should eventually know how to shift through varying strategies on the same setup. 

Some of my favorites patterns?

Last week I told you about how when I went fishing initially for ‘fish,’ I was unaware of which fish I was looking for to begin with, but I also had no idea how exactly to catch one. Once I identified the type of fish I wanted (catfish!) and learned where they hide, I was a step closer to catching one. However, I needed more than that — I needed the right rig and bait — the strategy! Here’s that link to the newsletter I was talking about too.

Five Star Hint: In the webinar last week, I went through my top setups — and gave traders all my top tips and tricks for trading them with small accounts. If you missed it, you can watch it again here.

A Five Star Setup:

Let me dive into one of those favorite patterns I mentioned a little higher up…

Let’s say I’m looking at a move in Microsoft to the $220-225 price point because I have a Five Star setup. 

Microsoft (MSFT) – Daily Chart 

Here’s a picture of the Fibonacci setup on MSFT, along with the key resistance zone and overhead target. I alerted Mastery members to a stock buy on MSFT on the dip to $200, and now I’m eyeing an options trade for the move into $220 which I’ll post for members to see as well. 

The next step is how to take pattern recognition and turn it into a strategy.

My Top Strategies:

Long calls — This is my favorite strategy to use when I have a really high probability setup, and I can get them within my risk parameters. On MSFT, long calls with 30 DTE will cost about $10.50 per contract. That’s within the parameters for my large account, but not my small account. For traders trading with a $5,000 account, this would really be stretching it, and I typically go to a cheaper strategy in this instance. I do like this choice here, it just depends on your allowable risk! 

Credit Spreads — On bullish strategies, I like selling put credit spreads, but again I like to have a solid risk to reward. Typically, I want to sell them for about a 1:1 risk to reward ratio. If I can’t get the spread for that credit, near key support… I pass on it. In the case of MSFT, I’d like to sell credit spreads near the 34 EMA or the 50 SMA. As price is up on the 8 EMA at this time, I’d prefer to wait for a pullback for this trade. Why? Because credit spreads are the highest probability when sold at key support levels. As such, I wouldn’t select a credit spread right now.

Butterflies –– I love using butterflies on a trending setup, especially on one with expensive long calls like MSFT. This can bring down your cost basis substantially, as well as give you the opportunity to hold through ups and downs (should they come in the market). 

I can get a bullish call fly targeting $220 for $2.69, instead of buying the long call for $10.50. That cuts my risk in a third! I love a butterfly in this instance. It fits great with the setup, I love the risk, and the risk-reward. 

Whenever I find a solid setup, I always go through what I call my ‘Strategy Selection Risk Gauge,’ and determine which options strategy I want to use to trade it.

What does yours look like?

P.S. If you’re unsure, this is something I teach in my Mastery!

And just a reminder… August 26th is the last day to be grandfathered into my Mastery before prices increase.

If you want more information on “what” exactly my Mastery is, catch my webinar here where I explain it.

4 thoughts on “Turning pattern recognition into a strategy”

  1. Hi Danielle

    I saw your movie about the tick reading and I’ve read john’s book. Allthough, I’m using tradestation and I’m added the index ‘tick-nyse’ but I never see ticks higher then 600 and lower then -600. Can you point me in the right direction what I’m doing wrong?
    Kind regards
    Peter De Coensel

    Reply
  2. Great article. Like the detailed strategy. Helps tounderstand your reasoning and methods one one strategy vs the next .

    Reply

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