The best book on trading stocks and options
by Jeff Bailey
I'm just learning how to trade options and would like to know
your thoughts on any good books to read on the subject.
I've given this great thought, and the book I'm going to
recommend cost's just a little over $3,000.00.
After you understand the ULTIMATE basics of price fluctuation and
understand what truly drives stock and index prices, then I've
got a very good technique for learning how to trade, where the
price of this education is LIMITED and need not be as expensive
as it may have been for some of your friends, when they "learned
how to trade."
The second-best book I've ever read on trading is Tom Dorsey's
"Point and Figure Charting," which give the trader/investor the
ULTIMATE understanding that all that really matters when
considering price fluctuation is supply and demand and how to
understand and measure MARKET/SECTOR/STOCK risk/reward.
I'm not here to sell books, but OI does offer the book in our
The BEST BOOK on learning to trade stocks/options is the one that
I've been writing over the years. It's not on paper so to speak.
You can read different chapters in the Bailey's Basics and here
in the Ask the Analyst section of the site. However, the best
book you will ever read on trading is the book that YOU write, or
at least learn on your own. You know the saying, "you'll never
learn unless you try." This is so true.
For many, "learning" to trade with your own money can be scary.
I'm not knocking a college education, or spending money on books,
seminars, etc. as I've learned a great deal when I went to
college, but no matter how "book smart" we become, it does little
good unless we learn on our own when applying all that we've
I dare say, that I've learned some things over the years from
books, college education and seminars, that when I've tried to
practice them, just haven't worked out like they were supposed to
from the teachings. Guess what? I don't use those "teachings"
I spent a full semester in college going through income
statements and balance sheets to try and determine a company's
value. What I learned in life, is that the value I might apply
to that company may not necessarily be in agreement with what the
MARKET places on the company. My value might be too high, or it
might be too low. What I did learn is that while I might be able
to look at a company's fundamentals and even project how they
will look in the future, it was much easier to test that analysis
against a stocks price over time, and see if the MARKET thought I
was too bullish, too bearish, or was in agreement.
Then I began to learn that it doesn't matter what I think about a
stock's fundamentals or valuation. All that matters is what the
MARKET thinks. And what the market thinks will show up in a
supply/demand chart, or other types of charts.
So lets suppose you've read Tom Dorsey's book on point and figure
charting, and begin to believe that even though company ABCDE has
a price/earnings ration of 10, and has been growing the bottom
line at 20% the last two years, its the excess of supply
(selling) that has the stock down 30% in the last four weeks that
begins to hint that something is wrong with the stock.
This is a lesson I learned years ago, and it wasn't from a book.
It was from personal experience, and being long a stock with
"excellent" fundamentals, quality management and superior product
that traded at an extreme discount to the broader S&P 500.
For many traders, learning how to trade isn't necessarily a
profitable experience when you first start. Yuck! That's a
scary thought isn't it. But that shouldn't be a deterrent or an
excuse to not begin trading.
When first stating out, "paper trading" is a good way to begin
learning. You know, the imaginary type of trade where you write
down on a piece of paper how many shares of stock you bought at
the price the stock was trading. Then, if the stock hits your
target or stop loss, you'd record the winning/losing transaction
and move on to the next trade.
However, the one thing paper trading doesn't allow the trader to
experience is the human emotions that only come from having REAL
capital at risk. Paper trading does not, in my opinion, expose
the trader to emotion as you know that you really don't have any
capital at risk, and when there's no emotions coming into play,
you can easily stop out a paper trade for a loss, don't feel all
that bad, and can simply move onto the next trade, try and apply
what you just learned to the next trade and try an not make the
same mistake again.
For traders learning to trade options, here's a technique that I
think will help a trader LEARN on their own how to trade options.
Find a stock that you like or at least believe has a viable
longer-term future that trades between $20 and $25. Open a
trading account with $3,000.00, then buy 100 shares of the stock.
This would have your cash outlay being between $2,000 and $2,500.
I paid for my own college tuition and can't remember now what the
cost of tuition was for a semester, but I think it was more than
From this point on (date of purchase) you will never sell this
stock. The only way you can keep from losing the $2K to $2.5K is
by constantly trying to protect your positions with a PUT option,
when it appears the stock is vulnerable to price depreciation.
You will NEVER buy a call option, as the underlying 100 shares
always has you long the stock.
The reason a trader might want to "learn" to trade by buying a
stock and not shorting it, and using call options to protect the
short positions, is that with a short position in an underlying
stock, your risk can be UNLIMITED, especially when/if you didn't
have a call position established.
By being long the stock, you the trader understand the most you
can lose in this trade is between $2K and $2.5K or the $3,000.00
you started your account out with.
Believe me. I know a few "investors" that used to be traders
that learned they didn't have the discipline or the knowledge of
how to trade stocks or options and it cost them MUCH MORE than
$3,000.00 to find this out.
If you think about it, lets say you lose on all of your put
option trades when attempting to "hedge" the $2,500.00 long
position in your account. How could a trader lose the remaining
$500.00 in his/her account on put options?
There are two ways and here is where your first lesson would be
You were buying OUT THE MONEY put options and while your
underlying stock position may have declined (or stayed
unchanged), it didn't decline enough to have the option gaining
in value by the options expiration. Lesson learned: Buying out
the money options is a lower probability of success trade,
especially if near-month expiration is used.
The second way you might lose the remaining $500.00 of the
account, is that the underlying stock you chose, was simply a
strong stock where demand was always sufficient enough to keep
the price rising. A good stock picker (stock you bought for
$2,500 and now worth $30.00 or $3,000) may learn ($500.00 loss in
put options) that they've got some further learning on how to
properly select options. But hey! If I could have only learned
to trade options for $500.00 with REAL money, I could have saved
myself from stress when first starting out.
Another lesson you will learn is that it is BEST to BUY TIME in a
put option. Traders that buy too little time find that their
options trading becomes DICTATED to by expiration, in that they
are making decisions as it relates to expiration, on not based on
the underlying stock's price action. There's nothing worse that
holding a put option on a stock that looks to be on the brink of
a potential major decline, only to have to close that put option
out because the risk of a slight rebound in the stock's price
ahead of expiration could have current profits in the option
being eroded rather quickly.
When you buy time on an option, it allows the trader to make a
decision on closing out the option ONLY as it relates to the
stock itself. If the stock looks to have stabilized at a price
you had hedged it to, then the option can be close out, but the
decision was based on the stock's price and not the options
At the end of 6-months, you're going to have an idea if you've
"passed the course" or not. If at the end of 6-months, the
bottom line of your $3,000.00 account is anywhere close to break-
even, and the stock you bought at $25.00 is $25.00 or lower, then
you've got a passing grade and have probably LEARNED how to trade
options profitably. If your account value is ABOVE $3,000.00,
the you've graduated at the top of the class! However, if you're
account is down more than $500.00 at the end of 6-months, then
keep educating yourself and keep learning! Don't give up! NEVER
give up! But make the decision yourself if its worth adding
another $500.00 to the account to keep learning.
Here's a novel idea for even more experienced options traders.
When you look at a stock's chart and begin to contemplate a call
or put option on a stock, try putting yourself in the shoes of a
trader that owns 100 shares of that stock (for put option buyer)
or is short 100 shares of stock (for call option buyers, either
at the level it is trading at right now, or a level just before
the put option SHOULD have been bought to have provided the
ULTIMATE protection from the hedge.
Let's face it, if a stock looks like its already made a
substantial move from an IDEAL action point, then this
observation could influence just how much money you expose to the
trade at a given point.
If you look at a chart and think.... "Ugh! This stock has fallen
too far in recent sessions to really have me looking to hedge it
at this point," then it may just be that you should either wait
for the stock to rally back to the "hedge level", initiate just a
partial position in an IN THE MONEY put option (that you could
add further to should the stock recover from an oversold level),
or just move on to another opportunity.
I'm a strong believer in also knowing or understanding how to
trade STOCKS from the short or bearish side. A good way to LEARN
how to trade a stock from the short side is to use a CALL option
as insurance while you're learning to trade a stock short.
Remember, OPTIONS were "invented" as a tool to HEDGE risk. They
were not "invented" as a tool for SPECULATION!
I strongly believe in education through books, subscriptions and
seminars as there is going to be something that "hits home" with
your belief system and can be successfully incorporated into your
trading discipline, but the BEST BOOK you'll ever read on
stock/options trading is the one YOU end up writing yourself.
And to write this book, you're going to need to RISK real
Hopefully the technique of buying 100 shares of a stock that is
priced between $20 and $25, and using a put options contract to
hedge that positions when deemed necessary will be of use.
As outlined above, the MOST you could lose is a little over
$3,000.00, but it the BEST book you'll ever read and learn from
on how to trade options. Again, I'm not here to sell books, but
here's a link to our bookstore where you can find Tom Dorsey's
Point and Figure Charting book.
Please send your questions and suggestions to:
Click here to email Asktheanalyst
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