How do I use option flow to pick the best stocks?
I get this question almost daily… “Swaggy what’s the next big play? What stock is going up 20% tomorrow”. Brotha, I DONT KNOW, and even if I did I wouldn’t tell you. If your whole strategy relies on someone else picking stocks then you are already one step behind the game. Think about this, do you believe guys who are consistently making big money in the market are following someone else’s stock picks? I’ll go through a few techniques and reasons why I would enter a trade and how I manage risk, but when it comes down to it, you need to find a strategy that works well for YOU. Everyone’s risk tolerance, bankroll, and appetite for YOLOs are different. Find something that works and stick to your game plan.
There are a few ways to be trading/investing.
- Day-trading/Scalping: These are short-term plays and typically you close the day 100% cash, prepared to make completely new plays the next day. I don’t FK with day-trading too often unless I see a real great opportunity I’ll jump in, but for more of a swing trade than a day-trade.
- Sentiment/Momentum Trading: This can be a powerful tool to add to your trading arsenal. This technique is most effective for short-term trading (weekly outlook). Many times some bids will come through the option flow and you start to see tradable moves taking place as momentum builds.
- Position Trading/Investing & Swing trading: I added swing trading in there because personally I consider it to be more on the mid-term timeframe of trading. Swing trading is looking for technical setups in overbot/oversold markets (or whatever qualifying data you want to use) and entering a position on hopes of the stock price reverting back to the mean and then continuing with strong growth in the company. I use swing trading style to build positions in stocks I like at prices I want to get in at. It takes a lot of patience.
When you get away from the YOLOs and putting 50% of your account into one play, you will begin to see your account grow. Keep in mind everybody loses, even the smart money. Many times I’ll come across good DD and/or big option flow only to see the stock go in the opposite direction. Having said that, EVERYBODY LOSES, but the guys making money in this game are able to win more often than they lose. What I see far too often is traders seeing big option flow happening in a stock, the stock then rises after-the-fact from the option flow and traders FOMO into the play when the stock is already up 8%. They are shocked when the stock pulls back and they are left scratching their heads. At that point smart money as already entered and exited the position, the money was made. So for that reason, option flow is not always a crystal ball, if you use it as one you will lose frequently. If I had to describe option flow I would say it gives a level/entry point where momentum is initiated following a consolidation or a continuation in a trend.
How do I use option flow to complement my trading strategy?
I use option flow as a guideline and NOT a signal to buy or sell a stock. You never really truly know what’s going on under the hood of a trade, what other positions the MM or player has open, so entering positions strictly from option flow and unusual activity can be quite risky. What I look for is option flow accumulating for stocks I already own or are on my watchlist. If I see something that interests me and is perceived as bullish activity I will add to my position or enter a new position.
I’ll keep about 20-30 stocks on my watchlist, mostly tech, and time entry points when the stock dips to get in on what I perceive to be a good price in the next several months. Trading is all about finding a sweet spot when entering a trade. Keep a set of rules to follow for every trade and LOG your trades in an excel sheet. Log what your cost basis is, log the credit received from selling covered calls (if you are hedging), log when you average down. If you are holding positions long-term a log is your best friend in seeing exactly how profitable your position currently is. For example, if you’re holding shares for 6 months and you’ve sold covered calls against your shares 20 times, the log will help you identify exactly what your cost basis is for the shares. It’s easy to keep track of a trade if you are only holding for a few days to a week, for longer-term plays it’s common to lose track of what you opened/closed each covered call for. Instead of estimating and saying “eh I’m up about $800 after selling calls”, it’s good to know to the dollar what your return and/or cost basis is.
Use option flow to reduce noise in your trades, are big buy orders coming in? Has the stock been consolidating for a while? What are the technicals (not that I fully believe in many technicals)? Is it picking up momentum? Learning to interpret this information will bring you to the next level of a trader. If you think you can blindly buy some calls that expire next week to make 100% gains you will be in for a rude awakening. Get away from the ‘stock picking’ and more into understanding how order flow works. Learn and get better at reading this information in a way that can consistently make you money in this game.
Also, learn the options Greeks. Understand how much THETA you will gain from selling a covered call or a spread. If your covered call strike gets reached too quickly you should understand the risks of rolling out for a credit and how much you will gain/lose from rolling or closing the leg. Understand how to look at extrinsic value of the option and when to sell. These are things that in theory can be taught, but the best way to learn is by experience and paying very close attention to your plays.
What kind of trading plan should I make?
Imagine you worked at a business that manages risk to earn revenues, or say, sold insurance on extremely high-risk assets (similar to stocks). You would most likely be required to follow a strict set of rules before entering any new relationships or positions. If you failed to meet those requirements and you end up fucking up on a deal you would most likely get fired, right? When you trade, you should meet the requirements of a similar set of rules. This is what your trading strategy should include, an “entry point” checklist where you meet most or all criteria depending on the trade you are entering. Why are you entering the trade? What’s your price target? How much of the account are you risking vs how much can you profit? What’s your timeframe? What’s your exit strategy if the stock goes the other direction? At what point do you take profit?
Always have a plan. Are you trying to do this full time? Are you swing-trading for passive income? Dividend investing? Doesn’t even matter the size of your account, big or small, are you trying to double your account in 1 month with YOLOs? Or are you ok with growing a $10k account by $250 per week ($1k a month). Is $1k in your pocket per month something you will be satisfied with? $1k a month is only $45 gain per trading day. If you look at it on the daily scale it’s quite boring, but looking at it per month or per year you will see that anyone would take an extra $12k a year. Have a plan, find what your goals are and then figure out what it will take to achieve them.
How does Swaggy enter trades?
Know your watchlist: Keep your watchlist TIGHT. Maybe 20-30 stocks, watch them at least once or twice a day to see the price action. Not everyone does this full-time and honestly looking at the markets, watching every number tick for tick, for 8 hours a day is not good for your health. In my opinion, the most important times of day to watch your stocks is at the open 9:30-10am daily, then maybe once or twice throughout the day, and again before close looking for new setups and opportunities. These stocks should be fundamentally strong and a good mix of value stocks vs growth stocks so that you can sleep at night without watching futures and every bit of news. Also, you should know what is going on in the markets, use the SwaggyStocks economic calendar to see what potential events can affect the market. Is JPOW speaking? Are jobless claims coming out? GDP numbers? Retail sales? It would also be wise to understand how the markets react to interest rates, bonds, treasuries, precious metals, etc. A lot of those can be indicators on what the market is actually pricing in at the moment.
Stay away from the urge to FOMO into meme stocks: Traders see a MEME stock absolutely take-off up 50% in 4 days and then decide to hop in looking to ride the momentum. Typically that momentum slows down once retail/most traders figure it out. The people winning were the ones who got in before they even knew it was a meme stock. Of course there is a chance the trend will continue, but you should always figure out how much you are really trying to squeeze out of a stock. Are you trying to squeeze out 5% more to the upside with 20% risk downside if there is a reversal?
Lastly, before entering a position ask yourself where you see the stock in 1/3/6 months. Is there a better chance it will be higher in the next month? Or could there be a pull-back expected after a good run? Are you bullish on the trade, so are you entering with shares? Calls? Call debit spread? Put credit spread? I like to mix up my plays based on if I think the stock might consolidate for a month or two before going up. Your play should always allow you to make money if the stock stays flat as well as if it goes up. That’s why I will mix up buying shares, selling put spreads (without tying up too much capital), and entering diagonals (buying long-term calls with selling short-term calls similar to a covered call). As an example, I entered a WMT (Walmart) position 2 weeks ago, the stock was at around $132 and I sold a put spread instead of buying shares. Why? Because Walmart typically moves like a snail in either direction, so my bet was that Walmart would stay above $132 in 4 weeks time when my spread expires. Here I am gaining on the stock not moving at all, or the stock going up. I thought to myself Walmart had good earnings, Walmart+ will be a driver of growth, and as Walmart further develops their online brand, that would be bullish for the stock. Also, WMT is pretty fundamentally strong and not going anywhere, so the PUT credit spread allows me to collect on some THETA and the stock inching it’s way up. Today, at the time of writing, some bullshit TikTok news was released that WMT was making a bid for and now my spread is at 90% gain, easy $500… BUT this position was slightly underwater for the last 2 weeks, my position sizing and confidence allowed me to hold without really worrying about what was going to happen. I could have rolled out, but I didn’t feel the need to. Even though the position was in the red until today, I only needed WMT to gain a $1.50 for my spread to close 100% profit.
The fact that you are in stock forums, finance Twitter, or wherever (no trading discords pls) shows you are already one step of the game and will be in the know of any new stocks that might be become hot/trending. Play the long game with investing in the market and your account will grow faster than trying to make multi-baggers or 100% gainz quickly.