Data-Driven Strategy for Trading Stocks & Options
How it works
The unusual option to make money works by analyzing large data sets to find high probability of profit trades in the stock market. When people buy or sell stocks or options, a trove of data is released to the public. Large volume data sets, also known as Big Data, are like treasure chests, full of information about the investment decisions of everyone trading in the stock market. To fully understand the data, high-level data science techniques and artificial intelligence (AI) algorithms can be used to conduct predictive analytics.
To successfully invest and trade like the rich, we need to first identify the trades made by wealthy people within this large dataset by filtering out the trades of everyone else in the stock market. One of the initial steps in this filtering process involves the statistical analysis of options trade variables, such as volume, open interest, option greeks, stock price relative to options strike price, expiration date, bid-ask spread, implied volatility, and the total cost of the trade. For example, a trade with a cost of $1 million dollars is more likely to have been made by a wealthy investor, than a trade that only cost $1,000.
After the data is identified as an outlier, also known as unusual option activity, it must be further analyzed with other market variables to determine the strength of the directional bias in the options trade: up (strong/weak bullish sentiment), down (strong/weak bearish sentiment), or sideways (neutral sentiment). Understanding all of this helps us develop and align the best trading strategy in the same direction as the wealthy investor, in order to follow the rich to get rich.
Finally, we analyze many other historical data, including the risk to reward profile of the trade in question, to get inside the minds of the wealthy investor by interpreting the trade psychology and meaning behind their investment & trading decisions. This allows us to confirm whether the result of our data analysis fits with the whole picture as to why the wealthy investor made this trade in the first place. Was this investment for long-term capital appreciation? Or generating cash flow for current income? Or for capital preservation to protect their wealth? Or speculating on stocks for high profits - perhaps even based on insider information? Since extreme market emotions of fear and greed are at the basis of the latter two investment objectives, preservation and speculation, they have the most potential to move stock prices, so we generally focus our analysis on these type of investment trades.
Capital Preservation Trades, or Hedge Trades based on Fear
Wealthy people have a lot more money to lose, so they have to protect their wealth by hedging with trades for capital preservation. Basically, trades that serve as a hedge are like insurance policies, reducing the risk of loss. Hedge trades do this by betting on the opposite direction of the main trade (what the rich truly believes will happen to the stock price). Thus, it is very important that we accurately interpret unusual options, so that we DO NOT follow hedging trades of the rich, as our main trade direction - one of the most common mistakes in the unusual option to make money.
Fortunately, hedging trades usually fit a pattern, which our analysis can identify early on so that we can avoid this typical mistake. However, this is not to say that hedge trades are without merit. We find value in identifying hedge trades because this data not only helps our decision in opening trades, it also helps in managing and/or closing our trades to reduce risk or take profits. For example, when a wealthy person/institution hedges their stock trade position, which limits their profit potential because hedge trades cost money, this begs the question why the rich is currently worried or fearful about their stock investment? The rich do not always sell their stock investments when they believe the stock price will be going down because they may have to pay high taxes if they closed their stock position. So instead, they open new hedge trades that are opposite in direction to their stock positions. Hence, we can use their insights of the upcoming stock price movement to our advantage by including hedge trades into our trading strategy.
Speculation Trades, or Insider Trades based on Greed
While speculation trades are very risky, the rewards in profits are considerably higher, attracting the interest of many people, including the rich. One of the most popular quotes in the world of investing is: "Don't risk more than you can afford to lose." This inherently means that wealthy people can risk more because they can afford more. Additionally, when they make speculation trades, the risk is usually lower because the rich have more access to decision-making information with their vast resources and networks. That is why when they make speculation trades, we can leverage their decisions into our trading strategy to also reduce our risks, while maintaining a high-reward profit potential.
While the irony is that the rich do not necessarily need to get more rich by taking risks, the rich are still humans - driven by greed, the basic human emotion that often leads people to do illegal activities, such as insider trading. Numerous cases of insider trading, from the historical Martha Stewart case to more recent cases, show that people consistently engage in these unscrupulous activities. When they illegally use non-public, insider information to make trades in the stock market, their trade data becomes public information, which is then legal for anyone to use. Our ability to analyze public data to identify insider trades is a very powerful strategy to follow the rich to get rich.