Take Your Trades to Obedience School

The financial markets cycle through many phases of opportunity and danger. With this in mind, it doesn't make sense to trade a healthy uptrend or persistent downtrend using the same strategy as a choppy or uncertain market. Collaring recognizes these behavioral shifts and adapts the trading strategy to match short-term risk characteristics.

At its core, a trade collar is just like the one you stick on your dog to keep him in check. Put the market on a tight leash when risk is high and opportunities are tough to find, and conversely loosen the collar and let your positions "run free" when the market is trending sharply, with the single-minded goal of getting from one level to another

The collaring process works best when traders make small adjustments each morning in response to that specific day's reward/risk profile. But longer-term collaring is just as important in building the right exposure to major position trades and even multiyear investment portfolios.

The collar signals when to let profits run and when it's the worst thing you can do. It also defines the right instruments to trade at any point in time. For example, go ahead and play volatile small-caps when the collar is loose and the market is printing money, but then stick with slower moving blue-chips when visibility is low and whipsaws are the rule of the day.

Applying the right collar in a particular session goes well beyond simple index analysis. For starters, is the pre-market setting up a big gap against your open positions? Losses incurred by overnight movement require a defensive collar even if everything else is firing on all cylinders. In a nutshell, the glowing red numbers that morning are saying that you're wrong about the market.