The 6 Most Dangerous Options Trading Errors
Have you ever lost money trading options before, or has someone told you that options are a losing game? That is probably because the methods being used to trade options were faulty or overly simplified. My mentor Conrad identified the follow 6 reason why the majority of option players fail to make money.
1 Inappropriate selection methods
Selecting the right stock (and the best corresponding option) is the first step in successful option trading. Some option traders will take a situation they just read about in the news as an option play. Others tend to look at longer-term measures like a stock’s valuation as an indication of its short-term potential. This mismatching of time frames is one of the biggest mistakes made by those who trade options. My staff and I sort through the entire universe of stocks with listed options, in order to pinpoint only those situations that look most attractive for sharp movements. The Option Advisor uses a methodology based on not one, but all of the key short term factors that drive stock prices — technical, fundamental, and sentiment.
2 Betting against trends
Trends in prices, whether up or down, have a tendency to last longer than people expect. Most traders lose the bulk of their money betting against trends. I’ve specifically developed my indicators to tell me not only the nature of the trend, but also the investing public’s view of the current trend. What I’ve found is that a prevailing disbelief of an existing trend gives a confirmation that the trend will continue, since there’s money on the sidelines that will eventually be convinced to buy into the trend before it ends. Thus, my approach in buying options with the trend allows you to trade on the right side of the market.
3 Inability to take a loss
Sure, everybody loves to hear about gains and profits, as this is what we all seek to achieve. While “loss” has negative emotions attached to it, the key is not to be emotional in trading, but rather to stay objective in all trading decisions. If the market is not validating my analysis, I have specific exit rules that get my subscribers out of option purchases before their expiration, so that big losses are often avoidable and capital can be preserved for future trades that are likely to be more profitable.
4 Lack of discipline
Many option traders fail because even when they do have gains, they let them slip away by not knowing when to get out and take a profit. Often, you should be taking a profit when the position is moving most obviously in your favor. What I’ve been able to teach option traders is that a mechanical system for entry and exit prices must be in place before the trade is initiated. I pre-determine the highest price that should be paid to enter the option, and the subsequent price that, when reached, will automatically force profits to be taken. This allows traders to prevent profits from slipping away, and enforces the discipline necessary in any successful trading approach.
5 Poor money management
Every smart option trader knows that even with a winning approach, money management is crucial in building an account’s value. The primary consideration is how much to invest in each trade every month. Often, amateur option players come into the business and make some nice gains right off the bat. Then, thinking this is a simple way to riches, they let all their capital (including all their profits) ride on a subsequent trade that wipes them out. Then they vow to never trade options again. The answer here is to first know the rules of the options game: there is great upside on winning trades, while you can also lose all of your investment in a particular option trade. Clearly no matter how good your approach, you will never win 100 percent of the time, and you should not allocate all (or even the majority) of your trading capital to any particular trade. How much do you invest? Each month, I tell Option Adviser subscribers how much of each portfolio’s cash reserves to devote to the recommendations in a particular newsletter.
6 Consensus thinking
Amateur traders tend to bet with consensus thinking, which is a sure way to lose in option trading over time. Whether it’s an article in a national publication, a hyped new product or a “tip” you’re betting on, Wall Street has a way of already discounting such news before it becomes widely disseminated. By that time, smart traders are looking for opportunities to bet opposite from the conventional wisdom. I’ve learned that you can use options very successfully in contrarian bets. Understand that a contrarian does not always “zig” when other say “zag,” but rather looks for extreme viewpoints that are apt to spotlight the key turning points in stock prices. That’s what defines true contrarians, and that’s a major reason why I’ve been so successful for those who subscribe to the Option Adviser.
By Conrad - (My mentor)
