5 Options Trading Mistakes You Can't Afford to Make

The discipline required to be a successful options trader

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    MISTAKE #1: MISALLOCATION, OR ALLOCATING TOO MUCH CAPITAL TO SOME POSITIONS AND TOO LITTLE TO OTHERS

    Dedicate a fixed percentage of your capital – not a fixed dollar amount – to each trade. Invest no more than 10% of your capital into any one trade. For option buying, reduce that to 2-5% per trade.

    Use the fixed fractional bet system (from New Thinking in Technical Analysis: Trading Models from the Masters). Every trade is a set percentage of your account. Lets you put more money to work after winning trades – leverage your upside to the utmost – while simultaneously conserving capital after losses.

    Only buy the number of contacts you can cover with your fixed allocation percentage, don’t go for “cheaper” deeper out-of-the-money options just to buy more contracts.

    MISTAKE #2: THINKING THAT HIGH WIN-RATES CORRELATE WITH A PROFITABLE OPTION BUYING STRATEGY

    This mistake can also be phrased as the failure to understand the relationships between winning rates, average return on winners, and average return on losers.

    For example:

    (40% win rate *  85% average winner) – (60% loss rate * 40% average loss) = +10%

    Is much better than...

    (65% win rate * 30% average winner) – (35% loss rate * 60% average loss) = -1.5%

    Win rates aren’t more important than returns. You need big winners and managed losers. BIG WINNERS ARE CRUCIAL.
     
    With the power of convexity working for you, win rates are far less important than average winners and average losers when it comes to portfolio growth!
     

    MISTAKE #3: NONEXISTENT PORTFOLIO DIVERSIFICATION

    One of the greatest things about options is that you can profit in any type of stock market environment including trending, choppy, flat, straight up, market crashes, etc.. The best traders understand the importance of options trading portfolio diversification.

    No single options strategy works in every trading environment.

    Always aim to include a mix of calls and puts among your open positions, with exposure to a variety of different areas of the economy.

    Diversification provides protection and eases the fears that can prevent some options traders from being successful.

    MISTAKE #4: LACKING DISCIPLINE AND LETTING EMOTIONS MANAGE YOUR TRADING DECISIONS

    We get it, we're all human here. One of the biggest mistakes options traders can make is not eliminating fear and greed, the two deadliest trading sins. Paper trading is one way to get started without the emotional attachment to real money.

    FEAR makes traders close out positions before they reach their full potential. Train yourself to stay the course! Options trades can turn around in an instant – don’t panic-sell at the bottom when the fundamental case for the trade hasn’t blown up and key support levels haven’t broken down. Set profit and loss targets and stick to them!

    GREED makes traders take unnecessary risk that does not increase their profit potential. Set logical trade management rules or every trade. Don’t take profits for the temporary thrill of adding a few dollars to your trading account. And don’t hold on to trades for “just a few more points” and find yourself overstaying the trend.

    MISTAKE #5: TRADING WITHOUT AN EDGE OVER YOUR COMPETITION

    Are you trading off the same indicators everyone else uses? You’ll just end up in crowded trades.

    Our in-house experts measure investor sentiment, options pricing & volatility, and unique technical quirks of thousands of individual stocks. By combining technical, fundamental, and sentiment analysis, we have been able to uncover countless home-run winners for more than 4 decades!

    The secret? SENTIMENT. Including quantitative and qualitative metrics to measure how bullish or bearish the prevailing attitude toward a given stock/sector. This gives you the most holistic picture of Wall Street’s mood.

    Finally, be sure to check out our latest presentation on Options Trading Mistakes to Avoid in 2022:

     

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