Trading has become increasingly popular over the last few years and it’s largely thanks to innovations in technology and the ease of access for each market. There are many different types of trading, but options have gained traction recently because of the flexibility they grant. However, rookie investors tend to make costly mistakes, which is why we’ve listed them here and suggested ways to avoid them.
Trading Without a Plan
Trading plans are designed to steer your decisions by codifying your financial goals, risk tolerance, and trading strategies. Having a solid plan is essential for remaining disciplined and objective while making decisions.
To stick to a plan, you need to learn how to follow your strategy in the face of loss and substantial profit. We also recommend reviewing your plan regularly to make sure your financial goals are still the same, and that your strategies are still aligned with them.
To help devise a plan, you’ll need to consume plenty of educational content including books, blogs, websites, courses, and podcasts. A great choice is James Cordier’s complete guide to option selling, which is written by a professional investor.
Many options contracts involve leverage, which allows traders to make investments far beyond their available balance. If the trade works in your favor, the profits for a high-leveraged contract can be enormous. However, if the market moves against you, the loss could wipe out your entire trading balance.
Managing risk is essential for all types of investing, but it’s especially important when it comes to options trading. Options contracts use leverage, which means the losses and gains are amplified. This is why you must learn how to protect your account balance. Fortunately, there are many tried and tested risk management strategies you can implement, including:
- Stop-loss orders. This feature allows you to set an automated withdrawal once a set level of loss has been reached.
- Position sizing. This is the amount of money you can afford to spend for each trade; your account balance and risk tolerance will help decide.
- Diversification. Don’t back just one horse. Explore different markets and assets.
- Limit orders. To help earn profits on favorable trades, limit orders let you buy security at a set rate.
The value of an option deteriorates over time, meaning it shouldn’t be held for too long. The closer to the expiration date, the less likely it is to move in the trader’s favor. For example, if you buy a call option on a stock with an expiry date of one month, the option is worth more if the stock value increases. However, when the price falls, the option will be worth less. If options aren’t in the money when expiration comes around, it’s essentially worthless.
Rookie options traders make these mistakes more times than not, so learn from the failings of others to make sure your journey is much more successful. You will always suffer loss at some point, but that’s okay if you can manage risk effectively.