5 Things Every New Options Trader Should Know
Don’t Become Overwhelmed by Markets!
Trading Stocks and Options?
The year was 2013, and I thought I was a genius after making a few hundred bucks here and there trading cheap biotech stocks. I was a clueless retail trader scanning Yahoo message boards for penny stock tips and biotech catalysts not long after opening my trade account, thinking I’d find an edge. While doing research, I kept seeing people talk about options trading, and they often showed some ridiculous gains. I watched a couple YouTube videos, configured my account for options, and bought my first call option on Bank of America. I was up 30% in an hour! And, from that point I was hooked.
I spent a ton of time learning about option trading strategies, and I still do! Markets are constantly evolving, and so are the strategies used to protect and build wealth. After spending years in the game, these are five tips I think every new options trader should hear:
- Do Not Believe Your Own Hype
- Large Positions Trade Different Compared to Small Positions
- Catch Yourself Falling Prey to the Major Trading Fears
- Start with Simple Strategies
- Do Not Chase Green
Do Not Believe Your Own Hype
Myself included, I’ve seen tons of people hit a big win trading options only to give it all back within days or months. The problem is, after finding some success people tend to think they know what they are doing and start to take bigger risks. Eventually luck runs out and inexperience managing money catches up. The account blows up.
One time I fell prey to this trap, I was trading Electronic Arts (EA). The stock price had just tanked after poor earnings and I managed to make a few bucks off a short squeeze days later. As a long time gamer, I foolishly felt I knew the industry and thought that EA wouldn’t stay down for long.
I doubled down on my position. Shortly after, my position was rocked by news about governments cracking down on the sale of in-game loot boxes, a huge source of revenue for EA. I got my ass kicked and ended up taking a big loss. Instead of paying attention to what the market was showing me, I thought I knew better. I believed my own hype and it cost me because I didn’t see what the market already knew. The day of the loot box was done.
Large Positions Trade Different Compared to Small Positions
If you have watched the options market for even a day, you’ll have seen how quickly the prices can move. Options are risky and volatile! If you’re new to trading options, start small, get used to the swings, and learn to use the Greeks to help predict how the option price will change as the underlying stock price moves.
It is easy to find people online who claim to have made small fortunes going All-In on options. They weren’t afraid to make foolish moves and go all in on high-risk positions, and it paid off for them once or twice. Even though you can find examples of winners, odds are that will not be you. When you put big money at risk, your stomach will churn when the price moves the opposite way of your position and that can lead to a chain of stupid mistakes. You have to get used to the price swings and know when to stop out before trading large lots of contracts.
It takes time to dampen the emotional response triggered by a big loss. Some are able to do it much easier than others, but for me, I still work on it. I have gotten a lot better at cutting losing trades early, but it takes time and discipline. To keep from blowing up your account, trade small and build up position size. Learn about strategies like spreads and collars to help limit risk too.
Catch Yourself Falling Prey to the Major Trading Fears
According to the classic book on trading psychology, Trading in the Zone by Mark Douglas, there are four major trading fears that lead to losing money in the market:
Fear of being wrong
Overcome this by ignoring the external noise like media and chatrooms. Trust your decision making abilities, and exit the trade quickly if it moves against you.
Fear of losing money
Overcome this by trusting your strategy will work over time. Keep a tight stop and don’t hold on to losers. You can always re-enter the trade!
Fear of missing out
Overcome this by having a strict entry strategy for your trades.
Fear of closing out
Overcome this by having a strict exit strategy for your trades.
The easiest way to overcome these fears is to find a strategy and stick too it. Remember to give the strategy time to work! Even the best traders in the game have losing days!
Come to terms with the fact that these fears produce costly mistakes and try to catch yourself falling prey to them. After taking my first big loss, I thought if I just learned more technical analysis I’d won’t lose next time… After taking another loss I thought, If I just learn more about trading psychology I won’t lose next time… After taking yet another big loss I thought, “If I just learned about xyz…”
The reality was, I was making costly mistakes because I was falling prey to the fears! You can never learn enough to anticipate every market move because there will always be an element of randomness. You simply can’t learn enough technical information to overcome the fear of loss. Instead, understand that loss and draw-down are part of the game. Trust your strategy and you can build intuition through experience over time.
Start with Simple Strategies
Trading options is a bit more complicated than trading stocks because there are more components involved. Strike prices, Greeks, Options Chains, Calls, Puts, Spreads… there is no shortage of things to know when it comes to options trading! I recommend starting with simple directional bets, buying a call or a put, with a few months time behind them. Get a feel for time decay and price swings.
Online sources will tell you that strategies like Iron Condors, spreads or other multi-leg setups are the best ways to be profitable with options, and maybe that is true for some people. Regardless, if you’re just learning, managing a position with multiple legs, long and short, is a lot to take on. Instead of complicated options trades, try things like pairs trading. For example, if you want to make a play on the microchips sector, maybe try buying a call on AMD and a put on Intel to limit risk instead of more complex long/short multi-leg strategy.
Do Not Chase Green
My best trades have always come from the times it felt most painful to buy. Everyone has heard it is best to be greedy when other are fearful, but it can be psychologically difficult to do. Most recently, I was buying into the COVID-19 crash every day of the decline. I was buying stocks, not options, and I was buying small lots, cost averaging into names I want to own long term. It worked out well as the market has recovered nicely from the March lows!
It can feel bad to be out of the trade and see a stock continue to rise after a couple big gaps up, but you have to recognize by the time you see that, the trade is crowded, the easy money has already been made, people will likely be looking to take profits and sell, and the risk to reward is no longer in your favor for a trade. Keep in mind this is from the perspective of an options trade, not equity. If you want to own the stock long term, it might make sense to chase sometimes; however, chasing has not worked for me when trading options.
Final Thoughts
Trading is not easy and trading options is no exception. They are risky and they move quickly. It is easy to lose all of your money if you do not understand the risks involved in trading options. Please do your due diligence before making any trades! If you’re new to options remember these five things:
- Do Not Believe Your Own Hype
- Large Amounts of Money Trades Different than Small Amounts of Money
- Catch Yourself Falling Prey to the Major Trading Fears
- Start with Simple Strategies
- Do Not Chase Green
If you’re interested in learning more about programming or data science, check out my other articles! Thank You!
- If you enjoyed this, follow me on Medium for more
- Get FULL ACCESS and help support my content by subscribing
- Let’s connect on LinkedIn
- Analyze Data using Python? Check out my website
