Dos and Don’ts of Options Trading
When you first start out with options trading, you may not know exactly what to do. Before you begin, it’s important to note that trading options can be complicated, and you should be prepared and educated prior to making any moves. Be aware of what you should and shouldn’t do going into the world of options to increase your chances of success.
Do: Go for trades with consistent returns
Trades known as base hits have smaller returns, but they’re more consistent and have a higher chance of paying off than home run trades, which are riskier. If you regularly go straight for the home run, you could see a lot of misses and potentially make a lot less than you could if you stuck with base hits over the same period of time. While it might seem better to start out with something that might yield a higher return initially, this might not always work out.
Don’t: Put everything in one position
When you buy way out of the money trying to cash out big, you are not setting yourself up with a good, long-term strategy. This play gives you a small chance of actually making a profit off your trade. Even if you do manage to make money with this method, it will not always work and eventually, you’ll end up paying it all back.
Do: Overfund your account
It’s a good idea to provide yourself with a little leeway, just in case you don’t win on your first few trades. Put a little more money into your account than you’re actually interested in trading, so you have a bit of a safety net if things don’t work out in your favor at first.
Don’t: Expect to get rich quick
Patience is key. With a good strategy and a plan tailored to your needs, you can set yourself up for potential profits. But, this won’t happen overnight. You can lose a lot more than you can earn if you try to rush things, putting everything you have into one trade hoping to win big. The best way to find success is to play the long game.
Do: Accept when your trade becomes a loss
The best thing you can do for yourself when you have a losing trade is to move on. By chasing the trade, you put yourself a higher risk for additional losses. Jumping on to a stock that’s already done well after the fact, especially as an options trader, the likely hood that this will work in your favor is low. It’s better to accept your loss than it is to risk losing out even more by chasing.
Don’t: Choose the wrong expiration
When choosing an expiration date, there are many to choose from. Luckily, the best expiration will typically become apparent if you’ve developed an outlook. Before deciding, you should know how long you think your trade will take to play out, if there’s enough liquidity, and what you’re sort of events you’re willing to hold through.
Do: Match your strategy to your outlook
Make sure that you’re confident in your strategy; it should clearly reflect the outcome you’re expecting. You can decide an outlook and form a strategy to match by using technical analysis, which you can do by taking a look at the volume and price of your option to find trends or check for buying and selling opportunities. You can also use fundamental analysis, which you can do by determining a company’s value prior to making a decision. Your outlook should predict the direction of the option as well as an amount of time in which you believe your prediction will take place.
Don’t: Ignore probability
Probability is one of the most important aspects of making an options trade. This helps you have a better understanding of your risk vs. reward and can show you statistically how your trade will likely play out. By ignoring this, you forfeit having a clear look at what you’re really risking when you place an options trade.
Do: Have a plan
With a solid trading plan, you can avoid a lot of common mistakes. In your plan, you should address the amount of risk you’re willing to take on, when you’ll enter the trade, and when you’ll exit. While this is not an exhaustive list of how to formulate a good plan, it’s a good place to start. Not only should you have a plan, but you should keep yourself accountable by following it, too. It isn’t uncommon for people to end up taking on too much risk than they can handle, so having a plan you’re willing to commit to is a great way to mitigate the possibility of overdoing it.
Don’t: Choose the wrong position
If you choose a position that is too large or too small, you might see a huge loss or miss out on what could have been a decent return. It’s crucial to choose your position size wisely and make sure that it works for you. Be certain that if your trade loses, you’re comfortable with the loss and won’t find yourself struggling to make up for it. On the other hand, don’t sell yourself short by making the trade size too small, eliminating the chances of high profits if the trade does win.
Options trading entails significant risk and is not appropriate for all investors. Option investors can rapidly lose the value of their investment in a short period of time and incur permanent loss by expiration date. Losses can potentially exceed the initial required deposit. You need to complete an options trading application and get approval on eligible accounts. Please read the Characteristics and Risks of Standardized Options before trading options. Relevant regulatory and exchange fees may apply. All investments involve risk, and not all risks are suitable for every investor. The value of securities may fluctuate and as a result, clients may lose more than their original investment. The past performance of a security, or financial product does not guarantee future results or returns. Keep in mind that while diversification may help spread risk, it does not assure a profit or protect against loss in a down market. There is always the potential of losing money when you invest in securities or other financial products. Investors should consider their investment objectives and risks carefully before investing.
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