Thursday, February 5, 2009
Keep your emotions in check.
That's good advice for almost anything in life. Whether you're playing poker, arguing with your spouse, or teaching your 16-year-old daughter to drive, keeping control of your emotions is a valuable skill. And it's especially valuable when trading options.
Of course, it's easier said than done. It's hard to be unemotional when the difference between a profit and a loss hinges on every tick in a stock. It's especially difficult when the market chops around like it has lately, and when triple-digit gains one day are followed by triple-digit losses the next.
The trick is to keep your risks small. Yes, that means keeping your profit potential small as well. But success in the option market doesn't come from making a huge profit on one big trade. It comes from multiple small profits.
Similarly, you won't fail as an option trader if you suffer a series of small losses. But one big losing trade can wipe you out.
You'll make more profitable trades if you keep your risks small. Let me explain...
Imagine you've done all the research. You've read through all the news articles, analyst reports, and financial filings. You've examined hundreds of charts with every technical indicator imaginable. And you've decided buying call options on Company X is a solid, no-brainer trade certain to double your money. In fact, you're so certain of this outcome, you put 100% of your investable funds into the trade.
This trade is guaranteed to be a loser. Here's why...
Murphy's No. 1 law of option trading promises nearly every position will go the wrong way in the beginning. No one knows why this is, but every trader I know tells the same story. We wait for the perfect opportunity to pull the trigger on a trade. Then as soon as we're in position, it moves the other way. It's just a fact of life when trading options. Nearly every position starts off in the red.
It's not a problem if we're trading with small numbers. Everyone can handle a small loss. A move of 10%, 20%, or 30% in the wrong direction on a small option trade isn't going to shake your conviction and it isn't going to bluff you out of a trade before it's had some time to work out.
But a loss of 10% on your entire investment account will cause you to rethink the trade. A 20% loss will have you staying up all night. And a 30% move in the wrong direction will cause enough intestinal discomfort to have you jumping ship just before the trade has time to start moving your way.
Most people lose money trading options because most people bet too big and then either blow up on the trade or wig out and exit the position too soon.
If you want to make money trading options, you need to bet small. You'll keep your emotions under control, you'll increase your winning percentage, and you'll ensure your longevity in the option game.
Best regards and good trading,
The Most Profitable Thing I Learned in School
Biotech still a "safe haven"... Life Technologies, ARCA Biopharma, and Cephalon hit new highs.
Refinery rally in full swing... new four-month high for Tesoro Petroleum, Valero and Sunoco also in uptrends.
Bank of America hits 19-year low.