How to Invest in Options: What I Wish I Knew 10 Years Ago
Whether you are trying to decide what trading strategy to use, deciding whether to buy or sell options, or looking to sell call options against stocks you already own. Trading is a journey, the road to success will have many curves, turns, windfalls and bumps along the way. While it is easy to look back at trades and find better entries and exits once trades are over, this is not realistic. If I could speak to my former self 10 years ago, these are the lessons I would like to tell me.
8 out 10 winning trades is exceptional
If everyone can trade 100% of trades that work 100% percent of the time, well then everyone would trade that way! The reality is, that if you are trading with real money, in real time there are bound to be times that you get things wrong. Yes, it is okay to admit that you have and will have more trades that don’t work. All traders have losing trades, by trying to have 100% of your trades work, you are setting unrealistic expectations and setting your self up for failure and disappointment. When you realize that not all of your trades need to work to make money, your expectations are more realistic and you might actually achieve your goals. My trading strategy is one that I can trust because I have been using it for many years and it has evolved along with the markets. Regardless of how the market is moving, I know that I have developed the skill set to trade in the markets that are before me. When I have a loss I know it is just part of trading and that I can rely on my strategy to make the money back. If you don’t have a working system or a system that you trust, making back money after a loss becomes challenging from both a logistical and psychological point of view. If your system is inherently flawed, and you are not able to generate more money from winning trades than losing trades then over time you will lose money plain and simple. If you don’t have a system that you can rely on then you will not have the confidence to get back in to the market and follow your trading rules. I know a lot of traders who’s downfall was changing how they traded each time they had a losing trade. This is not the recipe for success in options trading.
Your dollar profits should be relative to the amount you risk
Sure, you want to risk as little money as possible, and you want your money to triple every time. But is this realistic? Whether you sell puts, buy calls or trade a variety of options spreads, risk relative to reward is important. I would tell my self from 10 years ago that while it can be enticing to buy calls or puts that are cheap, these options are in fact, out of the money. When you trade out of the money, the cheaper cost of the option is offset by a lower probability of success in the trade.
Traders also need to moderate their profit expectations in terms of dollar returns. If you have a $5000 account, you would have to make a 1000% return to make $50,000. This is not realistically attainable for most traders. Keep your account size in perspective when you set dollar profit goals, even a 100% return on a $5000 account is only $416 per month in profit. If you had a great year and made 20% which is $1000, the monthly income would only be $83. If any trader only made $83 in a month they would most likely be upset, but ask that same trader if they are happy with 20% per year return and they would most likely be very happy.
I have found that most traders that first start trading are disappointed with a few hundred dollars per month in profit, they hear of stories of big wins in the market, but they do not think of the risk and amount of capital it required to generate those returns.
Create and follow rules for selling options vs. buying options
I can’t tell you how many times trading rules have kept me out of trades that don’t work. Trading rules are so important, and vitally important to help you avoid losing money. When I look at and decide whether I’m going to place a trade I always keep my trading rules in the back of my mind. Make sure you actually write down a list, it has been shown time and time again that we are better at achieving goals that we write down.
Trading rules and a trading checklist are important and keep traders making trades based on their proven setups, and not relying on emotion or hunches to trade. Following a set of rules helps remove the emotion in trading which I believe is one of the biggest roadblocks to trading success.
Your trading plan should always be a work in progress
Your trading plan should never to be viewed as a final product. I am constantly tweaking mine as the market shifts. The market is not static, the market’s mood is fluid and ever changing, we can not predict when the next news story or economic data release will create a shift in market sentiment.
Trading a high volatility and low volatility market is much different so is trading a market that is consolidating versus trading a market that ins trending well in one direction.
Adaptation is very important, not only must a trader adapt to the changes in the market, they must come up with a system to help them determine if market sentiment is shifting. Most new traders have difficulty when markets begin to transition, or change direction and are often just a few trades behind the market. It is only with a lot of time spent trading options that you begin to see the subtle clues that tell you when the trend of the market is changing.
Market experience is more valuable than theoretical knowledge
You need to learn about trading from time in the markets. You need to know basic options theory and understand how each options contract, whether a put or call or long or short will behave. Once you have the theory, you need to spend time trading to develop your skill as a trader. Yes trading is a skill, and you can learn it, you just need time. Why do people think they can place 3 trades in AAPL and that makes them an expert. You wouldn’t drive 5 miles and consider yourself a qualified driver, or hit 12 golf balls and consider yourself a golfer. Both are great examples of how we can read theory, how many volumes have been written about the perfect golf swing. You could watch all the videos you want of pro’s hitting 300 plus yard drives, but I would be willing to bet that the first time you step up to the ball the result will look nothing like what you saw in the video. Only after hundreds, sorry make that thousands of thousands of golf shots will you have created the muscle memory needed to hit repeatable shots down the fairway. I think a good way to look at trading is from the perspective of a skill, and anyone who has mastered a skill knows that it takes hard work to make it happen. So don’t be too hard on your self, you can get it to work you just have to build your skillset.
Develop Ways to be efficient in the market
Your time is valuable. You can spend hours looking for trades and I know I use to spend way more time looking for trades than I do now. I have now become very good at scanning through stocks to look for trading opportunities. Members from the trading room will often attest to how quickly we can find good quality trades. There is a difference between trading to find trades, or wanting to trade just to trade. The mobile text trade alerts can be a huge time saver. I think a lot of traders I speak with spend way too much time analysing trades, we can’t predict where the market is going to move next, we can just have an educated assumption, so over analysing a trade really doesn’t make sense to me. If it looks good it looks good, if it doesn’t I’ll move on, I have around 200 stock on my watch list, I can usually find a few each week that meet all my trading criteria.
You can’t predict where the market is going to move
This is such a valuable lesson, one that I wish I could repeat to my older self loudly….you can’t predict where is the market is moving. There is a much higher probability of success in my trades when I trade in the same direction that a stock is already moving. Instead of trying to guess when the direction will change. I can find trades from retracements on longer term charts like a daily or weekly chart, with an entry in the same direction of the trend.
By trading with the trend I find that I am increasing the probability that my trades will be profitable. I am trading with the market and not attempting to out guess where stock price is going. This does not mean that you will never have a bad trade, but it does mean that you are at least setting your self up for success.
Use statistics to your advantage
The market is efficient, it knows more than you. You can't out guess the market, so you might as well take the information it is providing and use it to your advantage. Learning to read between the lines and pick out data that supports your options trade set up and the data that does not support your trade will allow you to create a pro and con list for your trade and help you to make a decision. Empirical evidence that removes emotion is best when selecting a trade. By removing emotion and relying on data we are better able to remove judgement from the trade and rely on what the market is telling us.
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