Today, I want to talk about the top 10 mistakes that new traders make when getting into options. I want to go over this list fairly quickly, but it's important to understand that this is, obviously, not a comprehensive list of mistakes, but, really, these are the mistakes that I find people are making more often than not.
Even if you're an advanced trader, you often might be making these mistakes without even knowing it. Number one on this list, obviously, is buying a single leg, out of the money, puts, and calls.
Right, by far, the biggest mistake that people make is assuming that these lottery tickets, which are these out of the money calls and puts, are going to reward you with some big windfall profit, right?
The likelihood is, and we've known this, and we've tested this numerous times, the likelihood is that you're going to lose on those a lot more often than you're going to win.
Yes, you may have that one in a lifetime chance where you just pick the right direction, and the stock just explodes, but, again, if we're trying to do this as a business and trying to make consistent income out of options trading, this is not the way to go.
These are lottery tickets, and therefore, they act like lottery tickets. They're very cheap, they have a big potential payout, but the likelihood of getting that payout is very small. Number two is using the all in one strategy for every market, and this is the one-trick pony, right?
You have that one strategy that you know, and you try to jam this strategy into any market environment that you're in. You have high volatility, and the stock is going up, you use the same strategy. Low volatility and the stock is going up; you use the same strategy.
You just try to force this strategy into the market without understanding that you need to be a little bit more selective in what strategies you're using for any given market condition.
Number three is not having a defined exit plan, or not having a defined plan to adjust the trade before you exit. This is the case of the person who gets in here, and they get creative with the strategy.
They add an iron condor or a butterfly or a strangle or a broken wing butterfly, and they like the idea of adding that strategy, and they like the profit potential of that strategy, but they don't even consider how they're going to adjust or get out of that trade before expiration or even at expiration.
Not having an exit plan leads to you getting out of a trade early or getting out of a trade at the wrong price or just basically letting the trade go to full loss and wasting all of your money.
My suggestion is that you go ahead and learn ways to exit or adjust the trade that you're trying to make before you even enter that order. Number four is doubling down on your gut feeling or hunch.
We've all been victims of this before in the past, right? You just know, quote, unquote, that the stock is going to go higher or you just know that, at some point, it's got to turn around, and so you have this gut feeling inside, and you try to jam a square peg into a round hole, right?
You try to jam this trade down the market's throat, and you got the I'm going to get you market feeling, right, where you just need to get that market back for not doing what you thought.
The reality is, again, that we have no idea where the market's going, and even after a big rally or a huge selloff, the market can still rally or selloff beyond that, so we don't know what's going to happen.
All we can do is control the things that we control, which is trading small and keeping the strategy selection appropriate for the market that we're trading. Number five is trading illiquid options and underlying stocks.
This is the case where you become the only person out there, right, the sole survivor in the market. You really, really like X, Y, Z stock, but nobody else likes trading that stock or nobody else likes trading those options.
You end up paying more to get into it, you end up getting less when you get out of it because it has such a wide spread, and, again, we have so many video tutorials on finding the right types of options and stocks that are very liquid.
Trading illiquid stocks and options just don't work. I don't care how good the set up is; you don't trade something where you're the only person at the party. Number six is holding on to a position too long for that last $15 in profit.
Again, I see this all the time with people is that they have this trade and it starts to become a winner and then they just want to hold on because there's still $15 of profit left in the position.
Like a vertical spread that still has five dollars left in the position, well, there's no point to holding on to those trades too long because, at some point, they do turn around, the market does have cyclicality, and that profit that you have now could be totally wiped out in the future.
We're proponents of getting out of trades earlier, trying to manage that winning trade and get off the books and get into other trades. Number seven is failing to consider future earnings or dividends, right?
Again, we've all been there where a stock has earnings on a particular day, and we just didn't even know about it, and that affected the way that we traded that particular morning, right?
Stock jumps or falls after earnings, and we had no idea it was coming, or we get assigned a stock because of dividends. This is a huge thing, right?
It takes two seconds to just check into the future and say, "You know what, in the period that I'm going to make this trade, will this stock have future earnings or future dividends and will that affect the position that I'm trying to trade?"
In most cases, if you're focusing on earnings trades, you have to know when they're going to happen, right? Are they going to happen in the morning or they going to happen in the afternoon?
That can make all the difference between making money and losing money with an earnings trade. Number eight is what I call being diagnosed with a case of small account syndrome.
This is honestly where I see a lot of my premium coaching students that start out with me is that they have small accounts, in most cases, and that they want to trade successfully, so they think that by having a small account, they've got to be more aggressive in some way, that they've got to take a bigger bet in each of their trades, right, because they only have three or four or five or $10,000.
They feel like they don't have enough money in their account to make all these small bets all over the place. What do they do?
They become more aggressive; they make larger trades, they take a bigger undue risk on themselves, and they end up losing a lot of their money.
What I tell people, and, again, we have a ton of video tutorials on this as well, is scaling down your position size to anywhere between one and five percent risk per trade.
Again, that's not going to be a lot when you have an account size of about $10,000, but I can guarantee this if you can't trade successfully with a small account, what makes you think that you can trade successfully with a large account?
Number nine is getting too directional and not diversifying positions. This is a classic case of, again, what we talked about before is that hunch or that gut feeling that you have, but you get all of these positions, and they're all pointed in one direction like you need the market to go up or you need the market to go down to win.
What you really have to understand is that the market is cyclical, and it will go up and it will come back down at some point, right, so we need to have positions on both sides of the markets so that in any given month or week, we have an opportunity to take trades off at a profit that's just depending on where the market's going.
I like to keep myself fairly even in the market, and, of course, we'll still have a little bit of directional assumption given where the market has been and where it is going now, but, generally speaking, we don't want to get too directional.
We don't want to get too bullish or too bearish on any one position. Number 10, and by far the most important, is complete and utter ignorance of implied volatility. This is something that people fail to understand, and they fail to take the time to get to know and educate themselves on.
That's implied volatility, right, this idea that options pricing has a lot to do with where implied volatility is not only in the underlying option but where that implied volatility ranks going back in time.
Often, new traders, and even traders that have been doing this for a long time, and you know who you are if you're out there, you just don't want to take the time to understand implied volatility, right?
You know it's there, you hear it, it's a buzz word in the industry right now, but you just don't want to take the time to really understand it, and therefore, you don't really get why some traders make money and why other traders lose money in the market and it all surrounds this idea of implied volatility.
If you get nothing else out of this video, it's that you have to understand implied volatility to be successful at options trading. Again, that's all of the top 10 things that I've come up with as to why people make mistakes when they start trading out in options.
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