The choice to trade online instead of seeking the help or advice of the traditional stock broker has become popular. Most people are attracted into online trading because it offers outstanding opportunities to enjoy unlimited freedom. However unlimited freedom also comes with unlimited self-sabotage, there are several options trading traps that you should be aware and not to fall into them if possible.
The No.1 deadly options trading trapLeverage using options on the earnings announcement hoping for a big catch when the stock gaps is the No.1 Options Trading Trap that most options traders fall into and are unaware of.
Many naive options traders and wannabes who have been misled into playing earnings don’t know the dangers that they are facing. It is a real killer. Next time you hear this, you better run fast.
These people don’t know that the very occasional big win traps them into believing they can make money doing it again and again. It can ruin their lives as they are gambling their life savings away.
It is my duty as a trainer myself to expose the hidden dangers to the public and alert them of the consequences.1. High Risk Exposure - after the earnings are released, the Implied Volatility will immediately shrink often know as “volatility crash”. The options premium will lose its value so much that if there is no substantial movement in the stock price to push the option deep in-the-money to cover the losses, even it gapped in your favour, and you can still lose money.
2. Gambling – betting on earnings is all based on predictions just like playing baccarat, you bet on either banker or player base on intuition or gut feeling. Even with positive earnings the stock still can go down, past earnings does not guarantee that the same outcome the next round.
3. Addictions –You will be obsessed in finding jackpot trades. The amount of excitements you get out of the one strike of a chance winner can get you addicted. Just like drugs, addicts are after the “high” effect.
4. Mood Swings – the emotional implications are just too dangerous for anyone to handle. It can affect your life and family. The amount of stress can be damaging to your health as it screws up your mind. You will develop an “irritability” personality and become an angry or impatient person.
The truth about earnings is that they are very difficult to predict. Even companies themselves often are unable to forecast their future accurately. They take measures to ensure their earnings are right on target. What most investors don’t know is that companies sometimes “manage” their earnings to meet analysts’ expectations and we should not give them more respect than they deserve when assessing their estimates. Past earnings records do not guarantees future performances. Very unfavourable risk / reward ratio. All the odds are against you.
“An important key to investing is to remember that stocks are not lottery tickets” – Peter LynchCompleting your learning curve
There are definitely advantages to online trading, but as an individual trader you will have your learning curve in becoming an online trader. You’ll need more than basic computer skills if you want to excel in your trading as some of the online trading software may be quite complicated if you only have basic computer knowledge.
When a trader is trading online, he makes choices based on his own research and there is no broker to advice and confirm his order. Consequently, it is extremely important that online traders competency in operating their online stock trading software as it is common for traders to have pressed the buy button instead of the sell on their online trading software by mistake.
Try out the online trading system first before choosing your online broker; I am sure that you can find one that you are comfortable with before starting out to trade with your money. Most online brokers offer the use of a virtual account where you can practice and sharpen you trading skills.
When you begin to learn more and become more experience in your trading, you may become curious and want to try out different strategies or approach to reach your desired goals faster. As it is important to learn new strategies, remember never try it out with real money as you may suffer financial losses, speaking from an experienced point of view. Always use your virtual account to try out your new stuff. It requires time and money, save your money invest only your time.
“Don't limit investing to the financial world. Invest something of yourself, and you will be richly rewarded” – Charles R. Schwab
Know your risk toleranceThis is also the number reasons why people lose money is they get carried away easily and take unnecessary risk. It is estimated that 90% of the traders lose money in the long run. It is also important to know what type of financial instruments suits you, your personality and risk tolerance.
You may have guessed that intra-day trading is best for you in pursuing your goals quickly and aggressively, never to realize that you are not mentally prepared to take that kind of a stress yet. We are situated in this part of the world, 12 hours different which means that you’ll have to stay awake through out the night to trade. All of this requires a willingness to not only take risks, but also make scarifies to your family as they will be sleeping when you are awake. Be wise, making money is important but striking a balance is even more important especially where your family is concern.
If you are trading options do not misunderstand the word “Limited Risk” thinking that you are not going to lose a lot of money because the risks are limited. “Limited Risk” is not to be interpreted as it is, what it actual means is that as compared to buying or shorting a stock, the risk is limited. If you buy a particular stock for $50, you risk is $50 because the company can go bust which is most unlikely to happen but it can go down. Buying the stock option instead will limit your loses for you may only pay $5 for it. And comparing both, buy option seems to be a logical choice because you only have to pay 10% of the stock’s price; so naturally, you don’t mind risking it all. It is this mentality that most options trader loses money.
Understanding the marketSometimes you think that the market is against you. Well, the market doesn’t know you at all and it is not against you personally. It was you who interpreted the market the way you want the out come to be and if it does not go your way, you get disappointed. Don’t try to read the markets, let it tell you what you should do instead. Put the systems to work, test it out, virtual trade of course to see whether it works or not. Maybe it will help.
Rules to follow in becoming a better traderMastering a trading system alone would not however automatically insulate you from losses. It must always be remembered that the overriding rule is for one to exercise the required discipline every time, without compromise. Self-governing rules and regulations must be strictly enforced via self-discipline, so that you will not break any of the trading rules laid down and you will not be reckless in your trade and go into the punter’s mode. Having a system to trade can develop winning habit and the incisiveness to be committed to trade only if you are able to find high probability trades and become a better trader. Here are some of the trading rules that I have set up as my trading parameters.
1. Start to paper trade first to be familiarized with the trading platform.
2. Trade less and be more selective per trade.
3. Do not over trade, maximum trades – 70% of funds.
4. Start with 1 contract size and increase slowly.
5. Do not trade during the 1st trading hour.
6. Do not chase, be patient – Wait.
7. Make sure all the signals are in line before executing the trade.
8. Don’t trade the news.
9. Never average down your losing position.
10. Cut you losses quick and without hesitation.
11. Always use protective stops.
12. When losing bad, stop trading, take a small break or back to paper trade.
13. Stay away from stocks that hurt you.
14. Don’t be a gambler.
15. Do not try anything new with real money.
16. Do not make stupid mistake, think like a pro.
17. After the trade is done, off your computer and go to bed.
18. Follow the system and your trading plan.
"Habits are safer than rules; you don't have to watch them. And you don't have to keep them either. They keep you."
- Frank Crane
Ronald Lee is a Malaysian street smart entrepreneur, a professional investor/trader, a trainer and author. He provides contact coaching lessons on US stock options trading; sharing his trading experiences and how to achieve consistent profits systematically with his low risk, proven high probability trading methodology.
He is widely known for his blog, www.StreetSmartOptions.com, which is devoted to sharing his effective emotion-free trading psychology on reversal-driven quick profits and trading traps to avoid.