Options trading is an incredibly powerful investment tool that can provide huge returns but also comes with significant risk if not approached carefully. Whether you’re just starting out or have been trading options for a while, it’s easy to fall into common pitfalls. But with the right education, strategy, and risk management, you can potentially turn options trading into a successful part of your investment portfolio. Below are six key things to do if you want to become a better options trader.
1. Immerse Yourself in Education
If you’re new to options, the first crucial step is education. Before putting any real money on the line, get a solid grounding in options mechanics and strategies. Understanding concepts like time decay, strike selection, and the Greeks is foundational. Additionally, learn the various options strategies like spreads and how to determine which strategies are suitable for your market outlook. The more time you take to learn before jumping in, the better off you’ll be.
2. Start with Smaller Positions
One of the biggest mistakes new traders make is trading too large for their account size. When you’re just getting the hang of options trading, it’s better to start small. This limits the damage of losing trades while you refine your strategy. Even if you have a large account, resist the urge to make huge trades right away. Ease your way in so you can get comfortable with the mechanics. As you gain experience, then increase position sizes gradually.
3. Always Use Stop Losses
Stop losses are absolutely essential for risk management. It’s recommended to apply stop losses to every single options trade you make, no matter what. This discipline has saved many traders from turning losing trades into account blow-ups many times. Determine your maximum tolerable loss per trade and set stop losses accordingly. You can use mental stops for simpler trades but use hard stops for larger trades. Managing risk per trade prevents oversized losses and helps survive the inevitable losing trades all traders face.
4. Review Your Trades
It’s important to spend time reviewing your closed trades, both winners and losers. Some traders keep a trading journal to record details on each trade for later review. Studying past trades helps reveal mistakes and show you what works. Look at your losing trades and identify what went wrong. Could you have exited earlier or made a better strike or expiry selection? Review your winners as well. Was your profit target reasonable or did you leave money on the table unnecessarily? Find patterns in your best and worst trades.
5. Read Books to Accelerate Learning
While online courses and videos are great for options education, books provide the most thorough foundation. The Complete Guide to Option Selling by James Cordier is a good starting point for any new options trader. You can find out more about it on his website: jamescordier.com. Books allow you to learn at your own pace and absorb the material fully. Having detailed reference materials that you can go back to is invaluable.
6. Have a Strategy
Developing an options trading strategy is crucial for consistent success. A strategy includes your criteria for trade selection, risk management rules, portfolio allocation and position sizing. Without a defined strategy, it’s too easy to make emotional trading decisions. You’re more likely to chase trades, hold losing positions too long, or improperly size your bets. Approach options trading strategically and stick to your plan.
Trading options profitably requires education, risk management and strategic thinking. Apply the tips above to avoid common pitfalls.