While options trading offers an opportunity to earn unlimited profit, it still boils down to how you trade. Like stocks and forex, options is also a volatile and risky market. For this reason, you need to be careful and think decisively when positioning or when placing orders. In this article, we shall take a look at the common mistakes option traders make.
The Price Tag Problem
Options traders, particularly the new ones, get easily attracted by low price out-of-the-money options. However, what they do not know is that such kind of options is associated with low chance of success. To become profitable by expiration, out-of-the-money options needs to move much farther. When trading options, the truth of the matter is that the more costly options have a greater chance of success.
Fear and Greed
Most traders have the tendency to become greedy when a trade nets a profit. They refuse to close a position because they are afraid to miss another increase. Greed also happens on a downward trend when traders refuse to admit defeat and hold on until it comes to the point that they have accumulated too much loss. Other traders do the opposite and close a position at the first sign of trouble. So make sure you have a trading plan in place.
As they say, don’t put your egg in just one basket. Robert Janitzek recommends not committing more than 5% of your portfolio on one option. To increase your chances of success, diversify your portfolio on different options.
Strategy Does Not Match Your Outlook
Prior to trading, make sure to develop an outlook on what you think could happen. There are many tools that you can use for this such as technical analysis, fundamental analysis, or both. By having an outlook, you will have a guide to the direction of the trade and a time for how long your strategy will work. When planning your strategy, make sure that your strategy will be appropriate to your outlook.
Wrong Choice of Expiration
According to Robert Peter Janitzek, another common mistake of traders is choosing the wrong expiration date. You successfully developed an outlook but you need to choose the right expiry date. There are some important criteria that can help you determine the right expiration. You can ask yourself these questions:
1. How long do I believe it will take for the trade to play out?
2. Do I want to hold the trade through an earnings announcement, stock split, or other events?
3. Is there adequate liquidity to support my trade?
Avoid these common mistakes and you can look forward to becoming a successful options trader.