Trading options can be a great way to make money, but it is not without risks. Beginners often make mistakes when trading options that can lead to costly losses and even more damaging psychological effects.
Knowing these mistakes and how to avoid them is essential for any beginner trader. Let’s discuss the most common mistakes beginners make so you can stay one step ahead of the game.
- Not Having a Well-Defined Strategy
- They Don’t Manage Risk Properly
- They Don’t Use Stop Losses
- They Use Too Much Leverage
- They Don’t Understand How Powerful Research Can Be
- They Try To Make Quick Profits
- They Don’t Protect Their Profits
- They Rely Too Heavily on the Greeks
- They’re Impatient
1. Not Having a Well-Defined Strategy
Having a consistent strategy is key. But too often, traders make the mistake of entering the market without one and assume that simply making purchases will produce profitable returns.
Without a comprehensive strategy, traders won’t understand how certain conditions could lead to a significant gain or unexpected loss and are more likely to experience unfavourable outcomes instead of the positive results they had been seeking.
And no. “Apeing” isn’t a strategy.
2. They Don’t Manage Risk Properly
Options trades are risky and come with a certain amount of leverage, meaning that any movement in the underlying asset can result in significant gains or losses.
Traders need to understand how much they stand to gain or lose from each trade and set limits for themselves to stay within their risk tolerance.
3. They Don’t Use Stop Losses
Stop losses are an essential tool any trader should have in their arsenal, whether they’re trading options or something else.
They help protect traders from disastrous losses by automatically closing out a position when it reaches a certain price threshold.
However, many new traders fail to utilize stop losses and leave themselves vulnerable to greater losses if the market moves against them.
4. They Use Too Much Leverage
Margin can be a beautiful thing. Until you try to do too much. Sure, you can amplify gains, but you also amplify losses.
Too much leverage can work against traders if the market moves in an unfavourable direction since their losses can quickly add up.
5. They Don’t Understand How Powerful Research Can Be
Knowing what variables can influence the price of an option and how different strategies may perform in other market conditions can make all the difference between a successful trade and one that ends up costing you money.
Not having the proper research can lead to mistakes, and traders may be unable to take advantage of potential opportunities if they don’t have the data and insights to inform their decisions.
6. They Try To Make Quick Profits
Trying to make quick profits can be a mistake as it increases the chances of making poor decisions due to a lack of knowledge or just plain greed.
Developing strategies and sticking with them over time is essential for improving results in the long run. Instead of making quick profits, focus on learning and understanding how the markets work to build up a knowledge base and become more consistent.
7. They Don’t Protect Their Profits
Once traders have made a profit on an options trade, they often think that the hard part is over and start taking more risks to try and make even more money. While this may work in some cases, remember that markets can turn quickly, and those profits can soon evaporate if the market moves in the opposite direction.
Protect your profits by taking steps such as cutting losses and locking in gains when appropriate. Taking advantage of options strategies like covered calls and protective puts can also help minimize risk and ensure that any profits remain safe even if the market turns.
8. They Rely Too Heavily on the Greeks
The Greeks are important for understanding how certain variables can influence an option’s price, and all traders need a basic idea of what they are and what they mean.
However, relying solely on the Greeks and ignoring other fundamental factors can be a mistake. Look at the big picture and consider everything that can influence the price of a security before making any decisions. Taking a holistic approach to trading can help reduce risk and improve results over time.
9. They’re Impatient
User-friendly options trading platforms like Sofi and Robinhood have informed the next generation about the power of options and given them the educational tools they need to get started. But some things you just can’t teach.
Many traders make the mistake of trying to rush their trades. Trying to get into and out of positions too quickly can be a terrible move as it increases the chances that traders will miss out on potential opportunities or take on more risk than is wise.
Having patience and taking your time when entering and exiting trades can be beneficial as it allows traders to better assess the risks involved and make more informed decisions. Taking your time can also help traders stay disciplined and avoid making rash decisions based on emotions.
The Bottom Line
Ultimately, trading options comes with a great deal of risk, and there are a number of mistakes that beginners make when entering into these trades.
Understanding common pitfalls such as over-trading, not doing enough research, trying to make quick profits, and relying too heavily on the Greeks can help traders avoid costly errors and improve their results over time.
With the right knowledge and preparation, traders can maximize their chances of success in the options markets.