Let's face it: unless you're a complete trading nerd (like those of us here at Schaeffer's), you've probably heard the term "option" thrown around, and feigned knowledge of this elusive concept, for fear of being the only one who wasn't with the game. But that is definitely not the case! With new players jumping into the option arena every day, we're constantly receiving letters, emails, and calls about options.
Option Orientation is a series which is designed to give you a basic option education, suggest strategies for beginners, and introduce you to some methods for analyzing stock market activity. Using Bernie Schaeffer's home study course, 10 Days to Successful Options Trading, as a jumping-off point, I'll be your instructor for exploring the basic ins and outs of option trading, breaking down the fundamental concepts and strategies, so that options can be a perfect fit in your trading repertoire!
Today we're going to explore Chapter 2 of 10 Days to Successful Options Trading, which is about something extremely important to both new and experienced option traders: money management.
In case you didn't know, option trading can be an emotional game. It's easy to get swept up by the market's movements, which could translate into losses or gains at the drop of a dime. Fear is an emotion regularly experienced in trading, especially in more volatile markets, when your position could unexpectedly take a sharp loss ("flash crash," anyone?). When trading options, you have the potential for gains several times your original investment; however, many positions will post losses at some point during the duration of the contract. If a trader gets out of every position the moment it experiences a loss, he will never realize the profit potential of options!
Some tips for keeping a rein on fear -- and allowing an option trader to sleep at night:
So the above are strategies for handling fear, but this isn't the only emotion plaguing the option player. Traders can also succumb to greed when they start seeing handsome profits on their positions. It's human nature: if you're on a roll, why stop? However, greed can lead to devastating losses, so follow these general rules when trading options:
In the same vein, option players should note that losing is part of the game. In fact, by our calculations, successful short-term traders are correct on roughly 35-45% of their trades. What you must keep in mind, though, is the long-term picture, remembering that positive returns over time result from allowing your profitable trades to run and cutting your losses on losing trades.
As with so many other things, you have to keep track of the big picture when trading options. Every normal trading cycle involves losses, but just try to keep those losses at a minimum, by setting proper targets and exit strategies ahead of time.
For more tips and strategies on money management, turn to Chapter 2 of 10 Days to Successful Options Trading. Thanks for reading, and good luck trading!
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