Thursday, November 08, 2007

Review of My Options Trading Mistakes

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After reviewing my past trades including those in my live trading before I started this blog, I came out with a list of the mistakes that I’ve made. This also includes most common mistakes of other options traders.

Do not bear to cut loss
One of the mistakes in options trading is holding on to the losing trades for too long. I shall think that this is not only happen to me but most traders out there. Never hold on to an option in the hope that it will go back up.

Losing 40% is better than losing 100%. I’ve done that once and it has wiped off all my money. I bought calls with the assumption that any pullback will be short lived and the stock will go right back up. But it never happens!

I have to keep reminding myself again: if it's time to sell, take the loss and move on!

Violating rules
At times I tend to violate some of my rules by taking higher risk. For example, if the risk that I can accept is not more than 30% (or an amount in dollar term) but sometime if the pre-calculated risk is 32% I will be very tempting to enter when I see that the potential gain is quite high. Sometime I do gain profit but most of the time not.

Time decay was being ignored
Time decay is one of the factors that options premium depreciates. I always forgot about it and hold on for too long when the stock doesn’t move. I realize that the longer I hold, the nearer the options will be to its expiration date and the value of the options premium will become lesser. I end up losing money even if the stock does move a bit. This is also a very common mistake for those who used to trade stocks as stocks don’t have time decay.

Emotions take over
Don’t trade when you are physically and psychologically not in good conditions, for example, not feeling well, bad mood, confuse etc. Even if there is a good trade popping up in front of you, it is not advisable to enter if you are in the above conditions. You will probably making wrong judgment and end up with a wrong trade.

Adjusting stop loss too soon
Only adjust stop loss after the stock has tested its support/resistance line. Adjusting too soon will get stop out easily.

Tighten stop loss
Stop loss easily gets triggered when it is too tight. Meaning it is too close to the entry price. Do leave some room for the stock to fluctuate.

Perceive a wrong trend
It is better to look at longer period (e.g. 2 years) of historical chart than a shorter period (e.g. 6 months) when deciding a trend. We might see an uptrend in a 6-months daily chart but in fact it is a downtrend when we look at a 2-years chart.

Chasing an increasing price
Never chase the price when you see it is moving towards your directions even it perceives as very good trade. You might end up buying more expensive options and taking much higher risk.

Past trades not being analyzed
More often than not we are blaming the system or the market but not ourselves when we are losing money. By knowing that we are making losses is not enough but rather why are we making those losses. We must analyze it; accepting our mistakes and improve from there. It is essential to perform a quarterly analysis for your past trades if not monthly. List down those mistakes and keep reminding ourselves so that we are not making the same mistakes again. Just like what I did here ;D


I strongly believe that trade to be right is more important than trade just to make money. If you can trade in the right way, have a set of right rules or system and follow through, you will eventually make money and more importantly making money consistently.

6 comments:

OptionPundit said...

OTD, thanks for sharing your perspective on the trading rules/experiences. It takes a lot of practice (and retrospection on past mistakes)before one can craft a tool to help run the business.

At beginning of this year, I wrote few resolution to become a better trader that I keep on reviewing even if I am making lot of money.

http://www.optionpundit.net/market-psychology/trading-plan-resolution

Have fun and keep up the good work,
Profitable trading, OP

lawrence said...

Yo bro,

Nice post. I certainly agree with you that as a trader we need to have a system. We have to just cut cut cut. Alot of stock trader turn option forget about time decay and the other major factor which is the IV.

Time value + IV = Extrinsic Value.

Option is Extinsic value and without it, option is just another kind of stock ...

Nice post. im sure your nov record will be positive. all the best

akalawoo

M Trader said...

Hi Option Pundit,

Thanks for your comment, would like to learn from you though. You have a nice and informative site.

To your trading success.

M Trader said...

Hi Lawrence,

Great comment! I learn new things from you here.

Thanks!

tradelikemike said...

It is critical as you reach 8-9 days before expiration that you do something about your time decay. Options decay in a non linear curve, so at that point late in the cycle, you hit the steep part of the curve. I usually will replace my options with stock, roll out and down to another strike, or just roll out to the same line, different month. Good that you are so critical of your trading. Good luck!

M Trader said...

Hi tradelikemike,

Thanks for your comment. Ya, you are right. It is good if one look to buy options with at least 3 weeks to expiration.

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