Most individual investors and traders know that they need to have a plan, manage risk, and put in the work learning and practicing. If they do that, they are well on their way to success.
What follows are six option trading and stock investing “don’ts” that will help keep you out of trouble and deliver returns when you trade.
Don’t place market orders – Use limit orders, which set the maximum price you are willing to pay to buy, or the minimum price you are willing to accept to sell. A market order tells your broker to execute your buy or sell order as soon as possible and at the current bid or ask price. That strategy works for liquid stocks where the bid-ask spread is highly competitive and you are likely to get the best price. However, most options are far less active and have fewer traders wanting to buy and sell.
Don’t chase a trade – Sometimes you will not be able to buy your option at your desired price. When this happens, do not keep raising your limit price. If you do, you may end up buying that option at too high of a price for the expected result or target price to be profitable. There will always be other trades coming your way, so stick to your plan.
Don’t over-trade – While adding to a winning position is often warranted, you should never add more than you are willing to risk. Never think that you can make up for a losing streak with one big score. That’s how gamblers get into trouble. If you even find yourself with a string of losers, stop trading. Take a breath. Think about what might have been the problem. After all that, you can consider making your next trade.
Don’t wait until the last minute to make your trade – Set a “good-til-canceled” limit price based on your profit target, rather than trying to time it near expiration. In other words, sell when price reaches your target, no matter when that happens before expiration. Strange things can happen at the end of a day. Especially at options expiration. Liquidity can easily dry up, and that means you may not be able to get a price anywhere close to what you were expecting. In addition, the time decay factor embedded in an option can cause its value to crater at the last minute.
Don’t trade without a plan – This is exactly the same as the “do” mentioned earlier. You’ve got to know your trading goals, expected profit and allowable risk. And you have to know what will have to happen to make you cut your trade short before a small loss turns into a big loss.
Don’t bet the farm – We’ve already discussed this in a few ways, but it is that important. Do not take such big risks that one losing trade will drain your account. And never think that you can make up for a string of losers with that one big win. Keep your position size between 2% and 5% of your portfolio. If the market gets exceptionally volatile, make that even smaller. You want to be sure you live to trade again tomorrow.
These 6 simple stock option trading rules can help keep your trading on track because the market owes you nothing and can be a ruthless teacher. Respect the market, and you will do just fine.
