The Two Biggest Mistakes Options Traders Make Every Day

Have you ever found yourself  in one (or both) of the following situations?

You close out your trade and take your profits… Three days later, you’re cursing your computer screens because of all the money you missed out on…

You close out your trade for a loss… three days later, that disappointment – even anger- you felt over the money you lost quickly turns to happiness…

In the first scenario, you made money and ended up angry, while in the second, you lost money and ended up very happy.

That’s because in either case, you made two very big – and all too common – mistakes…

Never Place an Options Trade without an Established Price Target and Established Time Frame

Let’s take another look at the two situations above… only this time, in much more detail…

You go long on a stock you believed would move higher. Lo and behold, the stock bounces three points higher three days later. So you decide to take your profits and close out your trade… only to see the stock jump another three points over the next couple days. It was only three days ago that you were happy with your trade. And now… you’re mad.

You open a long call trade because you believe the stock will move higher. Fast forward three days, and the stock fell a couple points. So you sell-to-close your position in ordfer to cut your losses – and your suffering. Over the next three days or so, you notice that same stock plummeting another four points. But unlike other traders, you got out in the knick of time… so now, you’re happy.

So how can it be that you’re mad when you make money and happy when you lose money?

Well, when it comes to trading options, there are two things that will help you manage your trades better and also control the urge to make trading decisions based on an emotional reaction to the markets.

Both of these are absolutely crucial to making money and preserving your capital. But options traders too often end up angry when making money – or happy when losing money – because they didn’t take the time to do these two things BEFORE opening their trades.

So here’s how you can avoid making these same mistakes again…

#1: Establish Your Price Target

In the first situation, you would have likely held onto your trade when it was up by three points instead of selling it if you had a reasonal expectation of what the stock would do before you opened your trade.

Now there are a lot of technical trading signals constructed around moving average that give you a buy signal when a shorter-term moving average crosses above a longer-term moving average (or vie versa). But, for example, what if it crosses and gives you a sell signal before you get any kind of real profit, and THEN end up losing $300 (3 points * 100 option contract= $300)?

That’s why it’s best to establish your price target first. And you can do this easily by looking at a stock’s past price moves and patterns and eyeballing the time frames in which the price moves you need to happen. This can serve as your guide going into a trade – and save you the frustration and anger.

Here’s an example…

This sideways trading pattern shows three-point moves and the time frames needed to make them. If you were to open a long call option when the stock is on support at $74, you now know that the trade should be closed if and when the stock moves to $77.

Additionally,  this helps you know that if the stock breaks and or closes below the $74 support, you’ve got your signal to exit your position. You’re virtually able to see whether or not your trade is working based on the assessment of the price move you need and the time frame in which you need it to move.

The question is… how many charts, like the one above on OXY, would you have to cycle through just to find this information? It could easily take you an hour or more to go through multiple charts one by one, and you may eventually get to the point where you end up doing nothing but technical analysis.

So you want to make sure you’re using the most efficient systems and processes to get this information. I have my own proprietary tools, like Money Calendar, that crunch millions of data points to kick out a list that shows a stock’s average profit and price moves as well as the time frame needed to get there.

Below is an example:

And as you can see, this provides the opportunity to know what to expect from the stock or ETF – before spending any money.

#2: Establish the Time Frame to Reach Your Price Target

Establishing the time frame in which you expect to reach your price target is so important because it prevents you from taking an option position that will expire before the end date or by the date at which you expect that price move to happen.

Another reason to establish the time frame is so that you don’t buy TOO much time on your option.

Here’s what I mean…

If you expect a price move to happen in 25 days (by July 14, 2016) on GOOGL, as in the example above, why would you need to buy an option with a January 2017 expiration?

Of course, you want to give yourself enough time for the trade to work. However, if the stock hasn’t reached your target price by the end date (July 14), you should probably close your trade and either take whatever gains you can or preserve your capital.

Think about it…  there’s no data that shows what that stock can, or should, do past that date. To hold it until, say, January 2017 means that you’re back to holding a trade based on the assessment of your hope that it will go higher. You’re trading on “hopium,”  which is exactly what you DON’T want to do.

Instead, try using the standard, third-Friday-of-the-month expiration, which is what I try to do. If that pushes you out to the next month, see if there’s a weekly option with a Friday option expiration shortly after the end date, or target date, that shows a nice rate of return.

And remember…

The key to successfully managing your options trades is to reasonably manage your expectations.  So long as you have a reasonable set of expectations before spending your first dime on a trade, you can avoid the mistakes that options traders make every single day.

Always plan your trade and trade your plan!

Next week, we’re going to focus on Brexit and two of the best ways you can play the volatility in the markets.

Until then, have a wonderful weekend!

Tom Gentile