Note from Options Trading IQ: This is a guest post from Laura Gross at Best Bullion
It is common for new traders to start their trading careers with excitement. They have heard about the high returns they can make on Forex, options, futures, or day trading. They begin with unbridled and unchecked enthusiasm, with a dream of becoming wealthy or financially free in a short period of time, say less than one year. It is easy to remain in an idyllic state, that is, until they begin trading. Once their own funds are committed to a trade, they soon discover that learning to trade is hard work, and there are times when they are their own worst enemy. They experience fear, greed, or a combination of both. New traders may be tempted, for instance, to close out a trade too early if they fear a loss or fail to practice proper risk management, such as piling a significant portion of their funds into one trade or holding onto a losing trade for too long. On an ongoing basis, these sorts of practices will add up to large losses in their trading account.
So if you’re new to trading, it is important to note if you’re experiencing any greed or fear while you are placing and watching your trades. For example, are you tempted to load the boat or exit your trade too early? Whether you experience greed or fear first will likely depend on your temperament. If you like to gamble, for instance, you may notice that you are tempted to pile into a trade that you “know” is a sure thing. On the other hand, if you are cautious by nature, watch for the fear to creep in after you execute your first trades. In my case, I experienced fear when my first trade moved against me. I could not keep my eyes off the ticker, and I sent many an email to my coach asking about the status. After a few anxious days, I decided for my own sanity that I had to hide the tickers from view and check on my underlying stock only periodically. As a new options trader, I have learned a lot about myself this past month, and unfortunately, not all of it is good! But that’s okay; self-discovery is a necessary part of learning how to trade well.
In addition to discovering that my emotions swing towards fear while I am trading, I’ve noticed that I’m having some difficulty switching from a buy-and-hold to a swing trading mentality. If I buy and hold stocks as I have many times in the past, for instance, I could remain relatively relaxed if my shares fell in price, since I planned to hold my investment for several years. At times, I even decided that it was in my best interest to increase my position on pullbacks. But now that I am trading options, when a short-term trade moves against me, it’s another matter entirely. Because options are leveraged, the pace at which traders can incur gains or losses is significantly shortened; it is measured in days or minutes rather than years. This is why a good trading plan is key. It will outline a plan of action for your trades and help you keep your emotions in check.
As my mentor Bruce Dinger says, your trading plan must be as clear as possible and free from vagueness. He cautions that you could leave trading decisions up to your emotions if your parameters are not clearly defined. Here is an example: decide how much capital you are willing to risk on any one trade, and define what that is in numerical terms. If you are a new options trader with a $10,000 account, for example, decide how much you’re willing to risk, such as 5% of your capital on directional trades (calls and puts) and 10% on non-directional (hedged) trades that use a combination of calls, puts, or both. If you have these amounts defined, you will be less tempted to risk more than is prudent on any one trade. I have also discovered that clearly defined stop losses are also a key part of trading well. So is defining when I will take profits before I execute my trade. If I plan my trades and have both of these parameters in place, I know exactly at what point to cut my losses or take my profits. For these reasons, a clear trading plan and the discipline to stick to it will help keep fear and greed in check.
Fortunately, there are a couple more ways that new traders can minimize their losses and ensure their success. This particular website is a good example. In taking the time to review the outlined trades under GM’s Trading Results page, new traders can learn from his experience. The trades as well as the gains and losses are stated clearly. We can go back and look at charts for the broad market, sector, and the underlying stock for the time period during which GM’s trades were placed and can analyze what worked well and what did not. If we make it a practice, learning from the experiences of other traders can become an important part of our education.
In addition, it has also helped me to hire a coach. If you are coachable, you may decide that it’s in your best interest to pay an experienced trader to show you the ropes. If so, make sure that he has a proven track record of getting his students to the point where they are trading successfully. There are no shortage of programs out there that cater towards new traders, but if your coach does not have a passion for helping his students succeed, then it will not be money well spent. Before you hire anyone, vet him thoroughly so that you will not have any doubts. When you first start trading, you will need to place a lot of trust in your coach, so it’s important to choose wisely. A good coach will provide education, get you into live trading quickly, teach you discipline, help you grow your account while managing your risk, and more.
I am fortunate to have a coach like Bruce Dinger who goes above and beyond to make sure his students are successful, as well as access to a site like GM’s that caters to new traders. If you are new to trading, it is my hope that you will experience the same good fortune during the early part of your trading career. There are experienced traders out there with generous spirits who want to help new traders succeed. All you need to do is find them, be willing to learn, and trust that they will lead you where you want to go.
Laura Gross is a writer and novice options trader. She maintains an active Twitter feed and a precious metals related blog. She is at work on several articles that will soon be available as Kindle singles.