Getting into options trading can be a wild ride.
Get lucky, 3x your account and feel like you’re a pro.
Fast forwarded two weeks and you’ve over leveraged your account and lost it all.
Now begins the FOMO and slow grind to build your account back up.
Tons of new options traders find themselves in this exact situation
Follow these three tips to avoid those costly mistakes.
The easiest way to avoid blowing up your account is practicing proper bankroll management.
Just because you 3x your account in a day doesn’t mean you should start immediately increasing your position sizes or go all-in on positions you know are a “sure thing”
For starters, there’s never a sure thing in options trading.
Every position has inherent risk, being on a win streak just makes you blind to it.
Hold yourself accountable to overconfidence and don’t start throwing your own rules out the window.
When your account grows, it’s even more critical so you’re not giving all those sweet tendies back to Mr. Market.
The first step is to continue to manage your position sizing.
Sure your account is bigger, but doesn’t mean you need to immediately start making larger trades.
Take it slow and ease yourself into it.
Larger position sizes means larger swings, which is a completely new challenge in itself.
And second, don’t forget to keep diversifying.
I can’t tell you how many times I’ve seen traders feel like they’re invincible and go all-in on a single trade because “they were right the last three times”.
You’re right until you’re not
And you don’t want that single mistake to be the reason you blew up your account.
The second lesson you want to avoid learning the hard way is diamond hands.
Diamond hands is continuing to hold an extremely risky financial position.
It can either be refusing to sell a badly losing position while waiting for it to recover or refusing to sell a highly profitable position while waiting for even greater gains.
In either situation you’re either digging yourself a bigger hole or leaving money on the table.
In theory, diamond hands isn’t always bad. Having a quick trigger finger to sell can be equally dangerous since you won’t give positions enough time to play out.
But, for most new options traders diamond hands can be dangerous.
The key is to understand that not all trades are created equally.
Asking yourself some key questions can help you use diamond hands more effectively.
You can find a rundown of the questions to ask yourself here.
Last but not least, every new options trader needs to stop and learn about IV, or Implied Volatility, before they make a single trade. And in particular, IV crush.
In essence, implied volatility is a metric that captures the market’s view of the likelihood of changes in a given stocks price.
This likelihood of price movements is used to price options contracts.
Higher implied volatility will drive options premiums up while lower implied volatility will drive premiums lower.
So, when you see high implied volatility, the market is essentially anticipating a larger price movement in the underlying asset.
However, if somehow the outlook changes and the stock is not expected to move as much, then IV goes down and your options contract loses value regardless of current price movement.
That’s IV crush – a sudden drop in implied volatility due to a change in outlook, and your options contracts as a result.
This can happen for a variety of reasons.
Breaking news, political climate and earnings reports can all lead to more known information being priced in and implied volatility dropping as a result.
Whatever it may be, the end result is always bad for your tendies.