With all the press we hear on option trading, it can be very challenging for a trader to know where to turn. The risk and reward ratio is highly elevated, so even the slightest mistake will be magnified many times over. For this reason, there is also the possibility to lose a lot of money when trading options. Trading options is best done as an extension of your existing portfolio; it will give you the flexibility to structure your risk and reward.
A good trader needs to be able to perform technical analysis on stocks. This is extremely important if you intend to make the right stock picks. The best way to learn is to read through books dealing with technical and fundamental analysis. This is a very challenging task as only 5% of top traders succeed. So be prepared for long hours of research and learn everything that you possibly can about option trading.
If you are a first time trader or just getting started, you should consider the following points:
Make sure that you have at least $10,000 of speculative risk capital. This is very important because of the risks involved. Many people have made the mistake of using capital that they couldn’t afford to lose, putting them in financial difficulty. You must be prepared to lose some money; it comes with option trading.
Always look at both sides of the market. That way, you will have a clearer perspective on the situation and be able to make money when the market is going up or down.
Over confidence can lead you to making the wrong decisions, so make sure that you keep your confidence in check; it could cost you dearly if you do not. When making a move, make sure that you have looked at all the relevant information. Do not follow the masses as they do not always make the right choices. Follow your gut instinct.
You can reduce the risk by spreading your capital across different areas. Never allocate more than 10% to any one trade. This is a very important rule to follow and is related to being overconfident. It is so easy to want to place a large sum on a trade you feel will do well. But consider the consequences if it loses. It really does come down to using common sense and thinking before you jump in.