In How Can The Average Guy Succeed Trading Options?, I wrote about how there is no minor leagues for investors…that we are all trading the same markets. Of course, this is intimidating when you think about it.
After all, you are competing against sophisticated algorithms, well-financed hedge funds, traders glued to the screen, itching to move on the latest news that hits their Bloomberg terminal.
While I think there is a speed edge for them, that shouldn't affect the success you can create in the markets.
Namely because these groups have different approaches and objectives when trying to generate alpha.
So, how can you possibly compete as someone new, just starting out?
Most likely, you'll end up losing money. I know I did on my first options trade…but I chalked it up as a lesson learned and knew there was a lot more I needed to learn.
You see, there's a lot to learn before you can become a successful options investor. Not only do you need to know the mechanics behind options…but generating ideas and executing them, given the current market conditions.
After all, options are just a vehicle and an option strategy is just an expression of your opinion. Without placing a live trade, you won't know exactly what fits your time constraints and level of comfort.
Many successful investors will tell you that they have no clue on whether a stock will be up or down any given day…however, over a longer term horizon they feel they'll be right.
Whereas, a day trader can tell you where they think a stock will be headed over the next 5 minutes but have no clue on what it will do tomorrow or next week.
First things first, it's important to set reasonable expectations for yourself.
You've probably heard from a loved one before that you're special…and you are…but don't think that's going to translate to instant success, when it comes to investing and trading the markets.
Every now and then, I'll get emails from aspiring traders, they'll tell me how committed they are, how quickly they can learn and that they're analytical…all great things of course.
However, they then end the email by asking me if I think it's realistic for them to achieve 10-15% monthly returns if they do all the right things.
Unless you're some kind of prodigy, your first 6-12 months is a learning experience. The goal should not be making a lot of money…but simply not losing a lot of money.
Even Kobe Bryant had to wait till his 3rd NBA season before becoming a full-time starter for the Los Angeles Lakers.
So how do you get started?
The answer is simple, like the Nike slogan says…JUST DO IT. What I mean is opening an account with a brokerage firm and start trading small. But Josh, can't I get started with a demo account and paper trade?
You could, but I personally think it's a waste of time. Most likely, you won't take it seriously enough…and if you are not doing the stuff you'd be doing with real money then the entire exercise is a time waster.
By starting off small you accomplish a number of things:
- You'll have skin in the game
- You'll learn about execution
- You'll learn how you manage emotions
- You'll also be able to see how your idea plays out because you're not risking a lot
- You'll learn the foundations of money management
You see, one of the biggest issues new and sometimes experienced traders have is poor position sizing. By starting off small, you'll have the ability to evaluate whether your ideas are profitable or not.
Two things could happen.
The first, your confidence grows, allowing you to eventually add more size to your trades.
The second, your ideas don't make money and you have to go back to the drawing board.
In business they call this proof of concept.
Again, by starting off small, you'll gain valuable "screen time" and experience. If you haven't noticed, there is a lot of noise in the stock market. If you're over-leveraged, you'll most likely react to the noise, forcing you out of a position at an unfortunate time.
In addition, by starting off small you'll learn the foundations of money management. Not every trade is the same. Some trades you'll get in might be binary events, earnings, for technical reasons, fundamentally driven or even based on a view on volatility.
For me, a good chunk of my ideas are generated from unusual options activity using my SIZZLE Method.
Of course, I like to mix it up by shorting volatility in stocks or indices that I believe are over-valued. In fact, learning how to make the market beat you is probably easier to manage than buying options, which I've found that a lot of individuals struggle with.
In any event, you'll need to record and backtest yourself on each trade to see what works for you. For example, let's say you bought calls after following unusual options activity in a stock.
Some notes that you should record:
- What was the order, the quantity and price that motivated me to get in this?
- What is the implied volatility and how does it relate to where it's been this year?
- Did you pay up and chase these calls or are you getting in at nearly the same level they are?
- If these are near term options, do you think the order flow was driven by technicals or something else like an earnings, conference, rumors or some other news catalyst?
- If these are long term options, will you stay in the position until it possibly works? could your capital be better used elsewhere? Will you get bored and close out if nothing happens in a month or two?
- Is there any other activity in the sector or is this isolated in just this one stock?
The beauty behind unusual options activity is that you're given some sort of guideline on where the smart money thinks a stock will go and by when.
Of course, they are not always right…but there is some comfort in knowing that they're putting their money where their mouth is…and not some random talking head on TV sharing their opinion with likely no skin in the game.
Once you're in a position:
- Take note on how the options react intraday, daily and weekly. Of course, some stock options are more volatile than others. It's important to identify how you react to these up and down swings. By trading small, you won't be spooked out by the random noise.
- Pay attention to how the value of other options in the stock reacted. Could you be doing better if you bought another strike or another month? What if you sold put options instead?
- Take a note of anything that surprises you. For example, are you seeing other call options being bought in other strikes or months? Are volatility levels increasing or decreasing? Have the bid/ask spreads gotten more competitive or worse?
Most importantly, evaluate yourself as if you had more positions on.
- Would you be getting out if you reached a certain level of losses? If so, would that be the right decision or would you have gotten shaken out?
- Would you piecing out and taking profits as it moved in your favor?
- What if what you were playing for actually happens, will you take profits or get greedy?
- If you're wrong, will you be able to accept that and move on or will you take it personally and be stubborn and take in bigger losses. Being wrong is part of this game, losing money on trades is part of this game…if you can't accept that, then this isn't for you.
- Is your strategy scalable?
Again, these early stages are all about discovery.
Discovering who you are (and will be) as an options investor… and how you'll react and perform given different types of market conditions.
You'll discover which type of ideas work best and which ones don't. That means keeping a journal and recording the details of your trades. This topic has been discussed in greater length here …if you'd like to learn more about it.
There is a ton of noise in the market…trading small allows you to play out your ideas and strategies without getting spooked out of a position. The more experienced you become…the easier it will be to identify from what is real and what is noise.
Look, you can read all the articles and watch all the videos you want…heck, you could even shadow a great trader…but unless you jump in and start doing it yourself…you won't fully grasp what's going on.
A proud father can tell me everything I need to know about parenthood…but unless I experience it for myself, it won't hit home like it would if I was in his shoes.
The combination of a good options education and real-life experience is going to help you become better and potentially successful at this.
Sorry, but there are no guarantees here.
With nearly 10 years of industry experience, I can confidently tell you that I can help you in reducing mistakes. As well as, showing you how to spot opportunities that have a strong likelihood of success.
I understand that most trader educators have a bad reputation…and I agree some of them are snake oil salesmen. But that doesn't mean we should all be thrown in the same mix.
Elite athletes rely on several different types of coaches and trainers to help them get to the next level.
However, when it comes to option trading and investing, the general public believes they can pick up a book on Amazon or watch a free video on YouTube and they'll be ready to compete against the best, brightest (and sometimes crooked) traders and institutions on Wall Street.
It's not that easy folks, but hard work and doing the right things will help you succeed.
You know, I am a big believer in keeping things simple. I understand that some of the advice mentioned in this article may sound too simple…but believe me it works.
If you're looking for a good starting point to build a foundation, without a steep investment, check out Fearless Leverage for Income, a book I wrote that covers the basics on option investing…
I am also working on a course for those who are just starting out, something that I wish I had when I first started learning about options…probably would have prevented me from losing $2k on my first trade.
In the meantime, our SPX Method is a very detailed and easy to follow along course, aimed at helping those who do not have a lot of time to focus on finding quality opportunities. It will help you trade smart and prevent you from chasing the next hot stock in play.
If you decided to start off small, Congratulations!
I'd love to hear how you're doing. It's always good to bounce off ideas and thoughts with someone else who has (or is) going through the same obstacles as yourself.
I'll be hanging out in the comments section below.