Premature Celebration

Consider these scenarios:

You recently started using options and earned a satisfactory profit on each of your first six trades.   You think about it and decide that either the options game is easy to master, or you must be a talented trader.  

You’ve been trading for awhile and are confident that you know what you are doing, despite the fact that you haven’t made any money over the past three years.  A few weeks ago, you decided to adopt a new strategy.  It’s been working very well and you’ve had seven consecutive winning trades.  You believe you’ve finally got this trading game under control.

Is it time to celebrate?  Should you be congratulated?

In my opinion, the answer is a resounding ‘no.’ Not because it’s too soon to know how well you’ll do in the future, but because this string of successful trades can damage you.  You ask, ‘How can making money damage me?’

Overconfidence can be a killer.  It’s important to have discipline when trading.  That means

·        Knowing your capabilities and shortcomings. 

·        Being careful not to take on too much risk for the size of your bankroll, or too much risk for the potential reward. 

·        Knowing when to enter trades and when it’s preferable to pass on a borderline (or worse) opportunity. 

·        It’s important to understand when to exit a trade and not continue to hold just because it’s been working well.  There are reasons to hold, but the fact that it’s profitable is not one of them.

In other words, you must be on the top of your game to be a profitable trader.  You must recognize that losses are possible and that careless trading decisions will not be rewarded over the long term.  When you believe you are invincible, when you believe you are on a never-ending ‘hot’ streak, and especially when you believe ‘this is easy,’ - that’s when the profits from those early gains can evaporate instantly.  And if you still believe you are so very talented, it’s easy to get in over your head and lose your entire bankroll.

I believe new traders will do better over the long-term if a bit of humility enters the picture.  A few winners, some losers, and some gradual profitability can build respect for the markets and confidence for yourself.  And when the trader gains confidence by working diligently and by making appropriate decisions (note: that does not mean only decisions that turn out to be profitable are appropriate), that’s the path to success. Thoughts of quick riches are not the thoughts of winners.

Best of luck with your options trading career.  Please take the time to understand how options work before using real money to trade.