Comfort Zone

I often stress the importance for newer traders to define their comfort zones when trading. The idea is that there is so much to learn and so many lessons to think about that distractions must be kept to a minimum. Believe me when I tell you that the fear of losing money is a serious distraction.

    NOTE: Traders know that they are going to lose money on some of their positions. It is inevitable. However, being afraid that a specific position is likely to lose or that too much may be lost is a serious distraction. If you cannot sleep at night, get out of the position that is troubling you.

The best method for avoiding as many distractions as possible is to own positions that are comfortable to own. This is not as difficult as it may sound. To be comfortable with any given trade (and with the portfolio as a whole), several things are necessary:

  1. Understand the option strategy. Simply stated you understand what has to happen for the trade to earn or lose money.
  2. Know the maximum possible loss for the trade if the worst-possible scenario occurs. Yes, losing that sum would be discouraging and make you unhappy, but you must be certain that you can afford a loss of that size. NOTE: This is the loss that occurs when something unexpected happens, such as a gap opening in the market or when the company issues unexpected news and the stock price makes an unfavorable move. Good risk management technique does not allow for holding positions until the worst possible result is achieved. Good risk management requires exiting earlier.
    • —When the maximum possible loss is too large, the solution is to trade smaller position size (fewer options) or otherwise modify the original trade.

      —Make this calculation before you make the trade.

  3. Have a plan (a). Set a target profit and when that target is achieved plan to exit. Yes. You can re-evaluate at that time, but having a profit target is important because inexperienced traders who have no plan seldom know when to exit the trade.
  4. Have a plan (b). Set a maximum loss you are willing to accept for the position if and when the trade goes awry. This number is VERY different from the worst-case scenario. Good risk managers know when ‘enough is enough’ and that the original expectations for the position are unlikely to come to pass.

When you, the trader, own positions that you believe have a good chance to earn a profit and when you are sure that you do not have too much money at risk, it is far easier to concentrate on learning to trade. By remaining within your comfort zone, you can spend your time learning important lessons. For example:

    –Which option strategy is appropriate for today’s market conditions. This takes judgment that comes with experience.

    –Choosing the strike prices and expiration date for the options.

    –Making a trade plan that describes your target profit as well as the maximum loss that you will accept before closing the trade (this is not the worst-case scenario loss).

    –Watching the days pass and examining how the position makes and loses money on a daily (or weekly) basis.

    –etc. There are many aspects of trading that only come with experience. Those are the things that should occupy your thoughts. You do not want to trade any position without a sufficient understanding about how the trade is supposed to play out or else you will find it difficult to know when to hold longer or exit.

There is a lot to learn without worrying about having too much cash at risk. Nor do you want to find yourself owning a position without a good idea about ‘what do I do now’ if something unexpected happens.

Trading Outside the Zone

There reaches a point when a trader wants to grow. We all want to move beyond the beginner stage. For that to become reality, one thing must be true:

You must survive. You must still be in the business of trading. That means you did not blow up your trading account. It means that you learned how to handle and manage risk for at least one strategy. In short, you survived and are ready to continue growing as a trader.

Here are some recent ideas on expanding the borders of your comfort Zone by Dr. Brett Steenbarger

Some of the best traders I know make pushing the comfort zone a lifestyle. They will find the offbeat restaurant, the challenging vacation voyage, the stimulating theater or dance performance…

The above statement refers to very experienced, probably professional, traders. But the idea is sound. To improve, you want to expand your comfort zone. But the key point to remember is that the new trader must first survive the education process and to take things one step at a time.


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