Learning to Trade Equity Options

Reading other blogs, I came across a post from OptionClub.com.

I tried to post a comment, but it was not accepted.  Thus, I reply here.  I don't want to be accused of taking material out of context.  Please read the entire entry. 

I know there are many methods a mentor can use to educate investors who want to learn about options.  Some beginners accept minimal information and quickly learn on their own.  Others require a thorough knowledge before being willing to invest one dollar.  All we educators can do is offer the material in a manner that we believe suits the individual trader. 

When writing books and blogs, I present information and opinion in great detail. believing that the rookie deserves to understand what is being taught, and not merely be given a set of instructions with no idea how to think about trading.

I do not claim that is best for everyone.  However, I take a strong exception to those who tell a rookie almost nothing and expect that person to go out and trade.  But sometimes the expectation is even greater.  The suggestion in the blog post is for the newbie to make a few trades and then revise the trade plan.  What trade plan?  How is that novice supposed to formulate a plan, let alone revise it?

The OptionClub post was written in response to this question: "Just what do you have to do to learn how to actually make money in this
trading business?"

***

Chris makes many valid points, including the idea that an education is the foundation of the trading business.  And it is a business, not a hobby.

Where we disagree is in the practical advice offered.  He wants readers to make a plan and practice trading – with real money.  He dislikes paper trading.  His reasons make sense – for someone who is not a novice trader.

He cautions people to trade one- or two-lots, to learn, and then revise strategies as needed.

Paper trading allows a trader to encounter a myriad of situations, with an opportunity to follow a trade to its conclusion.  By keeping records, the learning process is accelerated.  Imagine owning a real one-lot position and not knowing what to do.  It's much better to avoid the panic of being concerned about money.  The newbie's task is to learn about options and discover how the chosen strategy works under real market conditions. and make some decision, see how it works out, and then decide if it was a good idea. 

The difficult part is learning to recognize 'good' and 'poor' decisions.  The temptation is to allow the results – profit or loss – be the final arbiter.  Good or bad should be based on the soundness of the decision.  That's beyond the newbie's ability at the moment.  But record-keeping, discussions with the mentor, and a multitude of practice examples results in a more transforming the novice into a new trader with some decent experience.


My reply to the question posed above:  To learn how to make money, you MUST first understand options.  Your goal is not to earn cash from the git-go.  If you accept that goal, then there is no point in using real money when your objective is to practice and learn. 

Telling people to go trade is the wrong approach – in my opinion.  Trading when you don't know what to do is absurd.  Making a plan when you don't know the nuances of options is an impossibility.  That's where experience comes into play.

Once you believe you have an understanding of how option prices move up and down (by practice trading), then you can adopt a specific strategy and practice until you believe you understand well enough to invest a small sum of cash in a position.  But there is no urgency.  Learn first, trade later. 

If the new trader learns well, he/she is better positioned to earn profits.  When the original focus (per the questioner) is on making money, then the focus is not where it should be – learning about options.

The response made no mention of risk management, adjustments, exits and various other decisions that a trader must learn.  How can a trader 'revise' strategies when he/she cannot get enough meaningful experience?  How can a trader survive when risk management is not presented as a necessary consideration – right from the beginning? 

I understand that there are many different ways to gain an education and many methods for teaching.  I'm not picking on the OptionClub.  I merely found this blog post worthy of comment.

To me, one of the big problems with option educators is that too many give beginners what they seek – confidence and the incentive to get started too soon.  But they fail to provide enough information.  There are too few details.  Too little guidance. 

I recommend reading, asking questions of people who can be trusted, and paper trading.  I recommend patience.  There is no substitute for seeing trades play out in real time and being forced to make a decision on how to manage the trade.  If the trader does not know when trouble looms, risk is high, or enough profit has been earned, how can that person be expected to make a good decision?  It becomes guesswork.  Winning traders do not make guesses.

Learn first.  Paper trade.  Understand how to limit risk (and it's not by adopting a strategy of buying options).  Even when there is no real cash at stake, to the serious student, the experience has everlasting value.


My response to the blog post:

Chris,

Understanding the basics of options and how they work is essential.  We agree.

Making a plan?  How is a trader who has zero experience with option strategies supposed to make a plan?  That trader would have a difficult  time choosing which options to trade when establishing a position – how can that trader plan for contingencies?  Impossible.

How can that trader know when to take profits or exit when in a bad situation?

The idea is to learn about a few strategies and pick one that 'feels' as if you may be able to use it.  Then practice trading.  Yes, in a paper trading account.  The idea is to learn about the strategy – not about whether you would trade differently using real money.  That comes much later.  The idea is to learn how the strategy works.  To learn what has to happen to make/lose money.  To acquire some insight into risk management.

The student must encounter situations when risk is unacceptable and test methods to reduce risk.   The learner wants to get hand's on experience deciding when it's time to take profits or abandon the losing trade. 

That's why the rookie is practicing.  To gain experience.  How can that rookie plan ahead with no knowledge of how to solve potential problems?

As the trader practices, he/she reads more about the strategy. Perhaps from multiple sources.   Read about managing risk.  Practice trading and making trade decisions.   If this strategy is viable – then the trader becomes ready to start using real money trading and is able to make a simple plan.  That is the time to begin trading small size.  Now is far too soon.  If the trader canot earn anything when paper trading, thre is zero reason to anticipate doing any better with real cash.

Steps must be taken in the correct sequence.  Paper-trading for the beginner is one of those steps.

Regards

748

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4 Responses to Learning to Trade Equity Options

  1. jesse 07/26/2010 at 9:23 AM #

    Just choose 1/2 strategies that one is comfortable with and paper trade it, AFTER one is familiar and confident about it, THEN one can enter real trades that are within one’s comfort zone. For me, after over 1 year of real trading, I still just use only covered call writing and selling cash secured puts (they’re synthetically equivalent) strategies. They are my star strategies as they suit my comfort level and I’m always on cloud nine when trading with those strategies.

  2. Mark Wolfinger 07/26/2010 at 12:27 PM #

    Jesse,
    Residence on Cloud Nine is very desirable.
    Congratulations.

  3. Andy (still learning to trade) 02/12/2011 at 8:17 AM #

    Hi Mark,
    I’m new to options and grabbed a copy of your free ebooks (many thanks). Wondering how much of what i’ve picked up about forex will be relevant here. Hopefully you will give me a grounding in the subject and help me aviod some of the pitfalls.
    Looking forward to checking out your work.
    All the best
    Andy

    • Mark D Wolfinger 02/12/2011 at 8:54 AM #

      Andy,

      I’ll give you my honest opinion: Some people believe that trading is trading. If you can trade one item (forex), then you can trade anything. The rationale is that all markets have something in common and that if you take a purely technical approach, and if you can read the charts with skill and predict what’s going to happen over the VERY short term, then you can do the same thing with other markets.

      Others believe that there may be some overlapping similarities, but that each market is its own beast, with peculiarities all their own. Trading one may offer some help trading another, but the skill sets required are just different.

      I don’t trade other markets, so am not in position to tell you how much your forex skills will transfer. My suspicion is that it will be helpful as far as entering orders and understanding markets go. My bottom line is uncertainty, but I doubt your experience will help a great deal. However, as mentioned, others disagree.

      Options are special

      I believe that options are different from other trading vehicles. Just the idea that they are a wasting asset and lose value over time is a huge difference to overcome. In addition, options can be used to reduce the risk of owning (hedging) other investments, and that also makes them different.

      If you have the skills to trade forex, you should be able to trade options with the same skills. However, there is much to learn about how options differ from trading currencies.

      Helping you avoid pitfalls etc represents a substantial portion of what we do here at Options for Rookies. But, this is a blog, not a book, so the material is scattered. Take a look at the categories (below) and perhaps you can begin with posts in the ‘rookies education’ category to get started.

      Welcome to the blog. BTW, you can expect to be ‘still learning to trade’ for the rest of your trading career. There is always something new to learn. That’s a good thing.