Losing is Part of Winning

This is what it's like to be an option trader. You've done all the due diligence. You've checked the stock and option charts and studied the fundamental issues of the underlying stock. The March out of the money- option looks like a good time interval and strike price to move into-the- money and hit your target price. You decide that it looks like a good option trade and you have three of your four technical indicators supporting your decision. You're just waiting for the stock price to move through the 20 day simple moving average (SMA). As, you watch the stock price move up to touch the SMA line, you call your stock broker and place a market order for five March 50 strike price call option contracts along with a 7% trailing stop loss. You get a confirmation and you sit back to watch the action. Your heart is beating faster and you move closer to the screen. "Come on, babies, show me the money", you murmur to yourself.

You've told yourself that keeping glued to the scream is something you want to avoid but for some reason you get hypnotized by the promise of seeing the stock and its option price move in your favor. Finally, the option price starts moving up slowly. You feel excitement and a sense of anticipation. You did exactly what your options trading system procedures called for and a surge of confidence brings a smile to your face. You decide to tear yourself away from the screen and go for a walk to enjoy the feeling and relieve the tension.

When you return to the computer, you gasp in horror as you see that the option price has retraced and is nearing your stop-loss. You quickly check the news and the charts for some indication of what's happening. Nothing. As a matter of fact, you notice that the RSI (relative strength indicator) has moved down. Maybe this is the testing before it really takes off. "But what if I get stopped out before it makes the move back up?" you ask yourself. You quickly call your broker and ask him to move your stop-loss lower to give your position some room to breathe. You know you shouldn't have done it but you did it anyway.

Within several hours, the price of the underlying stock is starting to move up and you watch with hopeful anticipation for the options to follow suit. But as you watch in horror, the option prices not only blow past your original stop- loss but also scoot right past your adjusted stop. Before the first day is over, you're out of the game and score some red on the trade. You're angry and confused. All the study and preparation for what? You should have listened to others and stayed away from options trading. No more options trading for you!

This scenario is too typical and is what separates successful traders from the majority of stock option trader "wannabees". Listen, losing is part of trading. As a matter of fact, a trader who has an option win-loss ratio over 60% is probably making good profits over the long term. The idea is that if you cut your losing option trades quickly and without second guessing yourself, and let your winners run, you will do well.

The key to becoming a successful options trader is being able to "stay in the game". Simply put, staying in the game is a matter of setting up a strict policy regarding the amount of trading capital allowed for each trade and religiously "punching out" when a stop loss is hit. Most successful option traders limit their trading capital to about 5-8% of the option trading account on any one trade. If they draw down the option trading account below 30%, most option traders will stop trading and go back to redesigning their trading system or adjusting their heads. Simple rules to trade by, but most new traders don't go into options trading with these sorts of con-straints in place. And even if they do, many let the emotions take over and will violate their own option trading system to save their egos or try to salvage money they shouldn't be trading.

In options trading, losing is part of winning. Nobody wins ‘em all, and any trader with a win-loss ratio over chance (50%) is usually doing well because the average losing option trades lose much less than the average winner. For example, if average losers have an 8% loss and the average winner gains 18%, multiply that average margin difference (in this case, 10%) by the number of contracts traded over time and that is what it's all about. It's not about hitting home runs, but hitting for average.