Options trading is an extremely tempting type of trading for those with a need for flexibility and profit potential. For many novice traders, however, one mistake can set their entire journey astray before it even has a chance to start.
In options trading, one such mistake can lead to extreme financial loss, destroys confidence, and even can end a promising career. The good news? The mistake is completely avoidable. In this article, we will find this critical mistake, why the trader falls for it, and how a measured approach can be the solution to remaining profitable in the long run.
What’s the Worst Mistake New Options Traders Make?
New traders get easily excited about short-term wins but forget that options trading means steady, consistent profits. Most common mistakes newbies have when trading in options over-leverage or significantly jump the position size after one or more successful streaks. This stems from over-exuberance; a beginner gets over-confident such that they think they just discovered a “sure thing” and they cannot fail after a couple of succeeding trades.
It can be very tempting when an account is growing at a good rate to drastically increase the size of a position with hopes of more massive returns. Options trading is volatile, and one bad trade with an over-leveraged position will wipe out all previous gains and leave the trader staring into deep losses.
Why Starters Get Caught In This Trap
Interpreting Winning Streaks
For instance, beginners with successive wins may feel falsely proud about the mastery of their strategies and options trading at large. However that remains mere theory, though one will find losses sometimes arising out of even best researched strategy due to volatile unpredictable nature of market trends during options trading.
Moreover, no winning streak really translates that a strategy will win without fail or does not involve any risk during every event. It actually showcases just the favorable outcomes prevailing at that time under different market conditions.
Dramatic Underestimations
In options trading, gains and losses can easily become huge when dealing with strategies like the iron condor, with an estimated 80% chance of winning but a possibility of huge losses. When traders do not recognize the true risk of their trades, they are likely to increase their position size without considering the potential downsides. This miscalculation often leads to devastating losses.
Neglecting Psychological Pressures
Consistent winning will cause euphoria and push the trader to be more aggressive on trades, without caring about the effect a loss will have when huge if it happens. A beginner won’t even know how it can bring down confidence with a big loss, hence irrational decisions later. This is the shock factor that will make the strategy abandoned or quit trading due to a huge loss of confidence.
A Common Example: The Iron Condor Strategy
For this, let us consider a very popular professional options trading strategy known as the 10 Delta Iron Condor. In it, the individual sells two contracts at near market price for example, one call and one put and buys two contracts more outwards purely for hedging purposes. Such formation makes traders money based on initial cash flows in that price range it does not move away from.
For example, a trader invests in an iron condor on the S&P 500 with an 80% chance of profit. One quarter may be so perfect that the trader goes on to get consistent profits. In due course, they begin thinking, “I am making steady money; why not increase my lot size and double or triple my gains? ” And the problem is that this time they finally experience loss.
A small market move out of range can result in iron condor closing out way out of range, where a huge loss would be sustained to wipe out months’ of gains.
Long-term Risks of Over-Leverage
Amplified Losses
Each loss is also escalated proportionately as the size of the position for every trader increases. Presumably, with a highly impressive winning streak of a $10,000 account, they multiplied their positions tenfold; losing can knock out from one single loss in a trading account a minimum of 50 percent and possibly more. Apart from causing psychological shock, this commonly works into a trader that they find nearly impossible coming back fast to the markets.
Burnout and Emotional Exhaustion
The emotional effect of such a huge, unforeseen loss cannot be expressed. Such a loss from over-leveraging can result in burnout or aversion to returning to the markets for a trader, and in the worst scenario, even lose all confidence in a strategy that had initially been developed. Most rookie traders lose confidence in their abilities to trade and get hammered further into a maze of confusion by the weight to recover losses.
Not to Categorically Adhere to a Proven Strategy
Over-leveraging throws out the disciplining part of a strategy implementation. Traders know all too well the importance of holding tight to a proven technique and then allowing time to pass while allowing an advantage to accrue over trade after trade. When beginner traders begin over-leveraging, they are literally throwing in the towel in respect of a strategy because it may become erratic. As the outcome, not much hope remains for tapping into that long-term capability that such a strategy offered.
Avoid the Over-leveraging Blunder
Identify Temporary Winning Streaks
It is also worth noting that winning streaks are normal but temporary in trading. No strategy wins every trade, and losses are part of a successful trading plan. A winning streak should not be used as an excuse for increasing risk to ensure that larger profits are made. Instead, each trade should be approached with a consistent, disciplined risk level, allowing the strategy’s edge to perform over time.
Increase Position Sizes Gradually
The growth of position size should also be gradual and measured. Instead of doubling or tripling the position size, after a few wins, increase by one contract or a small percentage of the total account. This does not allow sudden losses that can impact the entire portfolio. For example, in a profitable quarter with 2-lot trade, a beginner may move on to a 3-lot, testing his comfort and control at each level.
Account Size and Experience-Based Plan Position Sizing
Most professional traders prefer to advice a trader with position sizes relative to his account size. As an inexperienced trader, keeping one’s trades at maximum up to 1-2% of the account value is a good precaution measure in case of any worst possible loss. Last but not the least do not increase the number of positions after having many winning trades. This simply does not work that way, but calls for a consistent strategy; increasing the position when account naturally grows and also his level of experience will go in favor of taking increased positions.
Develop a Long-term Approach
Options trading is a game of patience, where a person has to bear his wins and losses. First-timers must also realistically set their goals so they know that small, steady gains compound over time. Building the trading muscle will take time, and discipline, resilience, and measured position sizing will be required. It will be more about slow and sustainable growth rather than some rapid wins.
Use Risk Management Tools and Evaluate Your Emotional Preparedness
Professional platforms offer stop losses, limit orders, and live monitoring to cap losses. Review your emotional preparedness is also required to increase the size of positions. One must keep a trading journal where one writes down one’s emotions toward losses, wins, and the urge to over-leverage. One can have self-reflection at a constant interval to keep himself stable and not to make any impulsive decision.
Conclusion
Over-leveraging after a few consecutive wins is the biggest mistake that novice options traders commit. The temptation to earn quick money can be high, but it typically leads to devastating losses, a loss of confidence, and the eventual end of what promises to be a lucrative trading career. Remember that the long game is always involved in trading, with success achieved through consistent implementation of a proven strategy involving controlled risk.
If the beginner can resist giving in to the temptation of explosive position size growth and does things gradually and methodically, he will build an account that will stand up nicely to the fluctuations in life and provide a foundation for healthy, sustainable options trading profit.
By embracing these patterns, you’ll be positioned to handle all that trading has to throw your way and give you your strongest chance at a fulfilling career as a trader.