Options Trading Mistakes to Avoid for Beginners

[Music] trading options could be daunting especially for those of you who are just starting out wouldn't you be interested in hearing about the past experiences of some industry experts today i speak with claude c chartered financial analyst trading instructor at the prosperity club and former montreal options exchange executive cloud will help demystify common option trading myths and some common mistakes for beginners claude welcome thank you ryan good to see you and thanks for having me no it's a pleasure having you thanks so much for joining us today claude i've heard you speak very passionately about your two mottos that you believe that these mottos can help with an investor's trading success what are these mottos and tell us a little bit about each of them yes every time i teach that's what i start with so the the first one is process before profit and the second one is risk before reward so the process before profit because trading is really a question about uh having a process and repeating the process over and over again and that's what the makes the big difference between a pro and a and a um a beginner is the pro is really into the process and and you got to love the process so it's like playing a game like when you play chess you decide on an opening a mid mid game and a closing tactics the same thing so it's a process that you need to repeat and the second thing is risk before reward is because we tend to focus on how much money we can make instead of the real question is how much money can you lose and you can't afford to lose anything because capital is everything so um that's why i really like them so what you're saying though is that you believe the psychological aspect is an important factor so with this in mind where should beginner investors begin yeah so i have a graph here that shows human nature when it comes to the market and it's something that we've seen over and over again where the market starts very low and you've got only the smart money coming in and then the institution gets in and then the media gets onto the market and it's get people excited and boom you get the retail investors joining and then overshooting the real value of the market and that's a um that's something that is really scary because you can basically take this graph and put it one on top of another over um the history of the world and all the big bubbles whether it's the tulip whether it's the um the uh the uh the south sea company uh the 1930 1987 all of them they're all the same and so it's it's really important for people to understand who they are as humans in order to get away from those bad habits of buying high and selling low now tell me a little bit more about those human behaviors are these human behaviors only occurring around major market tops no actually it's over and over and over again and you know this time is not different we're somewhere on the way to the top and and after the top it's going to come down there's going to be a bull trap where people are going to go out it's it's we're coming back to where the the how it was no it's not going to be like that and and we're going to eventually go down probably lower than we were before and if you take that chart on the other page i put um two of them together but you can actually put like 20 of them at one end of another and the same behavior you can start from the the late 1800s on an old charts and you can actually see this repeating over and over again human beings don't learn very well unfortunately and and that's why so daniel no sorry daniel crosby yes said in the behavioral investor and i like to quote him saying that your brain is outdated um impatient and hungry so you mentioned that the brain is outdated or danielle mentioned that the brain is outdated impatient and hungry that's a bold statement to make so what are the ramifications of this yeah that's not uh that's not fun to hear and actually if you think of your brain it was formed about 40 000 years ago in a very different environment than we are now and it actually stopped growing when we did discovered agriculture because we we became a one-trick monkey and and then just repeated the same thing didn't learn all these new um things we needed to learn we improved but not that much and it's gonna take years for us to get used to concept like um compound interest a compound interest in our brain i'll show you an example later on that is like stunning like it shows that we don't understand that and other stuff like our brain is impatient and it's impatient also because it's hungry so it uses 25 of the energy that your body produce so as soon as it can go into idle mode it can take a pause it will so it's gonna jump to conclusion and i got a good example here uh you got a the uh and it comes from a um a book called think fast think slow and think about a ball in a baseball a baseball so a ball and a bat sorry the uh the bat is one dollar more than the ball together they're a dollar ten how much is the bat and the average person will answer that the the ball is ten cents but no because if you go 10 cents plus a dollar that's a dollar 10 plus 10 cents that's a dollar 20. the answer is a dollar is five cents for the ball a dollar five for the bat and that's together that's a dollar ten and that shortcut that we took is even more um i would say scary thinking that you know if you're if you went through the process of getting college degree or in my case a cfa you know how important it is to verify your answers we won't so human beings don't double check themselves most of the time and it's so crucial that's a typical mistakes i i everybody answers ten cents and say yeah that has to be it and don't even verify so it's very very scary scary for me yeah that is kind of scary so you're establishing that we're very poor at understanding compound interest now why would you talk about this in a presentation about options and beginners hopefully you have some solutions for us right yeah so uh let me give you the compound interest example so i'll borrow a hundred dollars from you at four percent interest right so a hundred dollar four percent daily interest so every day i'm going to give you four bucks plus and then it's going to compound so how much do i hold you after 30 days 60 days 120 days or a full year 365 days well if i ask you that and i'm not going to put you in a bad spot on camera here but if i ask you that you're going to go okay 30 days i can pretty much figure it out the answer is 324. 60 days that's a little more than a thousand bucks i can get that 120 you're gonna start to have serious issue it's thousand sixty six dollars but if you go a full year the answer is 164 million so forget it like nobody's even close to that number and i typically ask people i said why don't you just come up with a number and then and then when they do as i multiply it by 20 and you're not even close and i'm right most of the time so it's really hard for people to come up with a real number and so the ramification of that is what i mentioned before um we go for the home run instead of going for the um having the the little gain that adds up so that's what you want as a trader you want those little gains that add up slowly and and then how you become rich is by growing your capital and it's not by hitting a home run every five years and yes home runs are great but they're very dangerous and if you're wrong they typically very costly yeah so let's get into some more of those mistakes those common mistakes that options traders should avoid i know that you have some solutions as well right yeah so the thing is the bottom line and we don't like to hear that but human beings are make very very poor traders so uh one thing um we do is we tend to cut our profits very very short and take our law and drags our losses forever and there's a saying that says that the uh amateur loses money by taking two large losses but actually pros lose money by taking two small gains so and it's something that you have to combat all your career the second thing is we try to uh to maximize the amount of time we are right instead of the returns what do i mean by that is for people it's very very important to be right when they trade and not really if they make money so that that's very and some people less scrupulous people are taking advantage of this weakness by selling uh program um like credit uh call and put spread where they promise you you're gonna be they're gonna be right like 95 of the time yeah but 95 times in a row you're gonna make 25 cents and the five time you're gonna lose you're gonna lose five bucks uh you're not gonna make money this way like and they they are the most expensive services on the internet so be very careful about that the second thing it makes uh from people um the covered call and i'm not saying a covered card is a bad strategy but it makes it very appealing to the human brain to to and it's an easy way for people and it's often how we use as professional when we try to get people to trade option with us that's the first thing we sell why because it's kind of easy and same thing because it increased the probability of you being right not of you making a more money and that's the problem and the last one we have this thing about breaking even like we always come back to uh i assume how many times did you hear people saying as soon as it come back to where i paid i'll get rid of it and i'll buy something that's going to go up why why why this thing just get out of it now and actually you know most of my i have many systems that i use or process that i put in place every day um one of my favorite one uh so my two favorite one one i take every loss that i have every position that i have in the in the morning at night sorry i get out and the other one is every friday so every monday morning when i show up i'm all green like everything i own is it profit and i love it it's like the best position to be in and as because of psychological side is so important i'm protecting my capital and i'm protecting my ego and my my my joy of trading my love of the game and it's very very important so the solution for that are simple so trading is about knowledge it's about knowing yourself learning these these bias that we have fallacies that are so-called are called and once you learn about them is recognizing as as they come to you because they will always do i made terrible mistake this morning like horrible and what did i learn from it nothing something i knew and i just did it again and so but now i know what it is and i can't panic it's just okay it's the past it happens to me every six months and i do something stupid but now it's gonna pass and the second thing is your rule your training should be mostly rule based so the rules are should be set up ahead of you doing a trade you should know what's going to happen in all occasions not going by your guts because your gut is going to do the uh wrong thing it's about knowledge it's your brain that knows what to do if you learn how to do if you spend the time watching videos like this because you want to learn well start by learning about yourself what the what are the wrong things you're gonna do next time you have a chance to take a profit it's very important i guess no matter how much you talk about it i still think about that home run what's so wrong about going for that home run you only need to score one big shot right yeah i wish and it does happen right so you're gonna have a few home run and and the more trades you have more chances you're gonna make money and and and but as soon as long as you can keep those right and not lose a ton of money and the problem is trading is not a sprint it's a marathon and so it's about getting that process and organize it and having an a a work ethic that's going to make it that you're going to repeat it and over time you're going to make money and once in a while you'll hit the mini home run but you're not going for those big big big home run and the reason for that is because that same slides you guys all know about that if you lose money the amount of effort it takes to make it back is huge so uh you should never um if you lose like 20 of your portfolio you need to make 25 in order to make it back right and that's that's really hard and so last year a lot of people lost 30 of their portfolio and they were lucky because the market came back or lucky or good and whatever it is but the market came back it could have not right and it came back because of the reaction of government and a lot of people are saying all they're doing is pushing it forward so if your portfolio is located like in my career what seven times i saw that more than 30 loss so if you lose 30 you need to make almost 43 just go back to where you were and in trading it's not that easy making 42 so you should always focus on your capital capital is key yeah so the big solutions are first of all learning to trade and and learn money management so don't don't skip like i said earlier the brains tend to skip uh apart just coach for it second thing is a rule of thumb never lose more than one percent of your portfolio on one single trade and people when you say that oh you're crazy no no that's mathematical it's been proven time and time again any large trader is going to tell you that's how it works the thing is one percent doesn't mean you have ten thousand dollars you only invest a hundred bucks is you can have a three thousand dollars position but on it you cannot lose more than a hundred bucks so that's the amount of money you would lose um the other thing is um you have to learn to take a profit and when and how because that's the thing this is one one of the psychological psychological effect of trading is you we tend to fall in love with the trade that gives us great return so we never get rid of them and we have popcorn like the trades that go really up and then they come back down and all this money is gone so you have to learn to take profit and obviously taking losses the job of a trader is taking losses and whether we like it or not we're going to have more losers most people have more losers than winners but those losers are going to be small losers and the winners are going to be big winners and that's how you actually grow capital and that's the problem so if if you had to um to um to think of solution um it would be take the time to learn the platform don't be afraid to trade in a simulation environment so most platform offer you the ability to trade in a simulation environment there's a lot to be learned by not losing real money and that's word so take your time take your time to learn an option properly you don't need to know everything about every greeks but you want to have some understanding on how it works if you're going to get an involved option and again so playing options is the best game so i always say that basically when you um when you trade stocks it's like playing checkers it's fine but you have the options on it it's like playing chess and it's a lot more fun i don't know the last time ryan you played checkers but unless you have young kids i'm sure it's pretty rare and and then um take the time to write your trading plan and by writing a trading plan you're going to know where you're going so it's like a business it's like having opening up a shop you're going to have an inventory of it you're going to figure out the profit per inventory you're going to figure out the hours you're going to trade how much when when you're going to put things on sale because they're not moving fast enough and stuff like that everything should be in the plan and then when you trade try to journal you're going to speed up your learning like you have no idea write down how you felt because what you're trying to figure out is who am i as a human what are my flaws so you write down every trade and why you did it and how you exit it and how you felt at the time and then finally take the time to plan each trade and trade the plan yeah i love all these items that you brought up it's such so many things to remember if you had clothe to remember one and only one of the things which one would you choose and you asked me if i just said a lot of things you asked me if the one thing to remember plan the trade and trade the plan don't don't get into something without a plan to exit whether it goes well bad or it doesn't do anything because then you're gonna rely on your emotion and you're guaranteed to lose yeah emotions in life like in trading are are hard to depend on yes so claude let's get very specific to the mechanics of an option trade what are some option trading mistakes that come up for beginners when they're placing their trades um so the first one is one that i um i struggled with it's hard to put a stop uh when you buy an option so one of the one of the way people do that when you say let's say i don't want to lose more than a thousand dollars what they'll do is they'll buy a thousand dollars worth of out of the money calls and that not that's not necessarily the best way to to profit from from from this um the um it might be a little better than um than keeping uh having more in the money and then just putting a stop somewhere and i know it's hard in some option market to put an actual stop in the market but some people do it and it's doable so let's say you buy something at three dollars and then you say when it touches two i'll get out of it uh so that's one very hard one and i think it's for everyone i i have yet to find the actual solution for this then we tend to keep low probability option as as lottery ticket and you know if there's 50 70 100 125 bucks in it an option and you can still get it like get out of it and and and take that money it's going to pay your commission for for a while and so how many times do those lottery tickets actually pay and my my experience actually is not very good in that so maybe some someone is luckier on that side we also used to um only one strategy with options so once you learn um to do one training it works for you it's it takes a long time for people when it stops working to actually switch so a lot of people start with covered right and they'll do that forever and and they'll do that in a bull market where volatility is so low and it makes no sense to do that instead of like it take instead of being more flexible on what they do we either also use options as speculative or income but you know you could use them as protection you can use them as as as a replacement there's many other ways you can use that and we have recency bias and that's one of the reasons is we always remember where we were successful lately and we think it's going to repeat but no so environment change and we have to adapt the and as i mentioned earlier we tend to go for the out of the money when we buy options and what you do is you're actually you're you're paying very expensive for gamma and but you don't have a lot of delta and that that they'll you'll make money if it goes in your way but it's going to take a while and and sometimes you know the movement is not going to be as large as you think and you're not going to profit from the movement so sometimes it's better to uh buy more in the money or sometime a call spread or starting with an option that's more at or in the money so imagine you buy a you have a stock that's trading at 50 and your goal is going to go it's going to go to 260. and so people will have a tendency to spend a thousand bucks on 54 calls uh but the reality if the stock goes from 50 to 54 you're probably not going to make a lot of money if if any especially if it takes a while uh where if you add more in the money option you will already be making money and there would be ways to recuperate some of your investment so uh again so it's this concept of lottery tickets so they seems cheaper but they are cheaper for a reason because their probability of success are much lower and i i see that a lot like people go for the out of the money instead of and what i see from a lot of professional trader are 70 delta so people going for options are already have a delta of 70 so if the stock goes from 50 to 51 they will make 70 cents and already if it goes from 51 to 52 they're gonna make 72 cents now 73 75 and soon enough for every dollar that the stock is going to go up they will make a dollar where if you bought the 54 at 54 you're still making only 50 cents per dollar that it moves so that that's the big difference i i understand it's really hard to to to understand and to learn so need you need to live both of them that's what i would suggest like if you ever have in a situation like that buy a call spread and buy a 54 and compare them and live the experience and you'll see they're quite different so we have a lot of mistakes to avoid and that's good any misconceptions about options that we should be aware of as well yeah the first one is um you need a big account to trade options uh and it is no so not true and i find actually quite the opposite people that don't have a lot of capital i think would be better off trading options not only because of the leverage and because of if you're buying an option your guarantee guaranteeing the amount of loss you're gonna have um and uh i mentioned today a mistake that i did uh the mistake was entering a trade i should have not and for the wrong reason but also i had slippage so my stop was executed way lower than it was and i had like a very much larger loss than than i was i could have expected like five times and an option that's not gonna happen so if you have very small amount of capital you can actually control pretty much pretty well how much money you're going to lose the second thing is you can only trade options in your margin account that is not true you can trade in registered accounts like rrsp and tfsa and they have rules like you cannot sell a put you cannot just do call spread actually you can't do but there's certain things you can do like copyright you can do buying a put to protect your position you can do so that's something that uh people should take advantage of and actually they're pretty flexible when it comes to some strategies like the risk reverse and stuff like that and the last thing is options are too dangerous for me options are very high leverage instrument but it only counts if you don't know how to manage your risk so it goes back to my earlier statement you should learn to manage risk and by by that i mean if it has a if you're calculating the amount of money you're going to lose instead of calculating the amount of money you're going to invest going to be very different and your approach is going to be very different and then therefore once you know how option works they're not more dangerous than any other product to the contrary they can be a lot less dangerous than just buying a stock so we talked about a lot of things today claude did we miss to cover anything um my advice for people just don't go at it alone like get help find peers uh there's options meetup i participate in a lot of them there's a td education program the one you're doing right now that is great like so much knowledge uh the option education days from the montreal exchange um and also if you're gonna buy a service buy a service that teach you out how to go at it and not buy a service that tells you what to do and that's very important when i i mentioned earlier some of the services that send you like buy this sell that that's not what you want to do because you need to discover who are you as a trader and and only then can you actually really profit from it so find system that are going to teach you um actually how to trade and not just buy this and then they don't you don't know their time horizon you don't know where their stocks are you don't know how much money to invest in it it's so dangerous all right great advice thank you so much and for those in the live session we now move on to questions

2021-06-24 05:02

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