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The 5 Most Dangerous Errors Made by Amateurs When Trading Options

Have you ever lost money trading options before, or has someone told you that options are a

losing game? That's probably because the methods being used to trade options were faulty oroverly simplified. Here are five reasons why the majority of option players fail to make money,

and in turn, why others have been able to be so successful.

1. Inappropriate short-term selection methods

Selecting the right stock (and the best corresponding option) is the first step in successful option

trading. Some option traders will take a situation they just read about in the news as an option

play. Others tend to look at longer-term measures like a stock's valuation as an indication of astock's short-term potential. This mismatching of timeframes is one of the biggest mistakes made

 by those who trade options. DiligenceWorks’ unique Watchlist sorts through a large list of 

stocks, in order to pinpoint only those situations which look most attractive for sharp short-term

movements. The methodology used is based on not one, but most of the key short-term factorsthat drive stock prices -- technical, monetary and sentiment.

2. Betting against trends

Trends in prices, whether up or down, have a tendency to last longer than people expect. Mosttraders lose the bulk of their money trading against trends. We've specifically developed our

indicators and disciplines to tell us not only the nature of the trend, but also if the trend will

continue. Thus, our approach in buying options with the trend allows you to trade on the right

side of the market.

3. Inability to take a loss

Sure, everybody loves to hear about gains and profits, as this is what we all seek to achieve.While "loss" has negative emotions attached to it, the key is not to be emotional in trading, but

rather to stay objective in all trading decisions. If the market is not validating our analysis, wehave specific exit rules to get out of option purchases before their expiration, so that big lossescan often be avoided and capital can be preserved for future trades which are likely to be more

profitable.

4. Lack of discipline

Many option traders fail because even when they do have gains, they let them slip away by notknowing when to get out and take a profit. Often, you should be taking a profit when the position

is moving most obviously in your favor. What we’ve been able to teach option traders is that amechanical system for entry and exit prices must be in place before the trade is initiated. We pre-

determine the highest price that should be paid to enter the option, and the subsequent price that,

when reached, will automatically force profits to be taken. This allows traders to prevent profitsfrom slipping away, and enforces the discipline necessary in any successful trading approach.

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5. Poor money management

Every smart option trader knows that even with a winning approach, money management is

crucial in building an account's value. The primary consideration is how much to invest in eachtrade every month. Often, amateur option players come into the business and make some nicegains right off the bat. Then, thinking this is a simple way to riches, they let all their capital

(including all their profits) ride on a subsequent trade that wipes them out. Then they vow to

never trade options again. The answer here is to first know the rules of options: there is greatupside on winning trades, while you can also lose all of your investment in a particular option

trade. Clearly no matter how good your approach, you will never win 100% of the time, and you

should not allocate all (or even the majority) of your trading capital to any particular trade. How

much do you invest? Refer to our Basic Options Lessons series in detail.