In Part 1 of this series on “Trades Gone Wild” we discussed the “Uh Oh” options trade. For those that missed Part 1, we talked about the Uh Oh trade being the trade set up that looks perfect when you enter the trade and everything is going great… and then… “Uh Oh.” You have a quick, and sometimes catastrophic loss. I talked about some of the main reasons this can happen and how you can try to spot potential problems or at least not be blindsided.
In Part 2, we will discuss more of the actual dollar risk of the trade vs the outside environment risks.
Let’s go back to our dilemma in that “something” went wrong with the trade. Is there any way to totally avoid unexpected losses? Of course not, but are there any steps we could have taken to avoid this dilemma? Are there any steps we could have taken to protect ourselves? There are some basic things you should always know as you start a new trade. Here are the basics of loss prevention:
- Realize how much “actual” risk you are taking with your trades – Trading should not be a game or for amusement. Always be fully aware of the max risk you are taking. Options do give you a lot of leverage and that is what draws people to trade them, however, do not focus on the maximum profit you might (potentially) get on a trade, without understanding your risk you are taking.
- Stay on top of things – This sounds simple, but I do see a lot of traders that could avoid problems if they kept a closer eye on their trades. Options trades can move very quickly so you must keep an eye on things. You need to be aware of the overall markets and events that can change quickly. If you are going to be on vacation or unable to watch things, close any open trades. It is that simple.
- Anticipate upcoming events – Again, this may sound simple and it is. We covered some of these in Part 1. Do not underestimate the magnitude of earnings, or a FED meeting, or Non-Farm Payrolls, etc. These are market moving events and you should prepare ahead of them if it negatively affects your trade. If the event is a very large event such as a potential interest rate hike FED meeting, I would consider closing some positions ahead just to be safe.
- Don’t wait too late – Once you do realize your trade is going against you or just not working, be proactive and close it or make defending moves. Don’t pretend the danger is not real. Do not put your head in the sand and ignore the problem, it will not go away in most cases.
- Don’t panic – This is easier said than done. When you do realize things are not going well, keep a level head, thoroughly evaluate your choices and make a clear decision.
These steps are some of the basic things you can do to help prevent losses or reduce the initial risk of the initial trade entry. If you have used these steps and still find yourself in trouble, you may be able to defend or adjust a trade and “save” it.
I will be following up soon with Part 3 of this topic to take this “trades gone bad” scenario and dig a little deeper. I will look at some basic steps to consider when you do find yourself in a losing trade. Until then, good luck and good trading.
See more of Bruce Marshall and his daily commentary, trade recommendations & analysis at Simpler Options.