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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Develop a flexible investment planReduce Your Stress Level Successful traders have to find ways to reduce the stress commonly associated with trading. I reconstructed my trading style after experiencing more stress than I had thought I could ever handle. In a typical trading day with the S&P 500 (Standard & Poors 500 Index, which represents the 500 largest companies in the United States), I found myself buying close to the high of the day. Immediately the market started to tumble so fast that I was down 100 points even before I got my buy filled (i.e., before my order was executed). I finally was able to regain my composure just enough to pick up the phone in a panic to sell as fast as possible. By then the market had tumbled almost 200 points. Worst of all, I had purchased too many contracts for the money I had in my account; and, to top it all off, it was my first trade ever in the S&P. That was the point in my trading career that I experienced the panic and stress of losing more than 40 percent of my account in three minutesmore than one months pay as an accountant. I did not trade again for more than two months while I tried to figure out whether I could really do this for a living. Luckily, I did start trading again; however, I reduced my trading size to one contract position at a time for more than a year. Many professional floor traders and off-floor traders have had similar experiences. However, these kinds of stressful events must be overcome and used as lessons that needed to be learned. Simply put, stress produces incomplete knowledge access. Stress, by its nature, causes humans to become tense in not only their physical being but also their mental state. For years, physicians have made the public aware that stress can lead to many illnesses including hardening of the arteries with the possibility of a heart attack or other ailments. Reducing stress can lead to bigger rewards and can be accomplished by building a lowstress trading plan. To create your own plan, follow this three-point outline: 1. Define your risk. 2. Develop a flexible investment plan. 3. Build your knowledge base systematically. Define Your Risk As a trader you have the ability to make large profits with the risk of potentially large losses. This is no secret. Unfortunately, that old maxim cut your losses and let your profits run is easier said than done. By defining your risk, you are assured that you cannot lose more money than the amount you have established as being the maximum position loss. You will also be able to develop strategies that create the potential for large rewards by predefining your acceptable risk parameters and by applying strategies that combine stocks and options on stocks, or futures and options on futures. Develop a Flexible Investment Plan The second step in reducing risk and stress is to develop an investment plan that is flexible. Flexibility allows a trader to cultivate a matrix of strategies with which to respond to market movement in any direction. Erratic market movement can change your position dramatically in seconds. Each price move (tick) rearranges everyones assumptions about what the market is about to do. This dynamic environment borders on schizophrenia, where the bulls and bears do battle trying to outmaneuver each other. This, in turn, creates profitable opportunities for the knowledgeable investor with a smart and flexible investment plan and creates nightmares for the uninitiated trader without a plan, only a hunch as to where the market appears to be going. Investors and traders have to be entrepreneurial by nature to survive. One of the greatest attributes of entrepreneurs in any industry is the ability to recognize a roadblock and change direction when one is reached. Traders must also exhibit this flexibility if they are to survive in the marketplace. Build Your Knowledge Base Systematically The third step to creating a successful investment plan is to systematically build a solid base of innovative strategies from which to invest wisely. Most investors start the same way. They read a few books, open a small account, and lose everything very quickly. However, there is one way to differentiate the winners from the losers. Winners persist at learning as much as they can by starting slowly and collecting tools to beat the market consistently. Successful options traders first learn to walk, then to run. Usually traders begin with simplistic strategies such as going long or shorting the market, and using stops to limit losses. Some just listen to their brokers and follow their trading ideas. Once initiated, traders accelerate their learning at the right time to become successful. Successful traders usually specialize in one area or just a few areas. This specialization allows the trader to develop strategies that consistently work in certain recognizable market conditions. A successful investor realizes that, in all likelihood, these situations will reoccur and the same strategies can be used profitably over and over again. At my alma mater, Harvard Business School, the same systematic approach is used. I never realized what the school was attempting to accomplish until after graduation when I had time to apply this approach to the real worldall those case studies on businesses I had no interest in fostered my ability to learn how to think in any environment. This systematic building of knowledge will enable you to quickly get up and running as a successful trader in the marketplace. CONCLUSION Options, the most flexible financial instrument that exists today, provide unique investment opportunities to knowledgeable traders on a regular basis. However, the entire options arena can be a very complex and confusing place in which to venture, especially for the novice trader. The primary reason for this complexity is the fact that options trading is a multidimensional process; and each dimension needs to be understood in order to trade successfully. Prior to initiating an options position, there are three main issues to consider: direction, duration, and magnitude. Direction refers to whether the underlying security will move up, down, or sideways. Duration refers to how long it will take for the anticipated move to take place. Magnitude refers to how big the subsequent move will be. In order to make a profit, the options trader must be correct in all three of these categories. This is the primary reason that many people lose money when trading options. They do not accurately understand the three dimensions of an options position. The first step in taking your options trading to another level is to understand and comprehend the interrelation of direction, duration, and magnitude. Additionally, the trader must use these three different variables in order to provide an edge in the market. It is imperative to be able to combine and exploit these three variables in order to give yourself an advantage; otherwise your trading will become no more than an exercise in giving your money away to other traders. Many times it is necessary to work with combinations of options in order to give yourself an edge in the market as opposed to just buying a call or a put. This is where understanding spreads, straddles, and various option combinations is helpful. There are a few general rules that I always follow when looking for and constructing option positions. The first is that when I am going to bet on the future direction of a security, I want to give myself enough time to be right. That means I will usually choose long-term equity anticipation securities (LEAPS) for directional trades. LEAPS is a name given to options with expiration dates further than nine months away. The second rule is in regard to magnitude or volatility. When combining different options together, I want to be a seller of expensive options (high volatility) and a buyer of cheap options (low volatility). The third rule is that I want to make time my friend as opposed to my enemy by purchasing options that have plenty of time left to expiration and selling shorter-term options. This allows me to take advantage of the time decay characteristic of an option. These guidelines are a brief summary of the issues that need to be understood when building trades that give you a competitive edge in the market. To the beginner, these issues may seem complex and convoluted; but with a little bit of practice everything should become quite clear. If you take the time to understand the concepts of direction, duration, and magnitude, youll soon be able to start experimenting with a variety of different options strategies. For example, if you want to be bullish on a particular stock, then you can take a longer-term perspective by placing a bull call spread using LEAPS. For shorter-term trades, you can take advantage of time decay by using credit spreads, calendar spreads, or butterfly strategies. Increased comprehension of these basic concepts will enable you to combine short- and long-term strategies together to help you become an even more proficient trader. As you build experience as a trader, you will become more confident in your ability to make money. After a few successes, traders are more motivated to develop the perseverance necessary to stay with the winning trades and exit losing positions quickly. In the long run, you have a much better chance of becoming successful when you start by acquiring a solid foundation of the option basics. In addition, keep a journal of every trade you makeespecially your paper tradesas a road map of where youve been and where you want to go on your journey to trading victory. Remember, patience and persistence are the keys to trading options successfully. |
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