Plan and Practice Your Option Trades
Professional airline pilots use flight simulators. Professional athletes spend countless hours practicing drills and memorizing moves. Professional musicians practice until everyone around them gets sick of hearing them play. And yet somehow, most beginning traders think it is a good idea to simply take an option trade without an instant spent practicing.
Thankfully many brokers have simulation or practice platforms for option trading. For example, at the time this article was published, Tradestation, TD Ameritrade, WeBull, E-Trade, and Schwab platforms did offer simulated trading accounts. Strangely Fidelity and Robinhood did not, so there is room for improvement. However, you don’t have to wait for your broker to implement a simulated trading environment. You can get a long way to simulated results even capturing your trades in an offline spreadsheet or even an unplugged, old-school paper notebook.
In doing so, you’ll want to be as conservative as possible about what trading prices you record. Use live quotes and record your entries and exits just one notch worse than you think they might need to be. Whether capturing your trades in a low-tech environment or a high-fidelity simulation, there are certain steps you’ll want to take as you practice option trading. These are steps anyone should take when making actual trades in a live market, so it makes sense to begin by practicing properly.
Step 1: Plan where you are going to get out of your trading position, even before you enter the trade.
This is a big mistake most uninformed traders make. The idea that you should simply jump in and initiate an option trade without any concern for how you plan to close the trade can lead to unpleasant endings. It’s not that hard to simply say to yourself or write down your plan for what price you’ll exit the trade in both a best-case and worst-case scenario.
Step 2: Identify whether you will get into the trade using a limit order or a market order.
Most of the time a professional trader will use a limit order to enter a trade, but many of them do recognize that there are exceptions to this rule. If you don’t know a good reason for having such an exception, then it is unlikely that you need to practice with one.
Step 3: Identify the number of option contracts you will apply to the trade.
A good rule of thumb is that you shouldn’t risk more than two percent of your capital in any one option trade–especially if you are using out-of-the-money options to trade with.
Step 4: Identify a real-time quote and watch to see that your trade would have been entered at the price you specified.
Step 5: Monitor the trade until it hits either of the conditions you specified in step 1. Record the results and make notes of anything you learned. Keep a running tally of any hypothetical gains or losses that might have occurred in the simulation.
Step 6: Repeat steps 1 through 5 up to 30 times and check your results. If your simulated trading results do not sum up to a positive gain, then you probably need to keep learning and refine your technique.
Practicing option trading in just this way can go a long way to avoiding unforced errors. Those are the kinds of mistakes that would cost a trader money in real trading but could have been easily avoided with some practice.
We hope that you have enjoyed this 10-part Beginner’s Guide to Option Trading presented by Raging Bull’s Options Academy. Take a minute to give us some feedback about what aspects of the education you liked or would like to see improved. We wish you the best in your trading.
-The Options Academy Team.