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How to Avoid Losing Money Trading Options and Stocks

How to Avoid Losing Money Trading Options and Stocks

Investing and trading expert, Michael Sincere, reveals helpful tips for successful trading.

In January 2021, the options market received a lot of attention because of the price action of GameStop (GME) and AMC Entertainment (AMC). To refresh your memory, a group of traders in the Reddit online forum joined forces to buy thousands of call option contracts (and also shares) on these two stocks.

The result? The prices of both stocks skyrocketed. For example, GameStop rose by over 1,500 percent within two weeks. Those who had bet that these stocks would rise made huge gains on paper. Hedge funds who had shorted (i.e. they bet the price of GME and AMC would go down) lost millions of dollars. One hedge fund lost billions.

It was a David and Goliath story except for the end result: Many, if not most, of the retail traders who had made small fortunes lost most of their profits within days as GME and AMC plunged. This is a common outcome: Many option traders who make big gains quickly lose all of their money.

To avoid losing money when trading options or stocks, consider these suggestions:

1. Sell options quickly.

Unlike investors, who can buy and hold indefinitely, options expire on a certain day and time. That means if you are trading options, take your gains fast. I recommend setting a “time stop” after buying, which means selling the options by the end of the day, week, or month.

In addition, if trading volatile stocks like GME and AMC, take the money and run! The euphoric rise in their shares (because of a “bull raid”) was a flashing red warning flag. By the way, several professional traders and company insiders sold shares within days. They knew this was a rare price spike that would not last. 

2. Don’t be a stubborn seller.

Many traders on Reddit made huge “paper” gains on GME and AMC but refused to sell. It could have been greed or hope, but several made online promises they would “never” sell their stocks or options. Not surprisingly, the prices of both stocks, after rising to unsustainable levels, plunged. Those who stubbornly held their shares or contracts lost all or most of their gains.

3. Don’t sell options on stocks you don’t own.

The biggest losses on GME and AMC occurred when traders sold “naked” calls or puts on stocks they didn’t own, and those who sold stocks short. Although the gains can be phenomenal if right, when wrong, the losses can be infinite. Beginner traders should not use either of these two strategies because of the extreme risks.

4. Cut your losses quickly.

If there was one rule I’d tell option or stock traders, it’s to sell your losers quickly. When trading options, that $300 gain can turn into a $1000 loss if you hold too long. In addition, if a once winning position is now at the “zero point” (i.e. back to even), sell before you have losses. When it’s clear the position is moving in the wrong direction, get out when you have a chance. Don’t let a small loss turn into a major problem.

5. Sell at the extremes.

If you are holding a stock or option position that is so profitable you can’t believe your luck, it’s time to sell, either half or all. I call it “selling at the extremes,” which means that when there are extreme profits, sell the position. The mistake that many traders make is holding winners (or losers) too long without understanding the risks.

Of course there are many more rules than these, all of which are included in my new book, Make Money Trading Options. I not only discuss how to make money trading options, but also how to reduce risk. After all, no matter how much money you make, if you are unable to hold onto those gains, it will hurt you financially and emotionally. Yes, you need to learn how to make money trading options and stocks. More importantly, learn how to keep those gains.

To read more from the author, check out his new book, Make Money Trading Options.
Summary
Article Name
How to Avoid Losing Money Trading Options and Stocks
Author

Michael Sincere has authored a number of investing and trading books, among them Understanding Options, Understanding Stocks ―both now in second editions―All About Market Indicators, and Start Day Trading Now. He has written hundreds of articles on investing for major brokerage firms as well as the MarketWatch column “Michael Sincere’s Long-Term Trader.” Sincere has also made dozens of appearances on radio and television. He was a corporate trainer and an adjunct professor at several universities.