I talk to prospective clients every week and one of the "red flags" I am on guard for is unrealistic expectations. Often I find the trader expects to turn his $2,000 account into a million dollars before the end of the year. Other traders have concluded from some of the marketing pitches that losses can be avoided entirely if you just know the "secrets" of adjustments.
Trading options can be very conservative or very aggressive. I am sure I could look back through recent history and develop some very attractive trades along the lines of, "If I had bought this call option just before Apple announced their earnings...". It wouldn't be hard to imagine scenarios where my thousands turn into hundreds of thousands. But is that realistic?
Why Do You Trade?
You may think that this is an obvious question. Certainly, we all trade to make money, but I am asking you to dig a little deeper. Why do you enjoy trading? Do you feel a sense of satisfaction when you have analyzed a particular stock and successfully predicted the market's response? Or is it more along the lines of being excited about making $5,000 in three days?
In my experience, better traders tend to approach their trading like a business - a coldly analytical business. They certainly savor their successes, but they aren't adrenaline junkies - they are serious business people. If a deeper self-analysis reveals that you are trading for the excitement, watch out! That could be dangerous.
The Deception Of Large Gains
Do you understand the natural characteristics of your strategy? If your favorite trade is an OTM debit spread that has a potential gain of 300%, you should recognize the probabilities underlying this trade. This is an example of the classic low probability trade; you may only win one out of ten trades, but when it hits, it is huge. So the long-term pattern of results consists of frequent, small losses punctuated by occasional large gains.
The classic high probability trade has the opposite pattern: frequent small gains with occasional large losses. Neither trade is superior and neither trade will be profitable in the long-term without a robust system of risk management.
Often beginning traders are seduced by the prospects of several hundred percent gains but don't appreciate the low probabilities of success associated with this trade.
Neither trade is superior but the trader's expectations need to be grounded in the underlying probabilities.