We want tastylivers to be wise because wise people learn from the mistakes of others. To help you do that we have listed what we consider to be the top mistakes that traders make. These are all easily avoidable and we are convinced that doing so will improve your trading. Tom began by noting that perhaps the biggest mistake traders make is size. They trade too big. “It’s so hard to trade small and everyone wants to trade big.” Tom continued that trading too big leads to fewer occurrences which results in less of a chance that the statistics and probabilities will play out.
Two of the mistakes are related to not trusting the probabilities. By using Delta we can approximate probabilities In this example, we see how Delta can be used to calculate the various probabilities. Once we know the Delta we know the probability the option will expire in-the-money (ITM), out-of-the-money (OTM) and the probability the strike will be touched. Part of knowing and trusting the probabilities is having a large enough number of occurrences so there is less of a chance that a statistical outlier, such as three consecutive losing trades when employing a high probability strategy will impact your results. An increased number of occurrences means the results will be closer to the probabilities. Related to this is the buying of cheap far OTM options. The segment of Skinny on Options Data Science from February 18, 2016 "Buying Cheap Options" showed how only 1% of cheap options bought for $0.05 expired for a profit and only 2% of these options were up more than $100 at anytime before expiration.
Another big mistake made is not sticking to liquid stocks. Illiquid stocks see greater slippage because of wide Bid-Ask Spreads and larger price fluctuations on low volume. When we are trading a spread trade such as a Vertical Spread or a Pairs Trading we want to trade the spread as a spread if there is a market for it. Legging the spread will result in, at best, a small gain and possibly a large loss. Misunderstanding sizing in Futures is not understanding the notional value. It’s easy to get too big too quickly when using Futures if one doesn’t pay attention to their notional size.
For more on related subjects mentioned here see:
Best Practices from August 17, 2015: "tasty Tenets"
Best Practices from July 25, 2016: "The Tenets of tastylive"
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the important takeaways and the biggest mistakes that traders tend to make so you can learn to stay mechanical, avoid them and be successful in your trading.
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