Most people enter options trading with big dreams—so why do nearly 90% end up losing money?
Our guide will review this phenomenon and bring some understanding of why so many traders fail to turn a profit when trading options for the first time. If you want to be a part of the 10% of new traders that have what it takes to succeed, we’d encourage you to get familiar with the concepts in this guide and ultimately avoid the fate of the 90%. Learn the top reasons why new options traders lose money on their investments and the steps you can take today to be one of the winners.
To give you a clearer idea of what we’ll be addressing in this guide: most reasons behind the failure rate for new traders are linked to disorganization and going into trading options without any kind of plan or goals in place. So many of the problems we’ll discuss in this guide can be alleviated by getting familiar with how options work and forming a clear plan to attain the profit you desire.
The 90% Statistic—What It Means and Why It Matters
How accurate is this statistic that around 90% of online options traders lose their money? It’s common industry knowledge amongst investors and those who spend a lot of time in the options market. There’s a somewhat ”back-of-the-napkin” logic behind the statistic, where it’s more of a rough estimation that it is an absolutely perfect reflection of the exact number of traders who find themselves losing money while trading online options.
Knowing that around 90% of new traders don’t make it long-term in the options market can help new traders understand the gravity of the risks involved. Knowing that the likelihood of succeeding with online trading is relatively low for the average person is a good way to give newcomers the perspective they need before risking their money in a live trading setting.
The advantage that traders have with modern trading apps is that they can use tools like demo accounts or paper trading simulators to practice trading concepts and strategies before putting their own capital at risk. This practice is a pivotal moment for traders to get a firm understanding of how options work, which strategies are most effective, and how to implement good risk management practices. Traders can use this time to find out if they have what it takes to succeed in options and be part of the 10% of those who can turn a profit.
Psychological BiasThe “it won’t happen to me” mentality can set in easily for newer traders who possess plenty of overconfidence—this psychological bias can quickly turn these traders into the 90% they are sure they will never become. Even when newcomers begin trading with a clear plan and goals in place, there’s still a chance that they will be wrong in their predictions or strategies, incurring a loss. The same is true for seasoned traders with lots of experience. Even they are prone to losses from time to time, though they are much more infrequent.
It’s important to go into options trading with the mentality that you’re going to lose money at some point. The idea that nothing bad will happen to you is simply absurd. Traders who go into trading with a lot of overconfidence can get confused when they begin incurring losses and can either spiral out of control or hit a wall entirely, giving up trading altogether.
The Top Reasons Options Traders Lose Money
Why exactly do options traders lose money when they’re new to options and have little experience? It comes down to more than just limited knowledge (although that’s one of the big reasons), and we’ll delve into the top reasons in this next section. A lot of the success that the top 10% of traders experience comes from being organized and having a trading plan in place. Consistency is the key to lasting long-term in options trading.
Lack of Education and Strategy
The sad story of so many new options traders is that they jump in without truly understanding how options work. This comes down to a lack of education about the subject and a failure to have a solid strategy in place with specific goals. Some traders come into this world with the misconception that it’s a “get rich quick” scheme. While there’s potential for significant returns, options trading carries some substantial risks and is more of a long game where profits are built over the course of time.
Perhaps the biggest reason that most traders fail in options is because they lack a rules-based strategy that has trading goals outlined and specific parameters to be followed. For instance, many traders set up a consistent position size for each investment, establish levels where they’d be comfortable taking a profit or incurring losses, and risk management techniques that leave no room for emotional trading.
Overleveraging and Risk Mismanagement
In the last point, we mentioned the mistake of not having a set position size for each of the positions in your portfolio, but it can also be a problem if you have too much money riding on a single trade or if you have your hands in multiple low-quality trades that don’t promise a decent profit. Greed leads to oversized positions and to traders taking on too many positions, more than they can handle. This mistake is known as “overleveraging” and it can lead to traders incurring devastating losses when they don’t have the money to cover their trades if they go south.
Example
A good way to demonstrate overleveraging and a lack of risk management would be when a trader ends up blowing an account on a few high-risk trades. This means that the trader loses a substantial amount of their money because they took on too many positions, used too much capital for each position they took on, or got into traders where the likelihood of the trade working in their favor was lower than it should have been.
Best Practices
Blowing up an account could be from emotional trading decisions, a misuse of leverage, unrealistic expectations, or a lack of risk management techniques. We cannot stress enough the importance of including the following best practices in your online options trading activities:
- Risk/Reward Ratio: Compare potential gains to potential losses to find out if a trade is worth the risk involved. You can arrive at the ratio by dividing the potential reward by the potential loss. A favorable ratio would be one of 1:2 or higher. A good example of a risk/reward ratio would be using $100 to lock in a profit of $200. You would take $200 in profit and divide it by the money you’re risking ($100) to get to a ratio of 2:1 or 1:2.
- Stop-Losses: To mitigate potential losses (but to do so by having it done automatically so you don’t miss out), use stop-loss orders, which are based on criteria set up around how much the trader is comfortable with losing on the trade. Once a position begins losing value, traders don’t have to worry about intervening manually because they’ve already set an amount they’re okay with losing in pursuit of the potential profit. Stop-loss orders will automatically trigger a sale once the level has been reached.
- Position Sizing: If you’re looking to do the smartest trading possible as a newcomer to the options market, you should only be using a conservative position of only 1-2% of your available capital. Any more than this and you’ll be incurring unnecessary losses. Obviously, you can expand this amount as you gain more experience, have more capital to work with, and develop a more aggressive approach, but it’s generally best for newer traders to adopt this principle.
Trading without a Plan
Trading without a plan can result in a lot of trading that’s rooted in emotions, something that has no room in sound, profitable trading sessions. Working without a solid trading plan with realistic goals, loss and profit numbers in place, and risk management techniques can result in traders and investors going by feeling and relying on their emotions to guide their decisions. And this is a huge mistake.
Options trading needs to be conducted using research and planning. It needs to be rooted in logic and objectivity and not guided by negative emotions such as greed, overconfidence, apprehension, the fear of missing out, pride, or frustration. Being guided by emotions, traders without a plan (or even with a plan in some cases) can rack up big losses because the approach isn’t guided by numbers, logic, technical analysis, or historical price points.
Emotional Trading Example
Chasing Losses/Revenge Trading—This happens when a trade ends up losing a lot of money on a trade and then proceeds to conduct additional trades in an attempt to salvage those losses. A lot of the time, traders can continue to rack up additional losses, digging themselves into a deeper hole than they would have been if they had simply accepted the initial loss and moved on.
Along with having a trading plan with clear goals, traders and investors should also keep a trading journal or playbook where they record all their trading activity including any losses or profits, emotions felt during the trading session, and any strategies used for each trading situation.
Ignoring Implied Volatility and Time Decay (Theta)
Implied volatility and time decay are two major factors that are critical in determining option prices and their profit potential, so traders who ignore them will quickly lose money on their investments. This misunderstanding of how options pricing works can have a negative impact, really quickly.
- Short Options: Because short–term sellers’ positions lose value as the expiration dates get closer, time decay has a positive impact on short-term options, something that’s important for traders to keep in mind when dealing with these shorter options.
- Long Options: When traders ignore IV and time decay in long options, they can lose money, even if the underlying asset moves in the right direction. This is ultimately due to the premium declining in value as a result of time decay and the effects of implied volatility.
A good example of a trader ignoring IV and time decay in a real-world setting would be if they bought out-of-the-money calls without considering theta decay. Because out-of-the-money options have a higher extrinsic value that decays quickly toward the expiration date, this can lead to big losses due to the underlying asset’s price movement not affecting the time decay factor.
Not knowing how IV crush can ruin a trade after earnings is another prime example of a trader not factoring in volatility and time decay into their trading decisions. Following the initial volatility associated with an earnings report, there is often a sharp decline in option premiums as there’s less uncertainty or volatility. This can lead traders or investors to lose money, especially if they are dealing with out-of-the-money options, which are highly affected by big IV drops.
Poor Trade Selection and Entry Timing
Selecting poor trades happens when traders or investors enter positions that will either result in losses or subpar returns. This happens a lot of the time when traders don’t have a firm understanding of the market or lack conducting a proper analysis. It can also occur when the trader is using a flawed strategy.
A common mistake that newcomers to options trading make is jumping in because “it looks good” on a chart. These decisions might not remotely align with market trends or macro conditions, a key example of newcomers misjudging the market or failing to do a sound analysis of the situation.
A few other common missteps that newcomers can make when trading options are lacking the patience to research their investment choices, which can lead to impulsively taking on as we mentioned in the last point. However, this impatience can also lead to taking on too many trades. Too many of these low-quality positions are one of the hallmarks of overtrading, which can produce losses or lackluster returns for traders at a higher cost than was necessary.
How to Avoid Being in the 90%
So, what are some of the steps you can take to ensure that you overcome the growing pains of trading options for the first time and ultimately succeed over the 90% who crash and burn? We’ve outlined what you can begin doing in your trading sessions to ensure that you’re making money more often than you are incurring losses. Being in the top 10% of new traders doesn’t guarantee that you’ll avoid losses, but it does mean that you’re likely to profit more than you’re losing.
Get Educated First
To avoid being a part of the 90% of traders who lose money with options, it’s key to learn as much as you can about how options work. Take time to study aspects of options trading like fundamentals, Greeks, and various trading strategies.
- Options Fundamentals: Study the underlying economic, financial, and industrial factors that influence the price of an asset. Get familiar with economic indicators like inflation, interest rates, or GDP growth. Take financial aspects into account like profits, debt, assets, or revenue. Industry fundamentals include trends in specific industries like growth potential, regulatory changes, or competition.
- Greeks: These financial metrics measure the sensitivity of option prices to changes in factors like volatility, time, the underlying asset’s price, or interest rates. Getting familiar with the Option Greeks can offer traders insights into managing risk effectively.
- Trading Strategies: Another core tenet of getting educated in options trading is getting familiar with the different strategies that you could use in unique trading scenarios. Learn about directional moves like buying calls or puts and rangebound, sideways market strategies like credit spreads. Get familiar with a few of the basic trading techniques before moving on and learning about new ones.
If you’re interested in having an all-in-one trading platform for setting up dynamic trades, executing your strategies, and analyzing metrics like the Greeks and other fundamentals, you should check out our options broker reviews. For some other free and paid resources, we highly recommend perusing OptionsTrading.org, where you can find some helpful guides on trading strategies, how to incorporate volatility or time decay into your decision-making, and learn good risk management practices.
Start Small and Paper Trade
If you’re new to trading options online, you should be taking advantage of demo accounts or paper trading simulators where you can use a virtual balance to practice online trading sessions. Why would you put your own money on the line when you aren’t yet familiar with how options trading works? Use these tools to your advantage to gain some experience and build up the confidence needed to take on a live trading environment.
Once you’ve trained up with a paper trading simulator, it’s time to enter the live trading setting, but you’ll still want to maneuver more defensively. What we mean by this is that, before putting a lot of your capital on the line, you can start with small position sizes in your trades to minimize potential losses.
Develop a Repeatable Strategy
Developing a repeatable strategy also involves backtesting, and simulating a trading strategy’s performance using historical data. Backtesting helps traders assess the viability of a strategy to pinpoint possible pitfalls before risking their capital. Once you’ve figured out which strategies have the most success and if you can repeat that success, you’ve likely found a trading technique or approach that will work well for your goals. It’s only then that you should consider putting your capital in the line in a live trading session.
When you’re new to trading, it’s good to start with small positions, but it’s also key to stick with a few core strategies until you’ve gained more experience to take on more. A few good places to begin would be using credit spreads or simply directional trades with calls or puts. Credit spreads come with a defined risk profile and come with lower margin requirements. Calls and puts are a great way for new traders to speculate on the direction of the market.
Another key part of developing a robust strategy is using strict risk management rules that align with your trading goals. For instance, it’s never a great idea to dedicate any more than 1 to 2% of your total capital to any given position. This can limit potential losses over time. Traders should also use stop-loss orders to exit losing trades automatically to stop the bleeding early.
Control Emotions and Stay Disciplined
Anyone who has had success in online trading will tell you that there’s no room for emotions. Not only do you have to use a trading strategy to succeed, but you must also use objectivity and logic in your decision-making—you cannot rely on your emotions to help you make the right moves to secure profit.
- Remove Emotion From the Equation—It’s always best to stick with your trading plan, but emotions have a way of creeping in when you least expect, especially when something unexpected happens during your trading session. A good way to keep overconfidence, frustration, or fear from taking a foothold in your decision-making is simply to take a break from trading to get perspective and reframe your thoughts back into a more logical and objective state of mind.
- Have Predetermined Exit Rules—Before you take on any trade, it’s key to establish how much you’re willing to take in profit and how much you’re willing to incur in losses. These predetermined exit rules take emotions out of the equation by establishing some boundaries for your trade. As long as you stick with these exit points and follow the course of your plan through, you’re trading based on research and numbers.
- Use Alerts, Not Gut Feelings—Instead of relying on gut reactions to make your decisions for you when notable market events occur, take a proactive approach by setting up alerts and notifications on your trading app of choice. These keep you in the loop on notable market events or when key price points have been reached for entering or exiting a trade. Once you’ve set up your trading parameters, use alerts to keep you accountable to the goals of your trading plan!
Use the Right Tools
Another factor that keeps new traders from making the same mistakes that 90% of new options traders make is simply using the right tools for putting their trading plan into action!
Options Profit Calculator
New traders can visualize their potential gains and losses using these calculators. Input factors like premium, strike price, and expiration date to test out different option strategies, a great tool for newcomers to options trading to figure out which positions are worth their time and money.
Volatility Trackers
Track and measure market volatility using these top-notch volatility trackers. New traders can use these tools to pinpoint market sentiment with certain companies and market sectors, and they can gauge the potential risks that come with these investments.
Backtesting Platforms
New traders can use backtesting to simulate strategies and their performance using historical data. It’s useful to backtest, so you don’t risk capital before testing out each strategy’s pitfalls and viability. To learn more about the importance of backtesting, especially when you’re a newer options trader, check out this article on backtesting options strategies for more information and resources on the subject.
Position Sizing Tools
Traders can use these tools to determine the appropriate size of a financial asset to buy or sell, which is an important part of optimizing your portfolio and managing your risks effectively.
Success Stories—What the Top 10% Do Differently
Let’s take a firm look at what the top 10% of traders are doing–these are the core principles that are responsible for their success. It’s these habits and behaviors that new traders should try to emulate if they want to have a decent shot at becoming the desired 10% of people who can turn a profit trading options.
Traits of Consistently Profitable Traders
There are more aspects of profitable traders that we could mention, but we feel these are the four main habits and behaviors that successful traders emulate that are a great starting point for beginners.
- Focused and Disciplined—Good traders have a plan in mind that they stick to, and they use tools like alerts, pre-determined entry and exit points, and risk management tools like stop-losses and take-profit orders to stay the course.
- Education and Continuous Learning—Traders prioritize knowledge of the options market and make a point of continually learning as they get better at dealing with options. They take cues from traders that have more experience, and they keep trading journals to track their progress over time. You get into trouble when you feel like you’ve learned everything there is to know. It can create a blind spot, which will cause you to stagnate in your approach.
- Always Risk-Averse—There is something to be said for aggressive traders who go out on a limb to grow their profits, but the best traders instead opt for a proven plan that delivers long-term profits with a steady approach. Traders who know how to experience longevity in options trading use a more conservative position size, and they know when to cut their losses early. It’s all about retaining capital and making smaller moves that capture profit in incremental steps.
- Data-Driven Mindset—Another key quality of the top 10% of new traders is that they stay away from emotions, adopting a data-driven perspective on trading. They consult historical price data, and study charts, and have preset limits for how much they’re willing to take in profit or loss on each trade. The strategy is rooted in data, not in overconfidence, fear, or frustration.
Final Thoughts: Don’t Be Another Statistic
Most traders fail due to poor planning, greed, and lack of education. To keep from losing money in options trading when you’re new to the process, try to emulate the attitudes and practices of the 10% of new traders:
- Develop a trading plan that has parameters for loss/profit and uses risk management tools to minimize potential losses.
- Use technical and fundamental analysis to inform your strategy.
- Look at historic price points and study charts to get a good idea of market sentiment or direction. Be sure to use these indicators and tools together to develop a complete picture of what’s going on.
- Make continual learning a priority.
- Adopt new strategies when you can, using paper trading simulators to your advantage. These tools let you practice new techniques and gain experience and confidence before trying those strategies in a live market.
At the end of the day, the top 10% of new options traders succeed with discipline, strategy, and patience. Keep learning as you go deeper into your experience—and avoid shortcuts!
