How to Prepare for Options Trading
If you are going to be successful in your options trading endeavors, then it's absolutely vital that you are properly prepared. The importance of preparation isn't really unique to options trading; no matter what form of investing or trading you are doing it really is essential to be fully prepared.
Anyone that starts trading without the right preparation is almost certain to fail, unless they are incredibly lucky; relying on luck isn't a good recipe for success. Good luck will only take you so far, and it's much better to dedicate some time to getting yourself completely ready before you get started. That way, when you do actually begin you can rely on yourself, your knowledge, and your skills to make money.
Time that you spend on preparing yourself will prove to be time well spent. If you have a clear idea of what you are doing, know what you are trying to achieve, and have a detailed plan for how you are going to reach your objectives, then you are far more likely to succeed. On this page we explain the processes you should go through to ensure you are fully prepared, specifically covering the following:
- Taking the First Steps
- Defining Your Objectives
- Writing a Trading Plan
- Simulated Trading
Taking the First Steps
The first step you should take before putting your money on the line is to make sure that you know everything you need to know about options trading. This doesn’t mean that you have to know absolutely everything that there is to know about options and how they are traded, but as a minimum you should be familiar with what is involved, how options work, the different types of contracts, and the different types of orders.
You should also have at least a basic understanding of how spreads are created because, they are the primary components of all options trading strategies. You'll also want to be aware of the most important terminology that is used.
We would strongly recommend that you read through our Introduction to Options Trading and our guide to the Basics of the Options Market & Options Trading. If you have already read these, then you will know the essential information that you need to know at this stage. There's still a lot more to learn, but most of the more advanced concepts and subjects can be learned as you go along.
If you haven't read these sections because you feel you already have good understanding of the fundamentals of options trading, we would advise that you at least have a glance through them to ensure that you are familiar with everything that is covered in them. You should also take notice of our Glossary of Terms because, that's a useful reference tool for when you are unsure of any terminology or jargon that you come across.
Once you have the necessary knowledge base, you are ready to move on to the next step and should start considering your own personal circumstances and how they will affect what you are going to be doing. You should especially be thinking about how much time you are going to spend on your trading: not just in terms of actually placing your orders, but also in terms of doing your research and analysis and planning your individual trades.
You should also work out how you are going to carry out your research and analysis. You will also need to decide how much money you are going to invest; with your starting capital, you will have to decide whether or not you will be adding to that starting capital as you go along. These are the sort of considerations that will help you put your trading plan, which we will talk about later.
Defining Your Objectives
The next part of your preparation is one of the most important things you need to do before starting out; defining your objectives. There is no point getting involved in options trading unless you have a clear idea of exactly what it is you are hoping to achieve. It's somewhat disingenuous for your objective to simply be “to make money” – you really need to be a bit more precise than that.
If you are starting out on a part time basis while holding down a job, then your first goal may be make enough money so that you can leave your job and trade full time. If that is one of your objectives, then you should know how much money you need to be making for that to be a reality and how much money you need to have set aside for emergencies. If you are going straight into trading full time, then you should have a target for how much money you want to make on a monthly basis.
Whether you are looking to supplement your existing income or replace it doesn’t really matter. Your objective could even be to put a little bit of extra money aside each month to help fund your retirement or your children’s education. The focus here is to make sure that you do have objectives in place. If you know what your goals are then it becomes much easier to put together a plan that can help you achieve them. You also have something to measure your success against.
If you don’t know what it is you are trying to achieve, then it's impossible to know if you are on the right track. Ideally you should have short term goals and long term goals, and they can always be flexible if your circumstances change. You just need to be sure that you always have something to strive for because, this will also help you to keep yourself motivated above anything else.
Writing a Trading Plan
Once you have followed the above steps, the next stage of your preparation is to write your trading plan. This is a vital part of the groundwork you should do before you start, and this is something you should definitely put a great deal of ime and effort into. While defining your objectives gives you something to aim for, it is your plan that lays out how you are going to acheive those objectives.
With a clear trading plan you are basically setting yourself your own guidelines for how you will approach things and providing the parameters for what you will do, when you will do it, and how you will do it.
There are a number of points that you should be aware of when it comes to writing a trading plan. First, there aren't really any rights and wrongs, other than the fact that it's right that you prepare a plan. Your plan will be personal to you, and it should reflect your own circumstances, your own objective, and the best techniques for you to achieve your objectives.
Secondly, you really cannot and should not underestimate just how important it is to write a trading plan. So many investors and traders don't bother with a plan and just dive into things without any clear direction, which invariably doesn’t turn out well. A good plan can help you avoid a lot of the mistakes that beginners make, and assist you in maintaining a strong focus on what you should be doing and when.
It should also be noted that any plan you write can be adjusted in the future. While it is important to follow any plan that you have in place, it can change over time. For example your circumstances may change, perhaps meaning that you have less time to spend on your trading, and so it's only right that you should amend your plan accordingly.
Also, as you gain more experience you might decide to start using a different approach, you may choose to use more advanced strategies. Again, you should make the necessary changes to reflect your new approach.
In reality, your trading plan should be under constant review and you shouldn't be worried about making any adjustments that may be required. You just need to make sure that you do stick to doing whatever the plan you have in place suggests you do.
Although, as we have mentioned, there are no specific rights and wrongs to writing your trading plan, there is a certain framework that you should follow in terms of the elements that should be included. Below, we have listed the important elements that you should feature.
Trading Objectives: This is probably the single most important part of your trading plan. There are a number of reasons for having clearly defined objectives, most of which we have already mentioned above. Objectives give you something tangible to aim for, and they help you keep focused and stay motivated. You should include any short term goals you have set yourself, in addition to your longer term ambitions. You should also incorporate some form of timeline for when you plan to hit your main targets.
Managing Time: Good time management is a big part of successful options trading. Although it may take only a few moments to actually make a trade, there is a lot more involved than just the placing of orders. However much time you have available for your trading, you should make sure that you allocate enough time to do everything you need to do: including carrying out research and analysis, and planning your trades. Ideally, your plan should stipulate exactly what you are going to be doing and when.
Researching Potential Trades: To give yourself the best chance of making good decisions, you will need to carry out a fair amount of research to try and highlight suitable opportunities for potential trades. Your plan should include what sort of methods you will be using to carry out this research.
Managing Risk and Capital: You should have a clear idea of what level of risk you are comfortable with taking and how much starting capital you have to invest; this should be reflected in your plan. You should also explain exactly how you will be managing your risk exposure and how you will manage your budget.
Selecting Trades: Somewhat obviously, a key part of options trading is selecting what trades to make and when to make them. Your plan should lay out your process for doing this.
Assessing Performance: Assessing your own performance is another important aspect of trading options, but it's something far too many people don't want to deal with. By monitoring your trades and keeping track of your results, it's much easier to see where you are making mistakes and where you are getting it right. In return, this will help you improve your skills which should ultimately help you make more money.
If you can put together a detailed plan that includes all of these elements, you'll already be in a far stronger position than a lot of traders who don’t put in the required time and effort to be properly prepared. While it is by no means a guarantee of huge profits, it will certainly give you a much better chance of being successful and meeting your objectives.
If you are unsure about how to approach some of the things listed above, please keep reading through this guide to getting started, as we offer advice on a number of these topics later on in this section.
If you want to start options trading feeling fully prepared and with a lot of confidence, then you may want to consider a period of simulated trading, or paper trading. This would basically involve spending a period of time following your trading plan, but only making theoretical trades – i.e. you do everything exactly as your plan stipulates but rather than actually making the trades, you just keep a record of what trades you have made and at what price.
By doing this, you can see how your plan works out for you before investing any money. This gives you a chance to fine tune your plan and the strategies you are using, if necessary, and the confidence to know that you are doing the right things at the right time.
You can paper trades simply by keeping accurate records of the theoretical trades you are making. However, you will find that a lot of the best online brokers have simulated trading platforms that allow you to make hypothetical trades in the same way that you would make trades in the normal way. They will even keep your records for you, so you can easily get an idea of how you would be performing as long as you were following your trading plan.