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Option Pitfalls

The Smart Profits Report: Issue #218
Tuesday, June 21, 2005

Option Pitfalls: Avoid These Five Options “Red Flags”
By Mt. Vernon Research Team
Mt. Vernon Research

Sometimes you have to trust other people… When you’re in for surgery and the anesthesiologist knocks you out, you don’t have a choice. You have to assume the staff is not going to insert a Whoopee cushion under your ribs.

When you are just beginning to invest, and especially when beginning to trade options, you will probably do a lot of trusting, too. Even for the self-directed, it is unavoidable, but you still need to be aware of a few option pitfalls.

A few examples:

  • We generally believe the authors of the trading books we read know their stuff… And having read many of them on my way to learning, I can assure you: that’s not universally true.
  • If you go to a seminar, you trust the tips you learn are true. Some aren’t.
  • And even if you subscribe to a trading advisory, you trust your advisor to give you the best of the potential trades he or she finds, not to save the best trades for his own portfolio.

But I encourage you to learn not to trust authors, advisors or “gurus” too much.

Instead, learn to trust your gut feelings, as well… Starting with the five guidelines I lay out below.

Follow With Eyes Wide Open

One of the questions that new subscribers to my options-trading service often ask me is whether they should take every trade I suggest. My answer: I don’t have a black-box system that avers you must follow every trade or you will spoil the golden machine. (And if anyone tries to sell you one, slam the door fast.)

So, on the surface, the answer is “no, you don’t have to take every trade.”

But which ones do you skip? Now, there’s a problem. How will you know unless you know so much you hardly need an advisor?

It has been my experience after interacting with traders for many years that the trades people skip - especially new traders - are usually the ones they should have taken. It’s almost uncanny and certainly against chance how often they’ll reject the best trades.

The very thing that tends to make a new trader nervous is often exactly the thing that makes it a better play. It will be unexpected and you will have a bit of edge going against the crowd because your advisor sees something that others with fewer well-sharpened and well-seasoned analytical tools are overlooking.

Option Pitfalls: Five Signs You Should Skip a Trade

Still, even though I work with new traders all the time, I don’t encourage anyone to depend too much. And I say that you should never do anything that makes you extremely uncomfortable.

So what are the rules for picking and choosing? Simple:

In general, I say that if my service or any other one suggests a trade that seems outlandishly risky to you, you should skip it.

  • If you don’t understand why the advisor believes the trade will work out, you should skip it.
  • If it makes no sense, you should skip it.
  • If it requires more investment than you find comfortable, you should skip it.
  • If you think the premise behind the trade is wrong (and all of us will be wrong sometimes), you should skip it.
  • Now this is good advice, but it is only half of it…

Next time, I’ll talk about the importance of tracking your trades - even the ones you don’t make. But more on that in Thursday’s report… Until then…

Good trading,

Mt. Vernon Research

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