Learning to Trade

We all learn to trade by gathering information. The source may be a specific book, a series of lessons, perhaps personal lessons from a friend or professional teacher. One obvious point — often neglected — is that our initial education is biased by the perspective of the information source.

For example, when working with students on their option-trading education, I emphasize that the idea of buying calls and/or puts in an attempt to capitalize from a correct market prediction is a poor strategy. I believe the chances of finding success are almost non existent — at least for the novice. Others preach that buying options is the simplest and most natural way to ‘play the options game.’

Your First Introduction

For the majority of people who are first getting involved in the investment world, the most common practice is to buy stocks. Depending on the source of your lessons, the new investor could come to believe any of the following:

    — Buy mutual funds and let the professionals make all trading decisions in an effort to earn market-beating returns

    — Buy index funds or exchange-traded funds (ETFs) with very low fees and accept average market returns

    — Do your own research and buy shares of individual stocks

      — Blue chips
      — Small growth companies
      — Penny stocks

    — Diversification is (or is not) important

    — Buy carefully and plan to hold for years/decades. Sell only when the stock no longer fits your criteria for stock ownership

    — Add to positions when the stock price dips. This is dollar cost averaging

    — Only add to positions when the stock price rises. This means adding to profitable trades, but never to losing trades

    — Buy for the very short term and never hold positions overnight

    — Buy with a short-term price target in mind and sell when the target is reached

    — Always use stop-loss orders to prevent the painful loss

    — Always grab a quick profit. Or the opposite, let profits run and be very slow to sell winners.

These represent just a handful of the possibilities. It is essentially impossible for the true novice to know how good or bad the received advice is. When we trust our source, we adopt habits that may last a lifetime, even though those habits may be completely unsuitable for us.

The point of this post is to be certain that anyone who learns to trade/invest has to recognize that there are many different approaches and that each of us cannot possibly be successful using each of them. It takes time for us to find our individual comfort zones. For me, I want to help the novice trader learn by adopting ideas that require fewer trades, fewer decisions, and a longer holding period. Not because this is the only successful approach; not because I am biased towards these methods; but because the newer investor/trader has to get acclimated to the idea of investing money into the stock/option/commodity markets and cannot be expected to make the many decisions required of a trader, especially a short-term trader. It makes sense to me for the novice to begin as a passive investor (index funds), and gradually, when it feels correct to this trader, to learn to trade individual stocks. Many investors never get to that point because they remain satisfied with matching the market averages, recognizing the difficulty in beating them. That is a wise decision for the vast majority.

For those moving into the options game, I prefer to see them begin with covered call writing . Not because it is the best strategy, Not because it is ‘safe’. But because it allows time for the new options trader to own positions that work slowly, giving that investor the time to see the effect of time on a position; to see the effect of rising and falling prices on a position. In short, time to watch and understand his/her first option strategy.

Once that is behind the new trade, other less risky strategies can be learned and adopted. Not everyone feels that way and some option teachers jump right into trade ideas that could confuse the newbie. We all teach differently and I want each of you to recognize that conflicting ideas are part of the game and that it behooves each of us to try to discover our individual comfort zones. Sure, ask your source for guidance, but recognize that the answers may be biased towards that teachers individual pet beliefs.

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