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Option traders must be very smart before they put their money on risk trading options.
In this post I will discuss some things what an option trader must look at before trading.
No 1 question should be – “Does This Fit My Portfolio?”
Before trading you must know your max risk in the trade. If your max risk is more than what you can afford its better to avoid trading. Do not trade against your portfolio size.
No 2 is – “What Plan I Have If My Trade Goes Wrong?”
Do not hesitate to take a stop loss if the position goes against you. However on the contrary traders seems to average out a bad position.
Here is an example. Nifty option bought at 50 goes down to 30. The trader buys another option to average out at 40. However this is a mistake. If you have 5 long trades its foolish to add more bullish trades if the strategy is losing money. Its better to keep some money to go short if the long trade is going wrong. If you do not have money to go against the losing trade no one is stopping you to exit the trade and take a stop loss.
No 3 – Check Liquidity Before Trading
You cannot do business in a marketplace where there are no buyers/sellers. So you must check liquidity of that strike before trading. If there is less liquidity change the strike to trade in a liquid strike. You cannot scale a trade that doesn’t have enough liquidity. If you become a good trader and want to become a full time trader you cannot do that with one or two lots. You may have to increase the lot size to make a substantial income.
If checking liquidity becomes a habit then it will be good for your future. A strike with good liquidity can be easily traded with “Market Orders”. However in strikes where there is less liquidity you may find difficulty getting out of positions even if you are in good profit.
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