forex trader

In a bid to avoid mistakes of our own, this week we look at some some common trading errors and what not to do.

1. Holding on to a position too long.

As options traders we all know that buying options is less risky than selling, however time decay doesn't stop for anyone. Whilst buying an option is a position of limited risk holding on too long can end up an in an option expiring worthless, OUCH! No doubt your broker has told you this before OR if trading online you've figured it out already. Either way here it is again.

The most important thing any trader has is their trading capital and this needs to be preserved. If a trade isn't panning out as expected give serious thought to selling out whilst the option still has some value.

Remember the stock might be worth twice what it's trading for, however if the rest of the market hasn't cottoned on wait until the sector / stock comes back into focus. Then pounce!

2. Rolling options - perpetuating a losing position

Hands up if you've rolled an option in the hope it would expire worthless in the following month - and then one month later it ends up being worth considerably more. Well, you're not alone - but that's cold comfort. Whether you're covered call writing or writing cash covered puts, if your original view on the stock has changed maybe the strategy should change as well.

Look back at some of the big movers of 2003 - AMP, BHP, COH, MBL, XJO etc. If you were involved with any on these over last year, mechanically rolling positions as the covered call portfolio demonstrated was not always the best choice. If there has been a significant change in the fortunes of a company, closing a position and taking time to reassess which strategy is appropriate might just be the best follow up action you ever take.

The same thing applies to long positions. Perpetually rolling long positions, if those options are expiring worthless can be likened to throwing good money after bad. Take note of the market and its assessment of the stock, not just your own view.

3. Sticking to one strategy to the exclusion of all others

Whilst it's not a bad idea to learn a particular strategy, trading one strategy and only that strategy is potentially dangerous. Case in point is the covered write. What's dangerous about that? In a prolonged bear market the value of shares can fall substantially with option premiums providing only limited protection. In a rising market covered writing can also under perform buying and holding.

It doesn't matter what strategy we select there will be periods where it performs fantastically and others where it under-performs. The best protection against getting caught by a change in trend is to recognise that all good things come to an end and that there are other strategies to take their place.

4. Naked writing - the downright risky

Profitable yes, but not for the faint hearted and potentially costly. The fact that writing OTM calls will be profitable 9 times out if 10 means little if on the 10th occasion all the profits and a great deal more are lost. Whilst naked writing has a place in portfolios it's not for everyone and certainly not the novice. If you start naked writing puts or calls remember, they can be bought back and the position closed at any time!