We talked last week about the, shall we say, "long and winding" path I took to making 50 times my money. I deposited $100,000 into a trading account, and that account ultimately grew into $5 million.
It took a long time - most of my twenties, in fact. And now that I've made it, now that I'm working an hour a day and living the life I've always wanted, I sure don't mind telling you...
I screwed up big-time along the way - many, many times.
I mean, I lost a bundle. So much it knocked me out of the market for a while. I left the country, booked up at a Buddhist monastery in Thailand, and taught English while I cleared my head and analyzed what went wrong.
The good news is you don't have to make the same mistakes I did. What I have to show you today will save you a lot of heartache - and a ton of money, too.
"School" Only Gets You So Far
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When I first walked out on the Chicago Board Options Exchange trading floor, there were hundreds of brokers running around, throwing hand signals, and shouting orders.
It was relentless, barely controlled chaos, and to top it all, I had to jump in headfirst. I had to trade fast, I had to trade smart; I couldn't make any mistakes.
I was lucky. When I was on the floor, a couple of veteran traders took me under their wing. They taught me how to make serious money working the floor.
But even that kind of education can only take you to a certain point. I still had a lot to learn... and, as I hinted a minute ago, I learned a few of these lessons the hard way.
Hard Knocks Lesson No. 1: Dumping (More) Money into a Losing Position
There's a famous saying in the market that goes like this: "Cut your losses short, and let your winners run." It may seem like common sense, but in reality, not doing this is one of the biggest mistakes new traders make. Philosophers and logicians call this one the "sunk cost fallacy."
Many times, when new traders are hit with a losing position, their emotional reaction is to put more money into the trade in the (almost always vain) hope of saving it.
But pouring good money after bad... Well, it's much like trying to dump water out of a sinking ship with a bucket - pointless and exhausting. And instead of wasting all that energy, you'd be better to jump ship and find help nearby. And it's the same for trading.
When a position turns south, don't let it continue to "sink." Sell the position, and preserve your capital for your next profitable opportunity!
Hard Knocks Lesson No. 2: Lowering a Stop-Loss
Growing up, my dad told me, "AK, always trust your first instinct. It's the only superpower humans have." I did my best to listen to him, but as a rookie trader, I fell short sometimes. Ouch!
This sentiment applies to trading, and it can help prevent you from making one of the costliest mistakes new traders can make.
Ever heard of a stop-loss?
In case you haven't, a stop-loss is an incredible trading tool when used correctly; they're designed to limit your losses. When you place an order, you set a stop-loss to sell when it reaches a certain price, which can protect you from losing as much money on a sinking position.
Sounds great, right? And it is - except when emotions make their way into your trading.
Having conviction in a trade you are making is important, and when a trade you believe in has continued to move down, it can be easy to think about moving your stop-loss. Because what if it's just moving down before it explodes?
But here's the thing: There will be plenty of other trades out there. So when you see a trade moving close to your stop-loss...
Let it hit your stop-loss!
Cut your small losses (which could have turned into big losses if you'd moved that stop loss), and move on to the next lucrative trade.
Hard Knocks Lesson No. 3: Not Taking Profits While You Have Them
This might be kind of hard to believe, but there's one skill you can learn in trading that's arguably more important than knowing how to pick the right stock to buy...
And that's knowing when to sell.
There's a common saying on Wall Street: "Bulls make money; bears make money; and pigs get slaughtered." And it's the truth. Being greedy in the market can leave you with some big losses and regrets. And while selling at the right time sounds easy on paper, it's much harder to follow through when it's your money in the trade.
Imagine this: You check out your portfolio midday, and one of your positions is on a run in the green - you're looking at a nice-sized profit. It would make sense to just take your money and run, right?
But what if you cash out, and the rally continues? What if this is your big-break position?
Sound familiar?
I get it.
But those profits aren't real until you take them. A profit on paper doesn't matter if you never actually pull the trigger.
And even if you do end up selling in the midst of a rally, remember: A gain is still a gain. And even small gains add up in the end.
It's kind of like going to the gym when you don't want to; no one ever regrets actually getting in a workout. It's just getting there that's the hard part.
Hard Knocks Lesson No. 4: Listening to the Talking Heads (the Guys on the TV)
I'm going to go ahead and address the elephant in the room: I know I'm on TV here and there.
Thing is, I'm the exception! Just kidding... but I do say this for a good reason.
If you turned on the TV and watched all the different financial news networks, each one would tell you something different.
One may be screaming about a recession; the next could be calling for market highs; and the third could be telling you to stay away from the markets altogether.
They may be perfectly smart people; they may be absolutely right! But they don't know your trading game plan or your goals, and they certainly don't care about your bottom dollar.
Hard Knocks Lesson No. 5: Buying an Option Too Far Out of the Money (OTM)
It's easy to see a cheaply priced option and follow your knee-jerk reaction to buy it - but it could hurt you in the long run.
While cheap options can be very lucrative, cheap out-of-the-money options are not a trader's friend.
Now, just in case you're wondering, an out-of-the-money option is where the strike price is not where you want it to be in relationship to the current price of the underlying security. So for a call, if the strike price is above the current stock price, it would be OTM. And it's the opposite for a put, so if the strike price is below the underlying security, it's considered OTM.
And OTM options are typically priced cheaper than their in-the-money counterparts, catching the eye of beginner traders.
But what looks cheap isn't always a good deal. Like always, some things are cheap for a reason.
I'm not saying that OTM options can't yield large returns. They absolutely can, and that's part of their allure - but there are strategies out there that can hand you nice returns and protect your bottom dollar. I'll show you some of those as we go along.
Hard Knocks Lesson No. 6: Not Paying Attention
I could go on for days about the importance of situational awareness, of what's going on in the markets. I've even written a few books about it. Simply being aware of unusual moves helped me grow my account to $5 million.
Every day, millions of shares fly back and forth. Most are for a few dozen, a hundred shares, tops. But every so often, some extreme and unusual moves get made. That's what catches my eye. Say some big investor somewhere in the world buys 10,000 shares of Kraft Heinz Co. (NASDAQ: KHC) - yeah, the folks who make your kids' mac and cheese. That's a $327,800 bet, more expensive than a lot of houses.
Here's the thing, though: Whoever made this bet knows something we don't. It's not like someone would just place a $327,800 wager for no reason. No, there was something going on under the surface, in the boardroom, or somewhere in Accounting. Something that's going to make the clued-up, well-positioned trader a truckload or two of money. If we shadow his or her move, we stand to potentially grab some of that windfall.
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About the Author
Andrew Keene is a globally known trader and a renowned expert on all things options.