The Trader’s Dilemma

Day trading, especially with options, provides many opportunities. However, this also brings a large responsibility to you, the trader. Yes, you have an edge, but an edge only goes so far if you can’t execute your trade plan and not let your emotions get the best of you; much easier said than done. 

As you set off on your options trading journey, you’ll discover the potential for substantial financial gains in the options realm. However, it’s important to remain cautious. Consider this scenario: you’ve just witnessed an options contract skyrocket from $1/contract to $10/contract in just a couple of hours. You had a position of 10 options contracts and were ecstatic when the contract was worth $1.50, and you cashed out for a profit of $500. But your excitement turned to shock when you realized your position would have been worth $10,000 had you held. 

The scenario described above is common in options trading, where contracts can make drastic moves intraday. This is almost a lose-lose scenario: you potentially exited your position early or missed the trade entirely and now have FOMO (Fear Of Missing Out).  While seeing the significant potential gains right before you, it’s easy to focus on the contract’s starting and ending values. However, the emotional journey to the $10/contract mark is often overlooked. The key question is: can you maintain your emotional discipline and stick to your plan, or will you allow your emotions to dictate your actions? The choice is yours, and it’s a powerful one. 

Once the contract’s value starts to increase above a specific value, it’s common for the contract value to make $1 swings in seconds. In other words, it’s common for a contract’s value to fluctuate by $100. Remember, your position is for 10 contracts; this means that your position will fluctuate $1,000 in seconds, frequently. Rather than speak in hypothetical terms, let’s look at Figure 1 below.

Figure 1: $SPX Options chart

We assume you bottom-ticked your entry around 13:00 while the call contract was trading at $1.50. We will also assume you entered 10 contracts; thus, your total position size was $1,500. Looking at Figure 1, your position is almost immediately worth $6,000. However, that is not good enough, and you are set on having a home run trade. What happens next? The contract loses half its value and is trading around $3.00, or your contracts are now worth $3,000. What is the first thing that might come to mind? “Man! I am so dumb; I should have cashed out when I had a 400% game; how could I let this happen to myself?”

That is one of many thoughts that may come to mind. The main question is whether you keep holding or exit for a 100% gain or a $1,500 profit. Let’s assume you exit; what happens? The contract’s value goes up to almost $8,000, and you are infuriated because you could have held and had a solid trade. However, what happens if you hold? The contract value has a nice increase, but how would you know you would have top-ticked the exit? Simple – you don’t. Hindsight bias is a massive enemy in the trading realm. 

It’s easy to kick yourself for not holding, but there’s one pill that is hard to swallow. Only one person is to blame for the lack of execution – you (and me). Before I dive into this, I will say this still happens to me today – getting disappointed in missing out on a major move. It has improved, but I still feel angry at myself for not executing and exiting my positions early. 

Although the discussion was brief, we can see how many rabbit holes our mind will lead us into thinking we could have top-ticked the exit. There are many ways to combat this, but we will start with stocks don’t go straight up or down unless it’s a black swan event. It is rare for a contract’s value to go straight up from $1/contract to $10/contract; thus, there will be an emotional journey along the way.

You may say, “It seems like the times I hold, the stock doesn’t go up, and the times I exit, the stock continues to trade higher.” While this may be true, these negative thoughts are your emotions trying to get you to fail in your execution. There is one thing that you need to use to ease this anxiety – trust your data. If your data supports your edge, and you have a valid reason for exit, who cares what happens after you exit? You have an edge and executed your plan – on to the next. 

Looking strictly at your profit and loss for your exits is a very elementary way to trade. While gains are nice, price action trumps all. You need to focus solely on price action and executing your plan – nothing else. It takes a lot of practice to have tunnel vision, but it is a necessary component of day trading. (It is slightly easier for trading options since there is not a 1:1 relationship between equity movement and stock movement; in other words, you will not 100% of the time know the exact price of your options contract(s)). 

So, where does the dilemma come from? Do you exit or do you hold? Do you go for the home run or exit for a satisfactory gain? There is only one way to have home run trades – you endure the emotional journey and hold onto your position. Much easier said than done. Cue focus on price action and execution and nothing else. 

There is a well-known trader who was featured on a Chat with Traders podcast and had a $1,000,000 trade. When asked how he endured the journey, he said he was so focused on the trade that he didn’t even realize how much he was up. You need to emulate this mindset and focus on good trading and nothing else. The home runs will come. 

The next piece of the puzzle comes from letting your winners ride and cutting your losses immediately (once your trade is proved invalid). Why is it easier to do the exact opposite? Because we like to be right. It is much easier to hold on to a loser, hoping you can end breakeven, but this is a catastrophic mindset. A small loss may turn into a large loss and potentially a blown-up account. 

The stock market, in any regard, requires constant discipline. Hence, why discipline is one of the Three Pillars of Options Day Trading. You have to let your winners ride so as not to mess up your edge. If you cut your winners too soon, because you want to be green, this small decision is horrible for your edge. Watch the video below to see this discussed in more detail. 

Conclusion

So, where does this leave us? EXECUTE. You cannot get distracted from your trade plan. You have to have tunnel vision of the stock and price action. Focus on good trading first, and if the trade happens to be a home run, good for you, but just keep in mind home runs don’t happen on every trade. Focus on the base hits, and a home run will happen (assuming you have an edge in the stock market). 

If the stock moves without you, who cares? There WILL be another day in the stock market. There WILL be another day of a major move (especially with options). Use this anger to fuel your fire to execute your plan better next time. Use this anger to better yourself as a trader and not falter on execution to that extent again. 

If you miss out on a trade entirely, you need to ask yourself if there was a valid reason for entry. If not, then that is gambling. If you want to gamble, go to the casino, not the stock market. If there was a valid entry signal on the trade, determine why you missed the trigger and set the appropriate tools in place so you can avoid missing an entry on one of your strategies again. 

Having a profitable account is much better than being right on a single trade, and you need to remember that. A loss should be nothing out of the ordinary. You cannot let one ordinary loss be the downfall of your trading career. You cannot let one ordinary loss get the better of you because the stock market could care less about your emotions. Mr. Market is a humbling beast, and you must respect him every time you tap on his shoulder for opportunity.

Published on September 30, 2024