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Understanding Options Trading and Risk

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  • Understanding Options Trading and Risk

    Even though options are some of the most used financial devices these days, they can be complicated and can be hugely high risk. On the flip side, option investing strategies have the potential to make investing safer. Options are probably the most flexible trading instruments out there and are also excellent and versatile tools that you can use as a stock investor to scale back risk and boost profits.

    Do you know the hazards with Option trading?
    • Greed. Here is the single greatest threat, which is altogether human in origin and is not inherently linked to options trading. A lot of people start out trading options simply because they start to see the massive potential profit and dream of "getting rich quick". Unfortunately the sentiments of greed induce people to abandon an investing strategy, make snap judgements, and begin gambling.
    • Loss of Investment capital. For those who have invested in stocks and shares, a negative turn in the market can set you back a small percentage, which typically (apart from when the market seriously fails) is below 10%. When trading options, although you are trading significantly smaller amounts of money, it is possible to lose 100% of the amount you put into the trade, in the event the market moves against you.
    • Trading on margin. Selling options entails providing a margin should your trade becomes a loser. More often than not, this margin condition (fixed by the brokerage) is not nearly as much as the total cost that you'd have to bear should your trade get trashed (which often can take place fairly swiftly). This could certainly leave you in debt to your broker.



    How you can safeguard against risk in options trading
    • Have a Trading Plan - develop a good plan through research and study, and refine it by practising using paper trading. When paper trading, ensure that you have traded for enough time so that you are able to experience some trades going against you - you'll find nothing better than this to help you discover how to read the danger signs. Stick to your trading plan!
    • Appropriate Technical Analysis. Often, options traders don't succeed because of over analysis. The principles for technical analysis for options can be quite different from those on stocks, and in addition, each options trading strategy features its own package of analysis techniques. After you have opted for a strategy, find out precisely which kind of analysis is called for, and stay with that.
    • Conservative Capital allocation. Don't over allocate! Most option traders advise that you don't commit over 2% of your funds to any trade. Because of this it is possible to take in a number of serious losses, and still retain some trading power. If you sell options, it is generally wise to leave about 20% of your funds readily available, allowing you to have the capability to "buy" yourself out of a bad trade just before it crosses the line and becomes a substantial margin liability.


    Article Source: http://EzineArticles.com/5913590
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