The Secret To Profitable Trading That No One Wants To Hear

Soccer players who score an own goal (accidentally kicking the ball into their own goal, giving the other team a point) feel foolish about this egregious error.

It is made even worse when their own goal wins the match for their opponent.

Players who make this mistake frequently quickly become former soccer players.

Baseball players who consistently make errors that cost their team runs become baseball fans before too much time passes.

Quarterbacks who throw as many interceptions as they do touchdowns are looking for new jobs before long.

In most endeavors, avocations, and occupations, consistent failure usually sends the unfortunate aspirant off in search of new activities and endeavors.

Except in investing and trading.

There, hope springs eternal. Everyone is sure they can make their fortune trading. The research clearly shows that they cannot. It also shows there’s one simple secret to make options trading profitable.

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The Dunning-Kruger effect is on display in grand fashion among retail options traders.

Most retail traders fail.

Most retail investors lag the market badly.

We overtrade.

We are overconfident.

We chase yesterday’s news.

Every investor or trader you talk to, though, is having a big year every year. No one on Twitter (now X) is making less than 100% a year, if you believe what they say. In spite of this, somehow retail investors routinely underperform the markets, and 75% of all day traders and 90% of all option traders lose money.

We are impatient.

Almost every retail trader I have ever known sells winners too soon and holds losers in hopes that the stock will bounce their way.

We like to be part of a tribe. Social media sites devoted to trading encourage herd following, which ultimately ends up as the financial equivalent of a pyramid scheme.

Those with FOMO who chase the story are almost always at the bottom of the pile.

A recent study reviewed in Science Direct examined trading behavior on the popular trading herd site WallStreetBets.

The professors found that “WSB attention increases overall risk levels as investors trade riskier stocks and allocate larger portfolio shares to new positions. WSB attention significantly reduces holding period returns (HPRs). Positions created when WSB attention is at its highest realize −8.5% HPRs.”

It gets worse when we turn toward options.

The options markets are a very efficient system. These markets almost effortlessly transfer money from traders with dreams of glory to market makers and options sellers.

A study published this year examining trades at major US brokerages with a moderately sophisticated trading clientele found that the average retail options trade lost about $4.

The average One Day to Expiration trade lost almost 5%.

The average short options trade made 20%.

If you are tired of losing money trying to trade using the same techniques everyone else is using, read that last sentence about 100 times.

Maybe get a tattoo or have the words sewn into a nice sampler you can hang on the wall.

Most option sellers make money.

For us as retail investors, the most important part of selling options is to make sure you really like the stock on which you are selling puts and understand trade management when you sell covered calls.

It is not an income strategy.

Selling options on minimum exchange margins without first evaluating the stocks is eventually going to end poorly.

Love the stock—sell the put to buy it cheaper.

Ready to part ways or just want to collect premium along the way? Sell the calls.

It is a total return strategy. You are using it to add to the returns of your stock portfolio.

You may recall from last week’s letter that my work (and that of most serious students of the market, who all have found some version of the same) shows that deep value strategies and owning companies with strong fundamentals momentum that attract buying pressure are the two best ways to build wealth over time.

Now add options selling strategies to enhance the return, and things begin to get impressive.

I usually skip being promotional in this weekly epistle, but take a look at what Anne-Marie Baiynd and I are doing at Trade Alerts Accelerator at Benzinga Research.

I deploy stock strategies, and she brings options strategies that allow us to collect premiums and build the total return on these already high-performing strategies.

Those in search of the biggest possible bang for the buck can add a little leverage and use partial margin to boost returns.

Partial margin.

Adding leverage only after significant down moves in the market gives you a favorable risk-reward proposition.

Deep value, momentum, selling premium, and smart leverage should put you into a position to earn returns that most so-called traders will never even come close to achieving.

The further out on the X-axis you go, the more the odds shift in your favor, and this strategy moves you way to the right.

Best of all, the only expiration dates are for options you sold, so time is your friend instead.

Some of you are going to insist that you are among the anointed and want to trade your way to fame and fortune.

Some of you just want some action and find stock and options trading more socially acceptable and interesting than the casino or the track.

In that case, pick a strategy and a time frame.

Stop looking for magic answers.

Stop focusing on how much you might make.

To be a profitable trader, you have to excel at risk control.

Choose momentum or reversion.

Have rules and stick to them. Be ruthless about closing trades that do not go your way.

I have seen some very interesting work done recently with five-day moving averages, opening range breakouts, and standard deviation-based reversion systems.

If you must trade, those are probably rabbit holes worth jumping into.

All in all, odds are you will be better off with deep value, momentum, and premium collecting.

Editorial content from our expert contributors is intended to be information for the general public and not individualized investment advice. Editors/contributors are presenting their individual opinions and strategies, which are neither expressly nor impliedly approved or endorsed by Benzinga.

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