Traders hear about all kinds of risk, but one specific type is common to traders at all levels, but rarely if ever discussed.
Are you the victim of "self-discipline risk?"
Most traders are. You set rules for yourself but make the mistake of breaking them later, based on how prices change. For example, you go long on an option with the intention of selling under one of two circumstances. If the price rises, you will sell when you double your original investment. If the price falls, you will bail out when you have lost one-half.
In practice, however, when the price rises it's tempting to hesitate, thinking perhaps the price will continue rising. Even when it eventually begins falling, you cling to this hope and miss your chance to double up.
When the price falls, you don't bail out, but hold on hoping to get back to your starting point. Eventually, the price declines even more and you end up losing 100%. In this all too common scenario, there is no point at which you can exit the position. You have programmed yourself to never take profits or limit losses.
Self-discipline, like patience, is gained with experience and often only after experiencing many losses. Consider not only the rules you set for yourself, but also how you actually behave. Do you follow your well thought out rules? Or do you change your mind as circumstances also change? An experienced trader knows that cutting losses is just as important as taking profits.
So a few smart rules to impose on yourself:
1. Set specific rules about when to close positions, just to take profits and to cut losses.
2. Follow those rules.
3. If you find yourself violating your own rules, ask yourself why. If your self-discipline is not consistent, you place yourself at risk as an options trader.
Self-discipline risk is chronic for even the most experienced options traders. By being aware of it and resolving to stick to your own rules, you are more likely to succeed in your trading program.
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