How does options trading work in the stock market?

Is gambling an addiction? If so, why? Especially in casinos, you will find people sticking to slot machines and forcefully pulling the levers. Trading psychology is similar to that.

According to Predictive Analytics, even if some of those people won the jackpot, they would prefer to spend all that money back in the slot machine. Isn't that interesting enough?

Some studies show that many slot machine addicts wear adult diapers because they don't even want to get up to answer nature's call. Finger crossed. These machines were designed to exploit variable reinformation, which is inherent in human behavior. You can google later.

What is Trading Psychology?

Trading psychology is defined as any response or action that provides a reward i.e. a person will be motivated to repeat a response if he gets a reward for it.

Humans crave predictability and struggle to find patterns, even in its absence.

Variability is the cognitive origin of the brain and according to the deduction of our brains, cause and affect get more priority than other tasks, such as self-control and moderation. This is trading psychology.

Different rewards induce addiction, and it stirs our minds.

Let me guess a little...

According to Professor Sanjay Bakshi, due to the presence of a happiness chemical called dopamine in our brains, small-time speculators are like butterflies that jump from one flower to another.

The degree of happiness is directly proportional to the amount of dopamine released.

Novel experiences like bungee jumping or one night stand provide the brain with huge amounts of dopamine. Another thing that dopamine delivers is unexpected, pleasant surprises.

Day traders get very small amounts throughout the day.

To your surprise, I want to tell you that a doctor would not be able to tell the difference between an MRI of a trader who has just won a trade and an MRI of a cocaine addict's brain. This is the trading psychology that a trader carries with him.

You are free to experiment.

As today is the first of the remaining days of our lives, so you and I, being stock market participants, should take it seriously.

Thus, anticipating that you will continue to read this article, I decide to proceed.

I noticed this and found out that it actually makes us blind. It motivates us and pushes us into the rat race, i.e. a vicious cycle of two emotions "greed" and "fear".

There is an old saying on Wall Street that the market is driven by just two emotions which are greed and fear.

Both of these internal emotional states are related to the term "uncertainty" for the stock market.

Bowing to these sentiments can have a "highly malleable impact" on investors' portfolios and the stock market.

It is always better not to advertise our ignorance. So, being a common man, I want to share some common "knowledge".

What is greed?

It is an inherent nature of man that once he gets something he longs back for it. This is one of the essential parts of trading psychology.

Please don't feel alone as a victim, I am with you.

It generates chemical rush through our brains and makes us biased by blocking our logical faculty in the brain. We get addicted to it.

What is fear?

Another form of trading psychology is fear. It is usually described as an uncomfortable, stressful situation, etc.

One of the most common examples I can think of now is the "dot-com bubble," with many referring to it as the "internet bubble."

It was built around internet start-up companies, which prompted investors to invest in businesses that had the "dot com" tag.

They became greedy which in turn led to more greed, resulting in a dire situation, which was giving rise to a bubble.

For a better understanding let me quote the Investopedia definition of bubble:

"A bubble is an economic cycle characterized first by a rapid rise in property prices and then by narrowing. It is formed by an increase in property prices, which is unpredictable from the fundamentals of assets and is driven by excessive market behavior. When no one else is willing to buy at a higher price, a massive low price is sold, which spoils the bubble. ”

Please don't be afraid, I can understand that "fear" is dominating your conscious mind. After the bubble crash, investors have moved out faster and started focusing less on uncertain buying.

Believe me, if you search on Google about the role of greed and fear in the financial world, the redundancy of information will plunge your head into the heavy noise.

To avoid this complexity we can simply create a toolbox called "risk management". However it is beyond the scope of this article to explain this whole concept. Based on this, a complete curriculum can be developed.

How to manage trades effectively?

As this article focuses on money management, my goal is to make a basic understanding of it.

It is an integral part of risk management.

A trader will not be able to survive long without it.

It deals with the question of survival. This increases the chances of the trader staying longer. Many potentially successful systems or trading psychology have caused disaster because the trader implementing the strategy lacked a method of controlling risk.

It is better to stay on shore than drown in the vast sea. I hope you will agree. Thank you for shaking your head.

A carpenter's tool box can make or break furniture. Similarly, money management can make or break a business.

You should be familiar with the term portfolio management. If not, it doesn't matter. Keep reading further...

What is Portfolio Management?

According to Investopedia "Portfolio management is the art and science of making decisions about investment mixes and policies, matching investments for purposes, asset allocation to individuals and institutions, and balancing risk against performance." Portfolio management is all about combating the strengths, weaknesses, opportunities, and trade-offs and determining threats to get returns out of debt versus equity, domestic versus international, growth versus security, and multiple risk trends. ”

You don't have to be a mathematician or understand portfolio theory to manage risk. Therefore, keeping all the complexities aside we will bring it to you here at a relatively simple level.

Please take a deep breath and read this...

According to renowned hedge fund manager Larry Height, we have-

1. Our lifestyles should never be at stake – never risk a large portion of our capital on one trade.
2. Always know what the worst possible outcome is.

I share some general money management guidelines by John J. Murphy. These guidelines mainly refer to futures trading:

• The total invested money should be limited to 50% of the total capital
• Total commitment in any one market should be limited to 10-15% of total equity
• The total amount of exposure in a single market should be limited to 5% of the total equity
• Total margin in any market group should be limited to 20-25% of total equity

What is the 2% rule?

The 2% rule states that never risk more than 2% of your capital on any one share.

Breakdown of 2% rule:-

• First pay attention to capital risk, i.e. 2% of your trading capital.
• You should reduce your buying and selling costs i.e. brokerage to get the maximum reasonable risk.
• Calculate the risk per share. To calculate the risk per share in Long's case, you should subtract your stop loss from the purchase price and make a provision for slippage.
• In case of short, you should reverse the process, i.e. subtract the purchase price from the stop loss before adding a slippage.
• To reach the maximum number of shares, divide the maximum allowable risk by risk per share

There is a famous saying, "More sweat in training, less blood in battle." Similarly, you should always "plan your trade and then trade your plan ." Do it. "

Trying to win in the markets without a trading plan is like trying to build a house without a blueprint – mehengi (and avoidable) mistakes are almost inevitable.

A trading plan simply requires a combination of a personal trading psychology with specific money management and trade entry rules.

According to Krause, the root of all the major difficulties faced by traders in the markets is the absence of a trading plan.

Dryhaus emphasizes that a trading plan should reflect a personal core philosophy . I need it.

He explains that without a core philosophy, you won't be able to hold on to your positions or stay connected with your trading plan during really tough times.

If you want to learn more about money management and trading psychology, you can enroll for NSE Academy Certified Technical Analysis.

What are money management techniques?

Maximum profit, not the number of wins  

One Hart points out that human nature does not operate for maximum profit, but for the possibility of profit. The problem with this is that it informs a lack of focus on the magnitude of gains (and losses) – a drawback that leads to non-optimal performance outcomes. This is the best technique of money management.

Pull out the partial gains

Remove a portion of the winnings from the market to prevent trading discipline from deteriorating into decency. To prove the procrastination of overtrading advertising in trading loss trades, it's easy to say, "These are just profits." Profits withdrawn from an account are more likely to be viewed as real money. In this way, better money management can be done.

Risk Control

Minervini believes that one of the common mistakes made by novices is that they "spend a lot of time searching for great entry strategies and don't spend enough time on money management". Strictly follow the steps given below –

1. Stop-loss point
2. Reduce positions
3. Selecting low-risk positions
4. Limit the size of the initial position
5. diversification
6. Short selling
7. Hedging Strategies

Always remember that "you are willing to accept a certain level of risk." Must stay, otherwise you'll never be able to handle the trigger".

Risk / Reward Ratio

It is often used as a measure for trading individual stocks.

The optimal ratio varies widely between trading strategies.

Generally, some trial and error are necessary to determine which ratio is best for a given trading strategy.

The empirical study shows that market strategists 1:3 are the ideal risk/risk ratio. Assume reward ratio

Traders can manage this directly through the use of stop-loss orders and derivatives.

I know you are very serious with every single trade you make, so, in a simple way, I will provide you with some screenshots on how to maintain your portfolio in Excel.

According to one statistic, only 10% of people read after the first two paragraphs of this article.

So, if you've read it, I can say you're already ahead in the game.

Who knows more, not these games, but a game that knows some essential ideas, goes a long way in reducing errors and increasing the quality of your trades.

After all, ideas are twenty-first century currencies.

Some people lose money because they think they don't deserve to win, but more people lose because they never do the basic work needed to become a winning trader.

Questions must be coming to your mind...

I don't want to waste your time, so, just a summary.

1. Develop a competent analytical method
2. Extract a proper trading plan from this method
3. Prepare rules for this scheme that include money management techniques
4. Back-test the plan in a sufficiently long period
5. Practice self-management so that you can follow the plan. Even the best plan in the world may not work if you don't act on it.

Let me quote Aristotle, "The things we have to learn before we do them, we do by doing them." Let's learn. "

Believe me, you don't need an IQ level of more than 130 (95% of the population scores between 70 and 130) to digest the concept.

All right. Peace. I am explaining.

He meant that we need to practice what we have learnt in different situations.

These ideas and strategies don't sit within our heads like artifacts in a museum, they need to be pulled out and experimented with.

Basics:

Some of the money management concepts mentioned here are the result of my thoughts based on an article published by Safal Investor and books by Jack D. Schwager.

There is a non-zero probability that the above strategies and conclusions are flawed. So, instead of taking them at face value, please consider them as a starting point to encourage your independent thought process.

I sincerely thank you for reading this article. Feel free to post your suggestions and questions in the comment box below.

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