Why young traders are losing money in options (2024)

In recent years, options trading has gained immense popularity, with the cloud of quick riches and hope to achieve financial freedom. This false façade, that it is easy to make high returns in a short span has driven many to venture into this complex financial genre. However, beneath the glitter of social media success stories and influencer hype lies a harsh reality: Losses, big big losses!

A recent study has also revealed that a significant majority of these people losing are young retail investors. The study, which analysed trading accounts from major brokerage firms, found that nearly 85% of young traders incurred losses within their first year of trading options. Experts attribute these losses to a lack of understanding of options strategies and the influence of social media hype.

Further, Bloomberg's investigation into retail options trading has uncovered that young traders, enticed by the promise of quick gains, are facing steep losses. Analysis of trading accounts shows that over 70% of novice traders lose money, often due to improper risk management and a lack of formal trading education. Industry analysts suggest that regulatory bodies may need to step in to ensure that new traders have access to better educational resources before engaging in high-risk trading activities.

The allure and the pitfalls

Social media platforms are flooded with videos, vlogs, and posts showcasing extravagant profits from options trading. Influencers flaunt their gains, often with screenshots of substantial profits, creating an illusion of effortless wealth. Unfortunately, many young traders, driven by the fear of missing out (FOMO), dive headfirst into options trading without a clear understanding of the inherent risks and missing the point that these screenshots may be be fake in nature.

One common trap is the underestimation of the complexities involved in options trading. Unlike straightforward stock trading, options require a nuanced understanding of market movements, volatility, and time decay. New traders, swayed by the promise of quick gains, often neglect these critical factors. This leads to poorly informed decisions and significant losses especially with the buyers of naked single leg options.

The risk of following the crowd

Social media can be a double-edged sword. While it provides access to valuable information and trading strategies, it also amplifies misinformation. Fake profit screenshots and misleading success stories create unrealistic expectations. The result is a wave of young traders who enter the market with high hopes, only to encounter the harsh reality of substantial losses.

Trading: A skill to be developed

Trading can be a highly rewarding profession, but it is imperative to acknowledge that it is not a get-rich-quick scheme. Just like any other profession, trading skills are developed gradually over time. Young traders must invest in their education and training before expecting consistent profits.

Consider the analogy of becoming a professional athlete. No one expects to become an Olympic champion overnight. It takes years of training, discipline, and learning from failures. Similarly, professional trading requires a deep understanding of market mechanics, disciplined risk management, and continuous learning

Essential tips for young traders

1. Educate Yourself Thoroughly: Before diving into options trading, take the time to learn the basics. Understand how options work, the different strategies involved, and the risks associated with them. There are numerous online courses, books, and tutorials available to help you build a solid foundation.
   
2. Don’t trade single leg options: Getting the direction right in markets is probably one of the toughest things to do. Trading single leg options not only forces you to be right in direction, but makes you dependant to do this in a short span of time as well. Hence it is always advisable to trade hedged strategies which are lower in terms of risk.
   
3. Start Small: Don’t put all your savings at risk in your initial trades. Start with a small amount of capital that you can afford to lose. This approach allows you to gain experience and learn from your mistakes without jeopardizing your financial stability.
   
4. Develop a Trading Plan specific to Options: A well-defined trading plan is crucial. It should include your goals, risk tolerance, and specific strategies you will use. Stick to your plan and avoid making impulsive decisions based on market noise or social media influence. Remember, your stocks trading plan and options trading plan are very different in nature and cannot be painted with the same brush.
   
5. Risk Management is Key: One of the biggest mistakes young traders make is neglecting risk management. Used hedged strategies to limit your losses and never risk more than you can afford to lose on a single trade. Diversify your trades to spread risk. Ideally more than 3% of your capital should never be risked in a single trade.
   
6. Avoid Overtrading: Overtrading is a common pitfall for all. It’s easy to get caught up in the excitement of markets, but making too many trades can lead to increased transaction costs and higher risk. It also sometimes leads to having a revenge mentality, be selective and patient with your trades. Another common mistake that leads to over trading is short term success. Having a few profitable trades makes the average participant feel like they know something that others don’t. This makes them over risk and over size their positions.
   
7. Seek Mentorship and Community Support: Engaging with a community of experienced traders or finding a mentor can provide invaluable insights can be very helpful in reducing losses. Learning from others’ experiences and mistakes can accelerate your growth and help you avoid common pitfalls.
   

Allow me to share an anecdote which has become a household story and very common now ! A friend of mine first started trading options, & was captivated by the potential for quick profits. He followed the advice of an online influencer who claimed and seemed to have a Midas touch. Initially, he made some gains, but soon after, reality slinked, and he experienced significant losses. It was a wake-up call that trading is much more than having a strategy; it required iron clad discipline, commitment, tenacity and a quest for continuous education. To sum it up, Options trading can be a lucrative venture, but it does not come without its risks. Young traders must approach it with caution, armed with proper knowledge and realistic expectations. The journey to becoming a successful trader is long and requires dedication, just like any other profession. By educating themselves, managing risks through hedged positions, and staying disciplined, young traders can navigate the complexities of options trading and build a sustainable path to financial success.

(The author is CEO of Hedged.in. Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)