Why do most people lose money in the stock market?

Something I wondered while entering into the financial securities industry is “why do MOST people lose money in the stock market?”

It’s interesting, after all, that the stock market is seen as one of the best ways to make money and yet there are so many horror stories of people losing everything. Statistically, 90%-96% of people who trade lose money in the stock market. How then, can you be different?

It’s not difficult to comprehend what actions you are supposed to take, the difficult part is sticking to the rules you’ve outlined for yourself and not getting upset. Here are some of the rules of wall street to help you make smarter investing decisions:

  1. Don’t buy options over the weekend
  2. Don’t buy equities on Tuesdays or Fridays (those are the market’s biggest UP days)
  3. Cut your losses after 7%
  4. Don’t chase Drawdown

Let’s start with these four. I’ll explain 2 of these today and try to get to the other ones/add more in the next posts.

Don’t buy options over the weekend

Put very simply (ELI5 material), options allow you to express the sentiment that you believe the stock will go either up/down or stay the same for a specified period of time and if you’re right you get paid. Sounds simple enough. A CALL option means you think the stock will go up. A PUT option means you think the stock will go down. Both types of options give you the ability to purchase the underlying asset/equity at the “strike price”, but either in a positive or negative guess at the direction. The “strike price” of the option is the threshold for measuring the option’s performance against your guess, essentially. If you want more explanations on what an option is, read this.

The “delta” of an option is closer to 0.5 the closer the option’s strike price is to its underlying asset’s price. This value denotes the change in price vs a $1 change in the price of its underlying asset (an equity in this case).

The “theta” of an option is the theoretical value that an option’s monetary value decreases every day from sheer loss of speculation alone. Let me explain that.

Today’s date (when I’m writing this thing) is 10/29/2019 for reference.

Here’s AAPL’s stock graph over the past month-ish.

Now, this picture does not have to make sense to you:

Let’s say you buy a PUT for Apple Inc that expires in two weeks (there are predefined expiration dates, but you can pick from the available selections they give you. Usually they are in increments of weeks or months) at the strike price of $240 for a premium of $5.72. That’s what the price is of the 240 strike option on the PUT side, so that’s what you would pay, x100. You must buy 100 copies of options contracts at all times.

The $5.72 = $572 you must pay for the OPTION. This is the premium price.

If you have the available funds, you can then either exercise the option when you’d like (if it’s American Style funds) or you will have to wait until the expiration date (if it’s European Style funds).

Regardless, most of the time this isn’t the play. That means you would have to buy x100 shares of AAPL, which works out to about $25,000. This is a large risk and probably wouldn’t be a good idea unless you were 99.9% certain Apple was going to fail hard.

The better play is usually to sell the option back to the market for a profit when SPECULATION rises. The hope that the stock will go down will drive the PUT’S price up or down, depending on the current outlook of the stock.

This means you can trade options like normal stocks! You could buy an options premium for $5.72 (spend $572), then wait a day, confirm your theory that Apple is going down, then sell and collect the increase of the premium since yesterday for the new people that now think Apple will go down in the future. Options can quickly gain and lose value, as while I was writing this the 240 strike option we were talking about dropped in value to about $5.47.

That’s about 10 minutes, to gain/lose about 7%.

Is it a good buy now?

Maybe.

 

You can’t know, obviously. But you can try to predict.

Back to what I was saying about theta. Theta is option’s ENEMY, as time is to our own life. Remember, theta is how quickly time itself eats away at the hope and speculation of the stock’s price movement. Okay, that sounds a little more dramatic than it is, but not really.

If you think Apple is going to go down in price to $240, and there are TWO WEEKS until expiration, (remember, we picked that one earlier), there is still a lot of time for things to change if Apple starts going up suddenly, right? This is the theta at work. People naturally assume (and are correct) that just because Apple’s stock is suddenly going up today, it doesn’t mean it has to go up tomorrow.

But what if the stock expires in ONE WEEK? Now, there’s a little less time to go. Will Apple’s stock go down still if it’s going up today? Maybe, maybe not.

What if your option expires TOMORROW, and Apple is still going up? Well, chances are virtually 0 that Apple will somehow drop 10% in a day and make you money off of your option, so the price will plummet just based off the speculation of the price changing alone. That’s the theta.

Theta can range from a variety of values but the theta value is simply the amount in dollars/cents that get taken off the premium each day, theoretically (assuming liquidity and volume remain constant, which is virtually impossible).

If you bought that option for $5.72, and the theta is 0.1, that means tomorrow your option will be worth about $5.62, even if nothing else changes, because of the lack of time for speculation about the future price changes of the stock.

However, keep in mind that this doesn’t actually reflect the real value of the stock’s price. Looking at the amount of CALLs vs PUTs, and the LVL 2 data can give you big insights about whether people’s general sentiment about a stock is positive or negative.

The point then, don’t buy options over the weekend. This should be obvious by now why, but it’s because you do not have any control over whether to sell your options over the weekend. If the theta starts burning, Apple comes out with a new product, the market is happy, and you’re definitely not, it’s going to be a very long weekend, and when Monday hits your option’s value will dump 40% and you’ll be sad. Don’t do it. I’ve done it a few times, it sucks.

Don’t buy equities on Tuesdays or Fridays

This one is for a pretty simple, statistical reason. The market usually goes up on Tuesdays and Fridays for the week, even in a general market downturn. The “Monday Effect” has been a thing and holds true for many years, stating that the markets typically dump harder on Monday. Thursdays and Wednesdays are usually bad for it as well, although I have observed Wednesday as being more of a wildcard day.

 

Good luck! Since this is the first official blog post in this vein I’ll put this once and once only.

Securities Recommendation Disclaimer


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