Did you know that FOMO (fear of missing out) causes more people to make stupid decisions than any other factor? I’m sure you’ve seen or heard about somebody making a foolish investment or decision because they couldn’t stand the idea of being left behind. Maybe it was friends taking on mortgages they could not afford, trying to invest in cryptocurrencies before prices skyrocketed, or even bidding on eBay auctions at two ‘ o’clock in the morning!
The latter is an example of what’s known as FOMO options trading. In this article, we’re going to look at how FOMO can affect your options trading and some ideas for managing its adverse effects through sensible strategy management.
What is FOMO options trading?
Let’s start by defining FOMO options trading. This is where you trade options because they are neither at, or close to, the money, and you think that if they expire out of the money, then it will be a big disappointment. I’m sure we’ve all done something like this before: got carried away and bought an option right before it expires.
Now we’re left holding that $10 call we bought for $1 just before expiry only to watch in horror as it goes into –$5. You can’t help feeling disappointed because you missed making a tidy profit whilst simultaneously being worried about the potential further loss on your poor investment. At this point, FOMO sets in.
What many novice traders do at this stage is to take quick action to ‘fix’ the situation. That is, they buy ‘insurance’ on their already poor investment by buying some more options that expire in the same month or next month. This might work for a small number of trades, but if you keep doing it, then FOMO will drive your losses even higher than they would have been had you just left well alone.
How to manage FOMO effectively
There are several ways to avoid becoming victim to this sort of behaviour, which is often caused by fear of missing out on an easy win. Here are three ideas for managing FOMO effectively:
Set up stop-loss orders
If your brokerage platform allows it, set stops at pre-defined levels so that if your option falls through those limits, then it automatically gets closed with minimal fuss. This way, you don’t have to think about it and keep control of your emotions.
Avoid trading near a key support/resistance level.
These days, FOMO options traders will typically buy options at the money or very close to the money because they see the option as being valuable in its own right. However, there’s a whole school of thought that says you should never trade an option without any intrinsic value.
The reason for this is that when an option has no intrinsic value, then all it has left is an extrinsic value (time and volatility), which could be negative or positive depending on how other traders react to price movements. In other words, if you sell an option that has no intrinsic value, then either time or volatility is likely to be detrimental to your trade.
Trade with a strong bias
Contrary to what you might think, having a solid and unshakeable conviction regarding an underlying asset’s movements can help reduce the risk of FOMO options trading. This approach of focusing on price action rather than random feelings means that you will be less panicked about the outcome of an option’s expiration and more focused on making high-probability trades that support your bias. As long as you follow through by closing out any options that threaten profits, then this tactic can work well for reducing emotions in general.
Trading options can be exciting but does come with some risk. Before investing real money, new traders should use a reputable online broker from Saxo Bank and trade on a demo account. For more information on trading options, go to this address.