Without further ado… TOP 5 TIPS Every Noobie Wallstreetbets Trader MUST Know.
I made this the first point because it is the gigantic mistake I see noobies here (r/wallstreetbet) making again and again. I’m talking to you, people who bought calls on PLTR at $30. If you learn anything from this post, you MUST learn this.
You see a stock make a massive move either up or down. Your immediate response is “this is a great opportunity to buy calls/puts on a volatile stock!” Right? WRONG!
In fact, when a stock has just made a massive move in either direction, that is perhaps the WORST time to purchase options in EITHER direction. Options are not stupid. Options are designed to price in the fact that a stock is moving wildly. This is called “implied volatility.” They become more expensive as a stock makes more dramatic moves, to price in the volatility you and everyone else is expecting.
It’s quite possible and even likely that you buy an option on a high IV stock, and the stock moves in your direction, and yet you LOSE money, because it didn’t move as dramatically as was expected by the implied volatility. This is called “IV crush.” It only takes one or two experiences with IV crush for most traders to learn this lesson for life. If you understand this concept before you lose a ton of money, all the better.
So, what should you do if a stock is highly volatile and options are expensive due to IV?
There are two choices: Trade actual shares, or SELL the options rather than buy them.
If you are bullish on a high IV stock, you can take a bullish position by SELLING a cash-secured put rather than buying the call. If you are bearish on a high IV stock, you can take a bearish position by SELLING a call rather than buying a put (although this entails greater risk and will typically require higher options trading level by your broker).
It’s a tale as old as time. A noobie investor does some research, reads some DD, and is convinced a stock is going to rise over the next couple years. So he buys in. A bad day or two hits and the stock tanks. He panics, and sells. The next couple days the stock rises and appears to stabilize. So he buys back in again, because he still believes in his thesis. The stock drops again, and he panic sells again.
In reality the stock is just trading sideways, but this idiot keeps buying on green days and selling on red days. This is perhaps the most idiotic, suicidal strategy anyone could ever employ. Buying on green and selling on red is a surefire strategy to lose money consistently over time.
This is why you MUST remove your emotions from your trades, because your emotions will usually tell you to buy on green and sell on red, literally buy high and sell low. As the boomer Warren Buffett once stated: “The stock market is a device for transferring money from the impatient to the patient.”
Here is a better approach. Set up your entire trade BEFORE you make the trade. Have a set price you will sell at if things go south. Have a target price you will sell at if things go well. Once the dust settles you can learn from any mistakes. Were you too aggressive, or too conservative in your targets? What emotions directed you to make those mistakes? Too much greed, too much risk aversion, too LITTLE risk aversion? Make every trade a learning opportunity.
In general, stocks will tend to revert to their trendlines.
This thesis is fairly simple. If a stock moons 10% in a day, the most likely event is a drop the next day. If a stock tanks 10% in a day, the most likely event is a rise the next day. This is because humans are emotional creatures. First, they overreact to big news. Next, one of two things happen: When the stock is way up, people see it as a profit taking opportunity, so they sell. When the stock is way down, people see it as a buying opportunity, so they buy.
I don’t have any hard data to back up this thesis, but I’m sure there’s a bunch of nerds out there with hard data that proves exactly this, as well as trading algorithms specifically designed for a “reversion to the mean” strategy that are consistently profitable.
Obviously there will be exceptions, as well as times when a big move signals a shift in the trendline. All I am saying is in the MAJORITY of cases, reversion to the mean will occur. Don’t go chasing stocks that have made massive short-term swings in a single direction unless you have strong reasons (not just hopes) to believe the trend has changed.
This is going to be controversial for some of you. But it’s just straight math. If you keep betting your entire account, or close to it, on single trades, it’s only a matter of time before you go broke. That is a mathematical guarantee.
Let’s say you are one of the most skilled, intelligent, informed investors on the planet (doubtful). So skilled your plays are 90% correct. If you bet your entire portfolio on each trade, you are still expected to go completely broke after around 10 trades.
Let’s say you aren’t a brilliant stonk gambler. Let’s say you are just average and your trades are a coin flip (which is generous for a lot of you retards). If you bet your entire bankroll on each bet, on average you will go completely broke in just 2 trades.
Again, there is a lot of complicated math we can go through to predict account explosion times and optimal bet sizing and so on, but that isn’t necessary here. Professional gamblers such as poker players have refined bankroll management theory, which usually means at the least they aren’t putting more than 10% of their cash on the table in one sitting, usually closer to 5%. (Take a look at the “Kelley criterion” for an interesting read: https://en.wikipedia.org/wiki/Kelly_criterion)
I know a lot of you are broke with no life prospects and hoping to get rich quick. I don’t fault you for that, I get it. The problem arises when you see the people who got insanely lucky with guessing 10 coin flips in a row who turned $1000 into $1,000,000, and hope to do the same… but for every one retard with a record like that you’ve got hundreds more who lose it all and have nothing to show for it.
I won’t fault anyone for making a gigantic, life-changing bet a single time. That is your choice to make, and it just might pay off. But if you think you are going to do that again and again and survive, you are delusional.
Fools and their money are soon parted. Don’t be a fool.
Your first instincts when hearing ANYTHING should be skepticism. Your friend has a hot stock tip? Start with skepticism. Some online DD on a meme or penny stock online sounds convincing? Start with skepticism. A highly respected financial or government agency gives future guidance on whatever… again, start with skepticism.
There are a million people out there trying to take advantage of you, to pump and dump you, to scam you, to trick you into spending more money on whatever.
There are times when being a conformist pays off, like when markets rally for months straight. There are times when being a contrarian pays off, like when markets tank and sectors collapse. Don’t be a consistent conformist nor a consistent contrarian. Be skeptical of every thesis and every hypothesis you hear, or even the ones you invent yourself.
When you take this approach honestly and still become convinced of a thesis, you have a higher probability than most of being correct.
Seek out opinions that contradict your biases, not opinions that confirm your biases. This is incredibly difficult and goes against human nature, but if you can achieve this ideal, you will out-trade 90% of the public.
Wallstreetbets Shop would like to give a special thanks to r/wallstreetbets user u/ContentViolation1488 for not only writing this highly informative article but also for also allowing us to post it. The original reddit post can be found HERE.