An Approach to Manage your Risk and Keep Your Trading Account Alive 

Tom Gentile

Posted in
Strategy

By: Tom Gentile
July 5th, 2022

5 mins read

When it comes to lasting as long as you can in options trading one key component for  success and for some the most important component in trading is managing ones risk.

One thing a trade management approach like the one explained here can do for a trader is keep them from feeling like they have to micro-manage their trade.

I t comes down to position sizing so that the amount of money at risk on any one trade is a calculated and an acceptable risk amount of the portfolio ahead of time.

Don’t Put all your Eggs in One Basket

We have seen and or heard of too many people trying for a home run type trade where they are hoping to make a ton of money on a big one-time trade only to see it not work out and they actually took the trade to zero and lost it all.

They feel this one trade will be the big-ticket winner or they got a hot tip from someone they consider a pro, and their hope is this one trade is going to be profitable to the tune they can quit their job and retire to the mountains.

Please do not risk all your money in any one trade.

Consideration of Max Risk % Per Trade

An approach is to calculate the amount of risk per trade you are able to accept as a loss and open the amount of contracts up to but not exceeding their max risk per trade.

A common account size many students have shared with me over the years and no matter where I taught in the world is a $25,000 account. Not their whole account, but the amount they are starting with for options trading.

All this dialogue is education and a point of view taught, but know we advocate you working out details about this with your broker / financial planner before trading.

A decision is to risk no more than 2% of one’s options trading account on any one trade. And when we say risk, we mean if you lose 100% on a trade, because the amount of that trade was only 2% of the account, the worst that happens is only 2% is lost in the account.

Remember 2% is the agreed or acceptable amount of risk one could take, and they wouldn’t lose any sleep nor stress about it.

Cost as Risk

Let’s run the numbers on a scenario. This is where the cost of the trade is the full amount of risk one is willing to take on that trade.

Using that $25,000 account if one is to risk 2% that means they are willing to risk no more than $500 per trade, (25,000 x .02 = 500).

If an option cost $2.50 or $250 per contract (excluding commissions) that means one could open 2 contracts and not exceed their risk per trade number.

If the trade loses the full / 100% amount of the trade they lose the full $500, but that is only 2% of the account, which was decided ahead of time as acceptable, (Not that one likes to lose any amount, but again the 2% is deemed what the account could absorb).

Micro-Managing an Option Trade

What this has done for folks is make it so where they don’t have to micro-manage their trades.

If one has a % stop loss they could find themselves hitting that percentage stop loss, take it and see the trade start working again into what would have been profit had they not stopped out.

Sometimes one can look at a technical stop loss point on a chart. Like a break of support on a bullish trade for example. Then they risk seeing the same thing happen in that the trade stops out and then works to profitability only to not take part in it.

With a willingness and knowledge of the percent they are willing to risk on each trade, no matter what the stock does or what percentage loss prior to the 100% loss it hits one can maintain the trade without getting shaken out.

Don’t Fudge You Numbers

Stay disciplined. If your risk amount based on your percentage risk per trade is $500 and the cost of the trade is $510, you either reduce the size so the cost is less than the $500 or pass on the trade.

If you find yourself saying it is only $10 over my cost limit, that to us is like saying you are only going 10 miles over the speed limit when you are driving.

Next thing you know you are pushing that limit higher and higher and like with driving your risk per trade gets out of control and you put yourself at a huge risk for loss.

This is not a discussion about how to manage your investment portfolio, but if you find the approach makes sense for what you and your broker are doing with that we leave that up to you.

We do offer this education as a consideration for managing your trade and money i9n your options trading.

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Disclaimers

Stock and options trading has large potential rewards, but also large potential risk.

You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.

This is neither an offer to buy/sell/ or recommend a particular stock or option.

Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.

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