As options traders who trade for income, it is our job to make money regardless of the direction of the markets. You can have every tool at your disposal, but the only way you will win over the long term is by embracing risk management in trading.
Risk management trumps all other tools and strategies
I use many different tools in my trading arsenal. Technical tools, like the MACD, bollinger bands, RSI, and Williams %R, help me analyze charts. Fundamental and macro data help me decide whether or not to get in. The options montage helps me determine the best strike and month when the chart and technicals are favorable. Putting all of those pieces together and creating a winning trade is useless if I do not have a risk management system in place.
The game of trading is about booking profits, PERIOD. There is no other goal. If you focus on booking gains, you will always give yourself a chance to stay in the game.
Sizing your position right is a great rule, and it’s one we preach often. It’s the easiest to understand, but it’s also the most abused rule in trading. The reason? Greed. Instead of showing discipline and consistency in the trade, sometimes we look for a big win to make up for all of those losses. That approach will usually end badly. There are times when trades move against us, and those are unfortunate moments, but if you size properly, then you won’t be forced out of the game.
Likewise, you have to be willing to book profits. No matter what you think the company may do or what the chart is saying, if you are not willing to take a profit at any time, then you will be vulnerable. If you are willing to take down a trade, you will always be in the game.
Taking profits is easier than you think, but the one question I’m asked constantly is, “Bob, should I sell here?” If you have a profit, my answer will always be, “Yes, take some or all of it off the table.” I always say that if you have to ask, it’s probably the right thing to do. The fear of missing out on future gains is very real. No one wants to be left behind if a stock runs up.
How I approach risk management in trading
When I enter a trade, I do not have expectations of a return goal or target. That may sound like a very odd thing to admit, but the market is a moving target. My plays are based on the chart and technicals, not the price of the option. I will shoot for singles and doubles, but I always give myself a chance to hit a home run.
My hard and fast rule in options trading is to take half off at a double. No thinking here, just take half and re-assess the position. At this point, I now have an extraordinary advantage: I am playing with the house’s money. With my original investment back in my pocket, I can afford the luxury of a free trade on the remainder. This frees up financial and emotional capital that can be spent elsewhere.
Good risk management techniques that include sizing right and taking profits will always giving you a chance in this challenging game we call trading.
This article was updated on May 11, 2023.
Copyright: andreypopov / 123RF Stock Photo
