In this very challenging market, we must stay on top of our game and be ready for any opportunity. If we want to live to fight another day, we need to have more than just survival tactics in place. We need great options trading strategies. One of the best and most critical for option traders – especially right now – is position sizing.
A great trader with a bullet-proof system can destroy his or her account without the discipline of proper position sizing – but what is “the right size?” After all, we need to make an impact on our portfolios! I stick to 1.5-2% of total capital on a trade. This is a smaller but manageable size for me, as I like to have many positions at work simultaneously. If I am wrong on a play of this size, it’s not going to kill my portfolio. Perhaps others will pick up the slack so I may even override the loss for a positive p/l.
At the end of the day, though, position sizing is very personal and comes down to how much risk you are comfortable carrying. Options give us great leverage to gain significant ground on the market with a smaller capital requirement, yet we can lose – and lose big – very quickly. Some traders disregard position sizing discipline, and while they may get lucky now and then, they will not be able to sustain the pressure of performing day in and day out.
With option trading, not only do we have to get it right with sizing and direction, but we also have to nail timing. When the market conditions are not ideal – or trending as they are currently – then our job is made that much more challenging. At these times correct position sizing will save your skin, especially if an adverse move hits any of your plays.
A stock trader or investor must also use solid position sizing rules. Again, they’re trying to advance our portfolios, but if they’re faced with an adverse move, they still want to stay in the game. Diversification is the only free lunch out there, and the best way to achieve that is by balancing a stock portfolio through position sizing.
In the Trifecta Stocks Portfolio for realmoney.com, Bryan Ashenberg and I employ a strict discipline of no more than 5% per position that we can build into over time. We are diversified through our positions, which give us a chance to beat the market with our stock picking skills and methodology. (You can also see position sizing discipline displayed by Jim Cramer and Stephanie Link in the ActionAlertsPlus.com portfolio (Cramer’s Charitable Trust).)
Have any questions about position sizing – or other options trading strategies? Leave a comment below, and I’ll be sure to address your questions in future blog posts.