The Number One Rule of Risk Management: Trade Within Your Means

I am asked quite often how I have managed to stick around as an options trader for as long as I have – more than fifteen years and counting. The long answer is that I’ve studied my successes and failures along the way and learned how I behave under certain conditions and deal with adversity. The short answer is that I’ve embraced the number one rule of risk management.

Always trade within your means.

Practicing risk management is easier said than done

Think of it this way: trading is a metaphor for life. If you see opportunity in front of you, your mind races to the greed side of the emotional spectrum (fear is on the other side). Because the opportunity window is often narrow, your natural reaction is to strike fast before it disappears. That’s a good idea – except when you’re wrong. If you’re wrong often – especially when it comes to money – you’ll soon be in the poor house.

However, if you have control over your behavior, then you are in charge of your portfolio/money/accounts. That control – that risk management – determines how much you win or lose in specific trading situations. I have seen more traders lose it all from mistakenly taking too much size on a trade, risking too much capital altogether or foolishly going “all in”.

While it may be fun to show off, you will eventually get pounded. It is those traders who establish strict rules of risk management who not only survive but succeed in this difficult and intriguing world of trading. For me, success is a long-term endeavor. My biggest and best gains have never come from large bets. Instead, they were sized appropriately for my risk tolerance.

Always trade within your means so you can sleep at night (or take a peaceful nap). Don’t be seduced by the perceived guarantee of a big win, whether it’s you or someone else who discovers the trade. Remember that there are no guarantees in trading, so don’t break your risk management rules. If you win, terrific. If you don’t, then you will survive to trade another day.