Understanding Risk & Trade Management for Options Traders: The Ultimate Beginners Guide in 2023
If you’re ready to take your trading to the next level, you’ll need to set real risk & trade management in order to get you to the next level.
You want to make more consistent wins, but you’re noticing that your trading account is taking a hit from your losses. You may be experiencing a backward trend in your account, even when you’re getting wins.
Are you ready to turn things around? Do you want to go from beginner to booming?
I remember when I had no trading rules or risk management knowledge. It sucked seeing my losses offset my wins, and just having a bad week overall.
Not sure how to set trading rules or risk management your account? I’ll take some time to break them down for you and give you practical, actionable steps you can implement to take your trading to the next level.
- The Importance of Setting a Stop Loss
- How Much Should You Size in Your Positions
- Takings Profits: The 50/30/10 Rule
- Following a Set of Trading Rules
The Importance of Setting a Stop Loss
Avoid the hopium drug.
Many traders–myself included–don’t set a stop loss or have extended a trade that just falls -60% or lower.
Don’t do that…
Most of the time, that comes from a place hopium–meaning an addiction to false hopes.
I can’t count enough, how many times I hit my stop loss and I kept telling myself, “wait a little longer, maybe it will reverse” or, “It it will come back”…
From my experience, those are words for losing trades. 85 percent of the time, once the trade goes -30 percent, it does not come back up.
Instead…
Of holding a losing position, get out and wait for another possible entry or find another setup.
There are a few times where I will push the stop loss to see how it reacts on the Supply & Demand zones–very rarely do I let that happen.
Typically my set stop loss for any trade ranges between -10 to -20 percent. Here’s a chart that illustrates how much you have to make back in your next trade to offset the loss.
How Much Should You Size in Your Positions
Another important step is your position sizing.
The trading life is all about probability, and making sure that the odds are on your side with minimal risk.
It’s important make every trade be the same amount for the day. For example, if you size in your first trade 10% of your portfolio size, the rest of the trades need to be the same size.
Why is this important?
It’s all math. Let’s see what happens if you don’t make them equal:
- Trade #1: You go in with $100, and lose -30 percent
- Trade #2: You go in with $50, and win 30 percent
- Trade #3: You go in with $50, and win 20 percent
One loss & two wins, if you do the math you come out losing -$5 for the day. But if you were to have gone in with $100 on all three trades, you would have come out with $20 for the day. Your biggest concern is to come out profitable for the day & week.
Lots of traders like to go super heavy in their first trade and smaller on the rest because they used a lot of their buying power in the first trade or they just fear losing more money.
I always recommend putting 10% of your portfolio size per trade. I’ve come to find out that you can still make a great return with that size of a trade while minimizing the risk of your portfolio.
Let’s pretend you have $1,000 account & and you took a trade that was 10% of your portfolio size–that’s $100 buckeroos…
You took a loss of -30 percent–that’s only $30 taken away from a $1,000. You’re still left with $970 left to trade with–with proper technical analysis and stop losses, you’re bound to get wins and make a trade that returns back your small losses.
As traders, we’re here to make the highest return while protecting our capital. It’s important that we don’t get greedy and create a mindset for the long haul.
Takings Profits: The 50/30/10 Rule
The market giveth, & the market will taketh away.
It’s my own personal belief that it’s important to learn to take profits at certain levels. Because if you don’t someone else will take it away from you.
I used to want to exit my full position at 50 to 60 percent profits because I was greedy. All that did was cause me to lose trades. It’s important to learn to appreciate 10, 20, and even 30 percent returns. The power of compounding is extremely powerful, and those small wins add up quickly.
Here’s what I like to practice during a trade.
I like to sell 50 percent of my contracts at 30 percent gains. At this stage of the trade, I then I will sell 30 percent of my contracts at 40 percent or will get out breakeven. In the last stage, I have runners (remainder 10% of contracts), and I let those runners go with a trailing percent stop loss–meaning, if the trade is at 50% I will subtract 20 percent and get out of trade positive in the end.
No matter what, your trade will come out positive. It’s just math…
Following a Set of Trading Rules
Follow your trading rules to a T.
Following your set of rules is critical and will make a great trader overnight–only if you stick to the plan.
I, myself have broken my rules and have lost weeks worth of gains as a consequence. I had to learn the hard way.
But by following a set rules, I gave myself the odds of being a successful trader.
Here are my set of rules, that I follow as a option trader:
- Stop loss: -20%
- Take some profit at 30%
- Position size: No more than 10% of portfolio
- Stop trading after 2 losses
- No setup, no trade
- No more than 3 to 4 trades per day
- No trading after the first hour
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