The key successful trading is risk management

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The key to successful trading is risk management

Options Trading

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The key to successful trading is risk management

We discussed in the previous article that the risk graph of the stock market involves unlimited risk. That means despite using super good stop levels, there might be days when the market skips your limit order.

Or, your market order could be executed at a price you did not expect. Consequently, a precise risk management cannot be achieved. Those who trade on the Forex market may groan now because this is not strictly true for them. Yes, the Forex market is not characterized by a gap up, gap down, therefore the STOP level can be more easily planned, as it is usually executed where we planned it.

One of the big advantages of the Forex market is the more balanced price movement. There is no gap, or it occurs in very extreme and rare cases.

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But what do we call accurate, pre-defined risk

management?

But what do we call accurate, pre-defined risk management?

We call it this:

If you determine in advance that the maximum loss of a position cannot exceed 1% of your total invested capital.

This is a healthy level of risk. It is sufficiently conservative, but it contains sufficient potential for growth. There's no mystery in this. 

It is not that hard to determine this, but it can be hard to comply with it.

Think about it, when do people lose their money?

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When do people lose their money?

Not when they follow the pre-defined, correctly specified rules.

They lose everything when they are driven by two basic emotions: fear and greed that emerge during trading.

This is the most difficult to work off. I did  not incidentally start my Trading Psychology Blog column with the article which shows that 90% of successful trading is psychology and only 10% of it is technique.

If you have been trading the markets for a couple of years, you can understand and feel the truth of this statement.

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Risk management

Risk management protects you from making wrong, emotional decisions. 

If you can maintain this one, you have bigger chance for a successful career on the stock market than 99% of the novice traders.

It is not too difficult - you can invest max. 1% of your total capital in one position. To give an example, if you have $100,000 with which you trade, you should risk up to $1,000 on one position.

There are two ways to do this.

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Here is an example

Here is an example of the first method:

You open a position on the Forex market and invest the total $100,000, but you enter the stop level to close your position at $99,000. This is a simplified example, of course. As I mentioned, in case of Forex, the STOP is usually executed at a guaranteed level. If you want to play the same thing on the stock market, the paper in your 100.000 stock position may suddenly open with a gap down, and your market stop order is executed at a price of 90,000.That is, you lost 10% of your total capital at once. I would not call this Risk Management.

The other method is provided by the options market.

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What are the differences between the regular and the options

market?

The answer is very simple. 

In the options market, you can determine the level of your maximum loss with the help of various strategies. Examples include but are not limited to the following:

Long Call: you can lose the amount you paid for the Call

Long Put: here you can lose the amount you paid for the Put 

Bull Call Spread: you can lose the amount you paid for the spread

Bear Call Spread: The maximum loss is the amount of the margin

requirement arising from the credit spread.

You can find the detailed description of the strategies in the Options

Strategies section. Here I would not detail all of them. What I would like to

emphasize again is the risk that can be accurately determined in advance!

In closing, here are the risk graphs of 1-2 options strategies with limited risk.

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Long Call Risk Graph

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Bull Call Spread Risk Graph

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Long Put Risk Graph

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Do not forget!

Do not forget - if you have not done already - determine the level of risk your account can tolerate and risk only this amount on one position! This is one of the most important directives that exists in the trading world!

Lessons learned:

-> Invest a predetermined % of your capital in a position.

-> The options market allows a planned, pre-defined determination of the risk level.

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Feel free to ask me!

Email: [email protected] webpage: http://www.optionsrules.com/

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