Risk Management is why you are not growing your trading account
Trading is discipline. Discipline is risk management. It’s a super power. If you fail here, the probability of losing capital is huge.
If you’re a trader, you’ve seen hundreds of articles about risk management and what you should or shouldn’t do. The problem? We don’t listen. We take on more risk per trade than we should, we add to losers (increasing our risk), and we let options go to zero or close to it.
The solution? Make it mechanical. Build a risk management strategy that you follow for every trade. For me, it’s 2% of my 40K account. This means $800 total loss per trade if everything goes wrong.
How many shares can I take? With a stop loss of 25%, your allowable dollars to spend on options is $3200. Now, I usually have a range of entry points to scale in - (aggressive - moderate - conservative) - and I use a third of my allowable dollars for each entry. For example, I have $3200 to spend on a trade, the option cost $2.50. This means I can purchase about 12 options total (or 4 options for each entry point). Remember, the stop loss for each independent entry point is 25%.
Here is where most traders fail. They set up a system (like above), but they constantly break the rules. It’s a mental and emotional game. It’s hard getting stopped out, to accept the loss. Accepting the trade failed. We don’t want to face it so we improvise, we add to the position to lower our cost basis. We look at the chart convincing ourselves that the stock will turn around. We think to ourselves, just stay in a little longer, it’s going to work. Truth is - it doesn’t. The stock continues down. Our loss becomes 50% then 75%. Risk of ruin is upon us. Now we just stay in because we’ve lost so much, what’s a few dollars more? This is how traders fail.
Here is an example. Last year, I had a friend complaining about growing his account. He was a very active trader but was profitable but not by much. During our discussion, I ask him to run a report from his trading journal and put in these parameters: only losses, and only dollar amount beyond the 25% stop loss. We were surprised at how many there were. Lot’s of them. When we added up the extra losses past the 25% stop, the total was shocking. He lost over $17K in controllable losses throughout the year. Hard to believe. Had he cut these around the 25% stop, he would be $17K richer. And this is an account worth around $50K. It really sabotaged his return and it was preventable.
What’s the solution? It’s up to you. This is one of the hurdles to success. There is no easy answer, you have to follow your own set of rules. No exceptions. Rules are there to protect us from ourselves. You must follow them and stay in the game. No BS, just do it. Trades happen every day. Getting stopped out is not personal, it’s just part of the game. Sort of like the other team scoring. It happens but it’s not the end of the world, it’s just trading. Everybody has losing trades … everybody. So suck it up, quit sabotaging yourself and trade with a defined parameter of risk management. You’ll be happy you did.
Conquer your ego, conquer the market
Paul