The key to good money management will minimize losses when selling options. The reason the above Mark Twain quote is so funny, is that we know it’s true. Yet, most investors have learned the hard way not to put off the inevitable until it’s too late. I have followed trades that went wrong with one or more of the following:
- Denial (This loss isn’t so bad yet that I can’t easily handle it. I’ll wait a little longer.)
- Hope (If I wait just a little longer, this trade will turn around and go my way.)
- and finally, Terror (I have made a stupid mistake that could wipe out my account.)
One of the questions traders ask me the most is: “How can I use more options to turn this bad trade into a winner?” I have to say I’m flattered when someone thinks I am such an option wizard that I can turn lead into gold. The only sure way I know how to avoid having any more losing trades – is just to hold a few bad ones until they completely destroy your account.
When traders evaluate the risk of a trade, they normally think they can grasp a trade’s risk when they place the trade. And for that moment in time, they may be quite right. What they don’t plan for is that things can change – and the risk escalates at a faster and faster rate.
In my newsletter Time Farming Training Bulletin, I post a selection of the trades I make in my own accounts. Over the last three months, I have placed an average of five (5) trades per month for a total of 15 trades. 13 of the 15 trades (as of today Nov.18, 2017) are profitable and two have lost money. The ratio of “winning dollars” to “losing dollars” is 3.75:1 This means for every $3.75 I’ve had credited to my account, I have lost only $1.00. Especially for small accounts – recommend a money management rule of “exit a trade when/if the premium of the sold option doubles.” When the premium I sold, doubles, exit the trade at the next opportunity.
I should point out that past results do not guarantee future results,but you know that, right?
If you have lots of money in your account, you can be more tolerant and “ride it out” if you choose. When you have a small to medium account, “riding it out” is dangerous to your account balance. Holding even one bad trade for an outcome can demolish your account balance. The investors with funds in excess of $250,000 (as an example) who are only invested at 50%, have plenty of room to modify a trade, or just to tolerate a higher risk, than those with small/medium accounts can afford to do. Having a larger account does give a trader more opportunity, but you also need to gain the experience to be able to manage this risk. Grow your position first to more capital, then advance to more sophisticated techniques.
In my newsletter, I have the “double premium” rule in order to teach small and medium investors that a trader can manage small losses and do it in stride. If you have 13 winners and two losses, AND you have kept the losses down to manageable levels – you will survive to continue trading. Not using good money management – can place your account in danger. Even if you have enough money to pad one bad trade, you never know when another trade could also dive, and this puts you in a position of not having enough money – and that can be the end to all your trading. Like a warrior, your first rule has to be to survive to fight another day, if you don’t, you die!
Money Management Will Minimize Losses
The thing about using more option combinations to try and save a trade gone bad, is that it can get expensive – and you will often take on the same or a larger amount of risk trying to ‘save’ a trade. It is better, I think, not to be married to a trade; just go find more fertile ground where the odds can be in your favor without the additional expense. As you gain experience, and your account grows, you will have earned the right – and you can then afford to try and stay with a losing trade for a turnaround or modification. Speaking for myself, I have learned to just exit and move on to the next trade. This is less worrisome, lower risk, and not as complicated. And it teaches me to endure inevitable losses as a part-of-the-game, and it keeps me from peril of more risks.
Just as in a good chess game, you sacrifice pieces for the greater good to win the game. You do not expose yourself to more risk and take on a bigger battle that could destroy you.
Sun Tzu from The Art of War: “Good military leaders start by winning easy battles and improving their position.”
On the average, if one has 13 winning trades and two losses over three months, you will have (13 minus 2) a net result of about 11 winning trades every three months. Don’t fight the battles you may lose; keep the easy wins and continue to improve your position.
The purpose of this blog is to help traders learn to think of their investments as an on-going business, a dependable source of income – and to continue learning about option trading and all the opportunity it offers. If you wish to send a friend this post, just copy this link and email it to them:
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