Knowing How to Stop Loss is the Key to Account Survival
A stop loss that works: There is a trader who never has losses and always make money on every trade; he/she exists only in your mind, but there is no such trader in reality. No matter how much you research trading, you will have losing trades just like everybody else. There is something very simple you can do about this: You can learn how to react and take action to protect your account balance by adapting a very simple rule.
When Selling Commodity Options, you should consider the “200% Rule.” As soon as the option you sold doubles in premium, exit the trade and take a loss. There will be times when you miss a fill at exactly at the double-price level, so you should know close enough will usually make this money-managing strategy work very well. Just don’t let the losses run and accumulate. If you think that a great deal of the time you might be better off holding the bad trade, you might be right – but I ask you to consider this: Losing profits not gained won’t put you out of business, but holding bad trades until they take a huge bite out of your account balance will most likely turn into a slow and painful death to your trading. Don’t do it. When selling commodity options, you must follow this rule if you want to last and make regular money.
Taking profits too quickly and letting losses run is called the disposition effect. You have be able to counter your gut reactions to be able to avoid it. It may be the #1 cause of trading-account-death. Having an money management plan should be high priority to all option sellers.
There’s an old joke about trading:
Question: What do you call a short term investment when it goes bad?
Answer: A long-term investment.
In very long-term stock investments – especially when using value-investing, this 200% rule does not apply of course, but when selling commodity options for monthly income, it works for me consistently – and I highly recommend it. There is a reason this rule works so well for the option selling strategies: Most of these trades have a 95% chance of being profitable and in return for that – I make regular income, not huge windfall profits. This means as long as I keep my losses contained and relatively small, my winning trades will collectively make about 3 or 4 times more than my losing trades. It is simple arithmetic, not any complicated algorithm or so-called secret formula.
I get asked a lot “What makes Selling Commodity Options such a great way to produce income?” My answer might surprise you. I answer that question this way, “Because I have learned exactly how to keep losses from wiping out my profits.” That is what the 200% Rule does. There is no system of picking trades that can ever guarantee you will have no losses; it simply doesn’t exist. If there is a “secret” that is it. Is good trade selection important? Of course it is, but without good money management that is simple to understand and execute, very few traders will last. Learn to STOP LOSS and you will always last to trade another day – It’s a lot more fun to count your profits than to total your losses. Learn to survive first – and then you will have a chance to thrive.
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” – Warren Buffett
Many traders do not routinely or automatically enter orders to exit trades; this is a personal choice. Not all types of orders are allowed on commodity options (see chart below.) A commodity option trader can use a LIMIT order (either DAY or GTC) to set a a fixed price at which to exit a trade.
JUST SO YOU KNOW: The traditional STOP and STOP LIMIT orders cannot be used with commodity options. The STOP ORDER names a price to be hit, then turns into a market order when triggered. The STOP LIMIT order names a price to be hit and then turns into a LIMIT order when triggered.
Types of Orders Allowed on Commodity Options
FYI: When trading commodity options, you should know that the use of certain types of orders are NOT available to commodity option traders due to the policies of their respective exchanges (your broker does not control this policy).
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