Risk Management in Trading Trumps All

During the recent period of high volatility many of my client portfolios took a ride up and then down then back up again, which may be of some concern.  I received a phone call from of them (of which I rarely do) and she asked if I could just ‘sell stuff before the market goes down and buy stuff right before it goes up’.  I certainly wish it were that easy!  Yet, my job is to make money for clients regardless of the direction, and with options my timing has to be nearly perfect.

If I have a good read on the direction then I give myself a chance for some nice wins.  However, those wins are not counted unless the gains are booked, which brings me to the most important lesson in trading/investing – risk management.

I use many different tools in my trading arsenal – technical tools such as the MACD, bollinger bands, RSI, Williams %R and others.  I will also recognize fundamental and macro data which may help contribute to my decision process.  Further, the options montage helps me to determine the best strike and month if chart/technicals are favorable.  Yet, putting all the pieces together and creating a winning trade is useless if I do not have risk management system in place.

The game of trading is about booking profits – PERIOD.  There is no other goal in mind and if you focus on booking gains you will always give yourself a chance at staying in the game.   Sizing your position right is a great rule and one we preach often.  It’s the easiest to understand but mostly abused rule in trading.   The reason is greed.  Instead of showing discipline and consistency in the trade we are looking for that ‘big win’ that is going to make up for all of those losses.  This is a bad approach of course and will usually end badly.   There are times when trades move against us and those are unfortunate moments, but if you size properly then you won’t get killed.

No matter what you think the company may do or what the chart is saying, if you are not willing to take a profit at any time then you will be vulnerable.  If you are willing to take something down you will always be in the game.

Taking profits is easier than you think.  But, the one question I’m asked constantly is ‘Bob, should I sell here’?  My answer, if you have a profit — will always be ‘yes, take some or all off the table’.  I always say that if you have to ask then it’s probably the right thing to do.  What are they afraid of?  Missing out on future gains of course, being left aside if a stock runs without them.  When I enter a trade I do NOT have expectations of a return goal or target.  That may sound odd, but the market is a moving target.  My plays are based on the chart/technicals and not the price of the option.

Basically I will shoot for singles and doubles but always giving myself a chance to hit a homerun.  My hard/fast rule in options trading is to talk half off at a double if I’m fortunate enough to be in that situation.  No thinking here, just take half and re-assess the position.  At this point I now have an extraordinary advantage, playing with the house’s money.  Having my original capital back in my pocket affords me a great luxury of holding a ‘free trade’ on the remainder.  This frees up financial and emotional capital that can be spent elsewhere.

Good risk management techniques which includes sizing right and taking profits will always giving you a chance in this challenging trading environment.    BL    Explosive Options