Learning How to Manage Your Risks
As an options trader, it is important to learn the right steps to manage your risks. There are risks in any kind of investment that you choose to go with, but options trading, since you will never actually own the underlying security, can sometimes be riskier than other choices. The good news is that there are ways for you to manage your risks, and ensure that you earn more profits in the options market. Some of the different ways that you can manage your risks with options trading includes:
Tip 19: Only invest what you can afford to lose
The biggest thing that you should do with risk management is to watch the amount of capital that you are putting towards your trades. You should only ever trade with the money that you can actually afford to lose. You should never strain yourself during these trades or use money that is meant for other purposes. If you want to succeed and stay with this for the long term, then you must make an effective money and risk management program that includes only spending the money that you have saved up and can afford to spend on the market, and nothing else.
Once you start investing more money than you can afford to lose, you will start to increase your risks too much. You will end up using money that was put back for rent, or for paying bills, or for some other purpose, and you will end up making more decisions based on your emotions, rather than basing them on what you should, logical and good planning.
Tip 20: Learn risk management for trading success
There are some traders who choose to ignore risk management. They assume they can handle the market and that they don’t need to pay attention to any of the tips in this chapter. However, all the success that you receive as a trader will lie in your ability to manage all of the risks of the market in an effective manner. There is always going to be some risk in the market, and even with managing the amount of risk that you take on, you could lose money in the process. But if you think through your trades and work to manage risk as much as possible, by learning more about the market and the things to be careful about, you will be able to keep your risks to a minimum.
Risk management is going to be one of the best things that you can work on when it comes to protecting your money and making sure that you bring home as much profit as possible on each trade. Never just jump into the market and assume that you know what you are doing. Learning some of the steps to manage your risks, and check out the other tips below, to ensure that, even though options are risky, you are limiting the amount of risk that you are taking on with each trade as much as possible.
Tip 21: Always work on a detailed trading plan
It is very important for you to have a detailed plan for all of the ventures you do in options trading. The purpose of having this plan is to help you execute all the trades that you do, help you to manage your money, and can limit the amount of risk that you take on. In short, you need to ensure that your trading plan has information about the amount of money that you are comfortable and willing to risk, as well as information about the amount of risk exposure that you are comfortable with.
Often, new traders are going to make a big mistake and try to use up money that was meant for other purposes. They will often start to use their emotions for these trades, and that can make it easier to lose all of that money. But, if you choose to come up with a solid plan, then it is easier to avoid these mistakes. When you make a plan and dedicate yourself to sticking with it, you will find that it is easier to actually make a profit with options.
Tip 22: Never do revenge trading
Everyone suffers losses on these trades. Even traders who have been in the market a long time will turn around and find that some of their trades lose. Understanding that, and being willing to accept that this can happen, are keys to seeing success. But one thing that you don’t want to have happen with your investment is something known as revenge trading.
Revenge trading is when you make a series of bad trading decisions after an initial loss. You feel that you need to make back that money and more, that you need to prove yourself. This leads to you taking on too much risk, and often you will continue to lose more and more money. Since you aren’t thinking through the trades that you are doing, you are putting your capital at a high risk and it is unlikely that you will actually earn any of it back.
If you find that your emotions are high after losing out on a trade, take a break. There is nothing wrong with removing yourself from the market for a day or two, and then come back in. This helps you to calm down, relook at your strategy in a logical and calm manner, and then enter into the market with the right tools to turn that loss into a win.
Your emotions need to stay out of your trades at all costs. If any emotions starts to come out, if your heart beats faster and the blood pressure rises, or you get angry, excited, or any other emotion starts to come out, whether it is in response to revenge trading or something else, then it is time to leave the market for a bit. Sticking in the market when you feel these intense emotions is just risking your money too much, and you are more likely to make a bunch of bad trades. take a few days or so off, and come back when you feel more comfortable with your ability to make smart decisions.
Tip 23: Adhere to the pre-planned risk levels
Before you go into a trade, make sure that you determine how much risk you are able to take. Each trader is going to be different, so don’t feel bad if your risk level may be a bit lower than others. But if you want to take on more risks, that is fine as well. The important step here is to know what your risk level is from the start, and then, once that is determined, adhere to it.
One of the biggest mistakes that beginners can make it decide they are comfortable with a certain risk level, and then they change it in the middle of a trade. They hope that doing this lets them follow more trades, and makes them more profitable. But if you weren’t comfortable with a certain risk level before trading, you aren’t going to be comfortable with it while you are trading. And making these changes outside of your comfort zone can lead to lots of lost profits with your trades.
There are several tests that you are able to work with to determine what your risk level is and where you will be the most comfortable. But no matter what, you need to have this determined ahead of time to make things easier overall. You may find that your risk level is higher or lower than what you had assumed in the beginning after taking a few of these tests, and knowing the information ahead of time will make a big difference in the type of trades that you do, and even the trading plan that you choose to go with.
Tip 24: Diversify your portfolio
Putting all of your capital into one trade is risky. And even trading on one market or one type of asset can be risky as well. The more you are able to spread out your assets, and diversify, the more money you can potentially make, and the less risk you will take with these trades.
If you put all of your money on an option for one underlying security, the risk is much higher. If this underlying asset does well, then you will make money. But if the underlying asset does poorly, then this means that you stand to lose all of your money and have nothing left to invest in.
It works a little differently when you diversify your portfolio. When you pick at least three or four securities to invest in, your capital won’t be harmed as much if one happens to take a turn for the worse. If all of them do well, then your portfolio will grow as well and you will see some big gains in your profits. But if just one does poorly, the other can protect you and you may still be able to leave the trade with a profit.
In the beginning, you may only be able to diversify with a few different assets. Your capital may be limited, but still try to invest in as many different assets as possible. As your capital begins to grow and you start to make money, you can increase how many assets you hold onto, and see some amazing results in the process while reducing your risks.
Tip 25: Follow advice, but make your own path
When you enter the market with options trading, you are going to receive a lot of advice. People will tell you what has worked for them, tell you about the news they heard, and try to get you to make an investment one way or another. Some of these people are well meaning and will want to try to help you out. And some of them may actually be able to provide you with some sound advice. But many times the other person either wants you to react to help them profit, or they really don’t have any idea what they are talking about, and following their advice can make you risk your capital.
There is nothing wrong with listening to advice on occasion. But you do need to make your own decisions when it comes to following the advice that you hear. If you can’t verify the information, and if you are worried about the place the advice is coming from, then it may be best to pick your own path for the investing.
There are many other traders who may be able to provide you with some information to help with your trading decisions. You can talk to your broker. You can talk to financial advisors. You can talk to some individuals who know more about the industry and who have traded in options as well. But no matter who you choose to talk with about your decisions, always remember that they are your decision, and you need to do your research and decide things on your own rather than just trading based on the information that they give you.
Managing your risks is so important when it comes to
investing. When you manage them, you ensure that more money will end up in your
pocket, and you reduce the chances that you will lose a ton of money in the
process. By following the tips above, you will be able to properly manage your
risks and options trading will be more successful for you.
