10/01/09 Pylesville, Maryland
The holy grail of trading is money management.
Good money management will make you money, even in tough times. And it will save you tens of thousands, perhaps even hundreds of thousands, of dollars, if you reach the rank of successful trader.
And it all boils down to this. You must take trades that have at least a 1-to-2 risk-to reward ratio. Of course, 1-to-3 (or higher) is even better.
In options trading, that is easy to ascertain. If I stand to make 100% but limit myself to a 50% loss, then even if I am only 50/50 on my trade selection, I’m going to come out ahead. Think of it this way: If my risk capital is $500 and I double that once, I have $1,000. If I risk $500 on my next trade and it is a loser, I still have $750 left at the end of that trade.
Keep risking only $500 until your account is up 300%. Once you have reached $2,000, you can double your risk capital to $1,000. If you ever fall below $2,000, just go back to risking $500 until you reach $2,000 again…
By only seeking to grow incrementally, always managing your risk, you can even go on a bad streak of 66% losing trades and still break even. Nobody wants to do that. But you better plan on it happening, because it will.
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This seems to be more than a bit naive in that it does not disclose the fact that a stop tighter than the target means decreased likelihood of a win.
One can’t blithely confer reduced losses upon oneself, in the mind, by operating with a tighter stop— the benefits are generally canceled by the increased frequency of losses.