Here is a simple question for you that all traders need to answer on a regular basis. Is the reward worth the risk? I pose that question to my students all the time. To me, it is a critical element to your success as an option trader. Without a doubt you can make money trading options, but you have to be disciplined. Let’s take a quick look at two different aspects to the risk/reward question.

Position Risk/Reward

As I have said numerous times in the past, you have to be a risk manager first and a trader second to be successful on a consistent basis over the long haul. Before you enter a position, you need to ask yourself, do you believe based on your trade assumptions that the risk is worth the reward? It is really that simple but, let’s be honest, not easy to do. Do you truly like the trade or are you getting caught up in the emotion of trading? Then, once the position is on, you need to re-evaluate whether you are up, down or breakeven on the trade. Always ask yourself as time progresses, is the current risk/reward worth it?

Technical Risk/Reward

The other risk/reward scenario that I find very important for traders, and not just option traders, is understanding what has a better chance of happening. Take, for example, support and resistance. These have a better chance of not letting the stock move higher over resistance and lower under support. Just knowing that improves your odds as a trader. So simple yet effective. And it just doesn’t have to apply to support and resistance. It could be any technical analysis you do that you know improves your odds. Put yourself on the right side of probability.

Remember to always think about how your risk/reward looks and whether you are putting the odds for success on your side. If you do think about that for every situation where it applies (which are most when it comes to trading) you have improved the odds for your ability to continually extract money from the markets.

John Kmiecik, Market Taker Mentoring