Understanding Risk and How to Reduce It

There is no sure thing as an option trader when it comes to risk and profits. Heck, there are not many things in life in general that are a sure bet either, no matter how much the odds may be on your side. All trading is speculative, but as traders we do our best to improve the odds. But what if there is not a setup that matches our criteria for entry?

Ducks in a Row

I like to call it the “ducks in a row” theory. As a quick example, what if you have a bullish setup, a bullish trigger and a bullish market? That could be considered a ducks-in-a-row trade. But what if your ducks are not in a row? The simple answer is, do not take the trade. But what if your gut is telling you something else?

Smaller Contracts

Fewer contracts equal less risk. The math is simple. What I like to do when I am taking a gut feeling or more risky trade is to do fewer contracts and maybe risk a little more percentage-wise. So instead of risking 25%, I might risk 50%. If I cut my contracts in half, that is not really reducing risk. Many times, I will do less than half to try to reduce the overall risk.

Gut Feeling Trades

By no means am I advocating taking gut feeling trades on a regular or semiregular basis. That is certainly a recipe for loss and disaster for a trader. Let’s be honest: There are trades that have nice potential setups even though the market may be a bit of a mystery. You need not go much further than looking at the current market conditions for a perfect example of that.

When in Doubt, Sit it Out

When in doubt, the best thing to do is not make the trade. Finding ways to talk yourself out of the trade always applies. As a trader, you want to feel like money is truly lying in the corner. We know that is not possible, but that feeling of missing out can be strong. Do not let that fear guide you too. When you understand risk and how you can reduce it, you are a smarter and most likely a more successful option trader even when your ducks are not all in a row. The risk manager inside of you will love it.

John Kmiecik, Market Taker Mentoring

Trader Education