Bringing The Option Beast Out
Becoming an options animal starts with a basic understanding of what’s at stake. Professional traders all agree that novice investors often fail due to their misunderstand of their trading ranges. There’s a sensitive dynamic between the money you hold in your account and the margins you believe you can make.
What you can make shouldn’t change how you perceive the potential loss during each trade. That loss must be managed, and this is why investors look toward options trading as a way to lower their risk. Some have even found ways to eliminate loss by having a strong understanding of how options work.
Determining Overall Risk
Risk is a factor to be considered during all trades. The common advice by professional investors is to set aside no more than 1 to 2.5 percent of your entire trading account per trade. Where many amateurs get confused is how. Let’s take a quick look at these factors to better gauge how risk can be managed per trade.
– Sizing Positions:
Options give us the ability to expand our trading positions in either direction.
This is possible through unit sizes. A unit is consider the amount of assets obtained per dollar, euro or yen spent in obtaining an equity. This is the beginning of how leverage works in the financial markets. The ability to dictate how many units you purchase is your first step in minimizing risk and by adjusting your position to the amount you’ve also set as a risk factor be it 1 or 3 percent per trade.
– Measuring Emotions Against Reason:
Consistency is key if you’re going to use a margin account. You might be swayed to change your strategy for example. Doing so invites higher levels of risk than you’ve planned to manage while trading. Managing this potential is all about managing your emotional perspective. This perspective is also why risk has to be tamed.
Losing is manageable while trading only if the risk isn’t perceived more than it really is. This risk factor is what can force traders to change their minds or to find a different course though the prior direction they’ve set was accurate. Managing these emotions isn’t about how much control you have.
It’s about how well you’ve organized your trading, so that you’re never caught in the position of risking more than you decided to.
– The Final Stop Loss Measure:
Stop losses make options trading very strategic when compared to stocks. A stop loss is a preferred price, pip or percentage level that you set aside to manage risk. This process works by first gauging how much you can afford to lose. You then want to calculate the potential lost you can make in your trade.
You can dictate your stop loss based on the invalidation point. This marker is the price that, which if reached, would suggest that your initial assumption was wrong. It could save you a world of financial troubles when set.
A Word On Leverage And Caution
Leverage is what makes options trading inexpensive when compared to common stocks. Leverage usually works in what’s called a margin account and based on a certain ratio as provided by your broker.
This ratio is often written as 50:1, 100:1 or 400:1.
The numbers of a 100:1 ratio means that for every dollar you hold in your account, you can trade with up to 100 dollars. This ratio can make a 1,000 dollar, euro or yen account worth up to 100,000 dollars, euros or yen when trading.
– Marginal Trading And Lot Sizes
These leverage rates are how you manage your units, which are also known as lot sizes. You don’t, for example, have to use your entire 100 to 1 ratio just because you have it. You can instead reduce risk by trading with only 2 to 1 of it.
These are a few steps to take as you trade options when reducing risk and protecting your money. Consider each as you invest, and don’t let your emotions take you off track. These tips are proven strategies that many professionals use.