Options Trading and Money Management Techniques for Online Investing   by James Glisson

in Investment    (submitted 2011-03-22)

Wealth management for online investing is no easy achievement in today’s stock market investing.  One day there is Bull Market trading and the next day there is Bear Market trading.  Many investors judge that proper money management is the most imperative and most disregarded consideration to their online investing achievement .  Options traders should have a firm grip of the statistical probabilities involved in the philosophy of money management if they conceive to increase their wealth in the future.
In his esteemed book, "Trading for a Living", Dr. Alexander Elder sums up the importance of this concept in one word.  That one word is innumeracy.  According to Dr. Elder, "Innumeracy"; not knowing the basic notions of probability, chance, and randomness- is a fatal intellectual failing in traders."  Not surprisingly, proper money management will work to work that dilemma.  While stock and options trading education is important for online investing, money management is a trader’s worst nightmare if not attended to fitly.
There is a little known investment reality that many investors fail to spot .  Traders can be profitable with a winning percentage of a smaller amount than 50 percent.  While investors strive to go beyond a 50 percent trading success, options trading success can be greatly affected by our money management.  Traders should be very vigilant to place a limit on their losings and let their winners run up when possible.
Despite the consequences, traders must consider their limits.  In fact, options trading can be successful with a winning percentage of a smaller number than 50 percent.  Money management is critical in options trading to preclude overexposure and preserve assets.  Options traders would be wise to place limits on the trade size equal to a percentage of the total capital they have to invest.  An instinctive mistake is to raise trade amounts of money during a losing streak but lower it during a winning streak.  Hence, more than ever, cut losses short and let profits run.
It is necessary in online investing for investors to know that losing is part of any business.  Losing streaks are upsetting and require very good coping skills. The elemental goal of achieving profitability will continue out of reach unless great care is interpreted to control the amount of capital allocated to each trading posture.  Proper money management techniques allow traders to live for another trading day in spite of the inevitable losing trades.
The allocation of risk capital is vital in money management with regard to each trade.  Each trader must come to a decision on the dollar amount to trade and this ending should take into account overall profit goals and expenditures of trading including commissions.
As mentioned earlier, one good money management approach to consider is a percentage allocation to each trade which embodies a set percentage of the total risk capital account.  For example, let's say a trader has $25,000 available for options trading and desires to allocate 10 percent of their entire account to each trade.  Therefore, the first trade would be $2,500.  
Let us presuppose the trade increases 40 percent, or a $1,000 profit.  Because the account size is now $26,000, the next trade would be for $2,600 (0.1*26,000).  In the other event, say the first trade lost 40 percent or $1,000.  The risk capital account would now stand at $24,000, meaning that the allowance is only $2,400 for the next trade.  Become aware of how this differs from a fixed-dollar scheme in which each trade investment would be $2,500 time and again.  This percentage will usually vary from 1% to 10% according to a trader’s margin to risk and amount of risk capital.
In no way should traders let the allocation order the direction of an option purchase.  For instance, say a trader has $2,500 for a trade and the trading system calls for higher-premium in-the-money options.  If the option is priced at $6 (four contracts, or $2,400), don't opt for a poor quality out-of-the-money option priced at $5 (five contracts, or $2500) just so the total trade meets the assigned amount.  Consequently, don't compromise the trading system for the sake of meeting the exact allocation.
A reliable money management discipline will enrich the options trading psychology, help reduce losses and increase the power to earn money.  Traders should assess their portfolio recurrently to be assured their money management snipe is functioning and adjust the percentages allotted to each trade to suit the comfort level of the trader.
Good Investing!
 
James Glisson, Contributing Editor 
Option4Options.com

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