SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

How to Control Losses and Protect Profits


One of the requirements when developing a trading method is that traders have to fully describe how to start and settle trades. However, when they are forced to describe how to adjust and manage the size of their positions, few traders have a concrete answer.

This is sad, because without a suitable size for the positions any method of negotiation will be incomplete.

 

Many people avoid monetary and risk management issues because they realize that controlling risk will not get rich. But the fact is that you will not get rich at all if you do not learn how to manage money.

 

One of the pillars of the industry is the search for the holy grail and in fact the industry is in love with the trading systems. Many traders, especially those who go through that initial phase of frustrating losses, are looking for mechanized trading methods that simply generate input and output signals to follow without asking questions. However, they rarely seek a "monetary management system" capable of generating clear "signals" about how to adjust and manage the size of positions. But the reality is that these techniques exist and, despite being mechanical, are much more effective than the signal generators of buying and selling.

 

Have you ever considered the following: If money is earned through trading systems, why do the vast majority of traders end up without profits or losing money? This is not due to the lack of consistency of forecast resources or services that are available for every trader. This is due to monetary management, which is practically a last minute idea for many traders.

 

Just Bad Luck or an Immutable Mathematical Law?


Let us now turn to the playing field of the negotiation: here, the percentage of Winning Operations and Profitability can vary with the change of market conditions. The only parameter that the trader can effectively change is the risk.

 

We will use the example of the launching of a coin to present some fundamental concepts of risk management. When we flip a coin, our luck is equal to a 50% winning transaction percentage. The risk is the amount of money that we play, and therefore put at risk, on the next release based on the payment ratio. In our example, our "luck" and our payment remain constant.

 

Following the example of coin tossing, it does not matter in what order the faces and crosses appear. If we first take 50 crosses and then 50 faces, the result would be the same as if we took 50 faces and then 50 crosses.

 

In options trading, the order of the operations that are performed, as well as the result of any operation are almost always random. Therefore, from a risk control perspective, it is not advisable to stick to or emotionally the result of an operation or a series of operations, nor financially risking too much.

 

To understand that what appears to be an unlikely outcome is, in fact, possible we need the help of the Law of The Large Numbers.

law-of-large-numbers-2-638.jpg

 

The Large Numbers Law tells us that a random event is not influenced by previous events. This explains why the percentage of Winning Operations in a system does not increase even if the system has recorded 20 consecutive losses. While it is true that recent operations affect the overall percentage of Winning Operations, many operators enter the market thinking that a corrective move should occur, simply because they have had several consecutive winning or losing trades. In doing so, they are expressing the belief in the so-called "gambler’s fallacy".

 

This brings us to the next point: imagine that you think you are unlucky after a really bad loss streak when it seemed like you had found a winning system. If there was a way to know how long a streak will last …

 

Well, if you know the probability of an event (percentage of Winning Operations) and how many times the event will take place, there is a mathematical formula that will indicate the maximum number of winning and losing streaks. But in trading the number of times the event occurs is not known, since it can cover your entire life as a trader.

 

If we knew the number of operations that you will perform during your life, you could calculate the maximum number of consecutive losses, provided that the percentage of Winning Operations remains exactly the same. By varying the percentage of Winning Operations, the number of consecutive losses will improve or worsen. But it is impossible to know both numbers in advance.

 

The Ralph Vince Experiment
 

Ralph Vince conducted an experiment with 40 doctorates without previous training in statistics or trading, which were given a simulated computer trading environment. Each of them started with $ 1,000, a percentage of Winning Operations of 60% and they were given 100 transactions with an Expected Payment of 1:1.

 

At the end of 100 tests, the results were tabulated and only two of them earned money. 95% of them lost money in a game in which the odds were in their favor. Why? The reason they lost was the belief in the gambler's fallacy and the resulting poor monetary management. Greed and fear were used to calibrate operations.

 

The aim of the study was to demonstrate how our psychological skills and our beliefs about random phenomena are the reason why at least 90% of people who have just reached the market lose their accounts. After a series of losses, you tend to increase the size of the bet by believing that a winning operation is now more likely - that is the gambler's fallacy, since the odds of winning are still 60%.

 

If you want to learn how to treat options trading as a business and put probabilities in your favor, I invite you to join us.

 

Start Your Free Trial

 

Related Articles:

cleardot.gif

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Put Writing in 2020: The Role of Timing Luck

    The impact of luck can play a meaningful role in the short-term outcomes of monthly option trades due to the requirement to roll expiring contracts. The extreme volatility in 2020 highlightsthis fact when we look at results of SPY cash secured put trades launched on slightly different start dates.

    By Jesse,

    • 0 comments
    • 151 views
  • The problem of Option Math

    Option traders may be divided into two categories. First are those relying on instinct or casual observation. This group tends to speculate on directional movement, future volatility, value, and on potential profitability of trades. The second group is involved deeply with math of trading and depends on what is perceived as certainty or near certainty.

    By Michael C. Thomsett,

    • 0 comments
    • 290 views
  • Put/Call Parity: Two Definitions

    Traders hear the term put/call parity a lot, but what does it mean? There are two definitions and they are vastly different from one another. The first definition involves the net credit/debit for any combination trade, with trading costs are considered. The second definition takes assumed interest rates and present value into mind.

    By Michael C. Thomsett,

    • 0 comments
    • 268 views
  • Do Options Affect Stock Prices?

    It is widely acknowledged that the price of the underlying directly impacts the premium of the option. Therefore, options are termed derivatives. Their current value is directly derived from movement of the underlying price. Is the opposite also true? Does movement of the option value affect the underlying price?

    By Michael C. Thomsett,

    • 0 comments
    • 477 views
  • Portfolio Withdrawal Strategies

    This article will discuss three ways to take systematic withdrawals from your investment portfolio that would be expected to last 30 years, which is a typical time period a 65-year couple might need to plan for in retirement.

    By Jesse,

    • 0 comments
    • 353 views
  • Pricing Models and Volatility Problems

    Most traders are aware of the volatility-related problem with the best-known option pricing model, Black-Scholes. The assumption under this model is that volatility remains constant over the entire remaining life of the option.

    By Michael C. Thomsett,

    • 0 comments
    • 532 views
  • Option Arbitrage Risks

    Options traders dealing in arbitrage might not appreciate the forms of risk they face. The typical arbitrage position is found in synthetic long or short stock. In these positions, the combined options act exactly like the underlying. This creates the arbitrage.  

    By Michael C. Thomsett,

    • 0 comments
    • 728 views
  • Why Haven't You Started Investing Yet?

    You are probably aware that investment opportunities are great for building wealth. Whether you opt for stocks and shares, precious metals, forex trading, or something else besides, you could afford yourself financial freedom. But if you haven't dipped your toes into the world of investing yet, we have to ask ourselves why.

    By Kim,

    • 0 comments
    • 544 views
  • Historical Drawdowns for Global Equity Portfolios

    Globally diversified equity portfolios typically hold thousands of stocks across dozens of countries. This degree of diversification minimizes the risk of a single company, country, or sector. Because of this diversification, investors should be cautious about confusing temporary declines with permanent loss of capital like with single stocks.

    By Jesse,

    • 0 comments
    • 572 views
  • Types of Volatility

    Are most options traders aware of five different types of volatility? Probably not. Most only deal with two types, historical and implied. All five types (historical, implied, future, forecast and seasonal), deserve some explanation and study.

    By Michael C. Thomsett,

    • 0 comments
    • 649 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido