As I held my weekly LottoX live training, a member posted a question that caught my attention…
Trading as long as I have, things like this become second nature to me.
So it’s not something I think about often.
I want to lay out 3 common methods to help you decide which one works best for you.
- Account percentage
- Fixed amount
- Stairstep method
Each has its pluses and minuses.
And you can switch amongst them as you see fit.
The important thing is that you adhere to some strategy.
Otherwise, you could wind up on the wrong end of a trade that destroys your account.
I know, it’s happened to me before!
I speak from experience here when I say this.
One mistimed and excessive trade can destroy your account.
Here’s how it usually goes down.
Joe trader struggles for years to create consistent wins.
One day, he makes a nice trade.
The next day, he comes back and does the same thing.
Now he’s thinking he could be on to something.
Two weeks of the same occurrence, Joe believes he cracked the code. Now he’s starting to plan how to generate weekly profits at this level.
Riding high, he spots a beautiful setup with an exceptionally high probability.
Similar trades won 90% of the time for him.
So he drops a fat amount of cash on the trade, 25% of his total account.
His luck runs out and he hits the 1 in 10 loser.
But, he doesn’t lose his entire 25%. However, it’s about 3x-5x what he typically loses.
He decides he’s ok with that because he’s playing at the adult table now.
So, he keeps at that same position size even on lower probability trades.
Eventually, the math works against him.
He loses trades as expected, but the losses are way bigger than imagined.
Now he’s struggling to just get back to where he was before this entire mess.
Most of us have been this person or know someone who has.
Joe didn’t stick with any particular risk sizing plan and blew up his account.
Risk management plans are part of trade management.
And trade management should govern ALL of your trading.
Account percent method
The account percent method is probably the most common out there.
You decide on a percentage of your total account value to risk as the maximum amount you could lose on the trade.
For example, if I have a $10,000 trading account and I decide on 1% per trade, the most I want to lose on any given trade is $100.
This method works well for scaling up and down with your account.
Say you take a string of bad losses and your account is now down to $5,000. 1% of that would be $50.
On the flip side, if you grow your account to $20,000, 1% is $200.
Something to keep in mind – your risk should decrease as variance of your results increases.
In layman’s terms – the more your results swing around, the less you should risk. If you get more consistent outcomes, you can risk more.
Fixed amount method
The fixed amount method is pretty straightforward.
You choose a specific amount of money, shares, or contracts to risk per trade.
Most traders choose an amount of money and then round off shares or contracts.
This method is quick and dirty as you never need to think too much about how much to risk or the size of your account.
The downside is that it doesn’t scale with your account the same way the percent method does.
So, you need to come up with rules to increase or decrease the amount you risk.
Example – Every time I grow my account crosses a $1,000 threshold I increase or decrease my risk by $100.
The stairstep method works with one of the other two methods but with a bit of a twist.
As I noted before, a series of wins or losses can throw us out of balance mentally.
Using the stairstep method you set the maximum and minimum thresholds for a possible trade size….
…say it’s 1% and 5% of your account.
Each time you win, you move up 1%.
Each time you lose you go down 1%.
You stop when you get down to 1% or up to 5%.
This keeps you constantly focused on risk management and forces you to immediately recenter yourself with every trade.
I like using this, especially after bad beats. It starts me out small and gently works me back into my full position sizing.
Adjusting your size based on the specific trade
Different options strategies have different odds of success.
Butterflies are low-risk high reward setups with a low chance of success.
Credit spreads have defined risks and rewards from the outset.
The trade strategy I choose plays a big role in how much I risk.
One of my favorite strategies to work with are long calls and puts.
They’re straightforward and fairly easy to understand.
And, there’s no better place to learn how to trade them then my LottoX Service.
Each week I hold live training, just like the one I started this article with.
Plus, you get access to my real-time portfolio, trade alerts, and more.
Come see what it’s all about.