Welcome to The stock Market Millionaire podcast. This is episode number 16. My name is Robert Roy. I am the founder of WealthBuildersHQ.com. And today, our episode is called, “Control Options Trading Risk, or Blow Up Your Trading Account: You Decide.”
So we first need to define what “trading risk” is, and for each trader, there will be some differences in there and your personal risk profile, your risk tolerance is going to be critical. So I will give you a very quick example of this. You place a trade on Amazon, whether it’s option, stock, makes no difference, but you spend a lot of money, no matter what you did on an Amazon compared to Ford, let’s say. And, you go to bed last night and your eyes are wired. You can’t go to sleep. You are freaking out wondering what’s happening in the European or the Asian markets. Is it going to drive the price down, go against you, you’re going to lose all your money. If you can’t sleep after you’ve placed a trade, that trade has too much risk for you, for your risk profile, it’s too high. You need to determine based on what stock price and/or options price you feel comfortable with, where can you go to sleep and say “it doesn’t affect me.” And I don’t mean, “well, I don’t care about the money,” I’m not talking about that. You should care about the money, it’s yours. You probably worked hard for it as most of us have. I’m not referencing that. What I’m talking about is, you understand and take on the risk that is associated with that trade setup, which fits your risk profile.
So for me, as an example, I’m an options trader. I love to trade options, all different types of trades setups. I trade a plethora of options trades, which means I have different trading risk for each of the different trade setups that I utilize. So if my trading risk, as an example, if I am looking at an Amazon, maybe I don’t want to buy a directional trade for Amazon, meaning I buy a call option. I’m going to spend a hundred for a swing trade, I’m going to spend $140 per share of $14,000 to do one contract. Instead, maybe I go ahead and I do a credit spread, because now I’ve reduced my risk in that trade. I have a minimum risk, minimum rate of return, better chance of being right, which we’ll cover in a whole different podcast, but my risk profile is really based on my individual strategy that I’m looking to associate with. And, there are ways of controlling risk, even in those bigger companies – the Amazons, the Googles, the Bookings of the world – and we’ll talk about that in just a moment, but understand first and foremost, each trade setup has a certain risk profile – for me.
That’s going to be, how much am I willing to put into the trade? How much money am I willing to risk? And, is that trade even too much risk for me? So again, go to an Amazon, we do a naked call, an uncovered call. What does that mean, Rob? That basically says you have a limited profit potential in the trade, and an unlimited risk. See, unlimited and risk. They’re not oxymorons; they’re fricking crazy morons. When you put them together to me as a trader, that’s my risk profile. To put on a naked call and hold overnight, for me, insane. Now I know traders – they love to trade that way and that’s okay. Amazon might not be the first one to start off with, just as an FYI, if you’re looking at that, but you trade what fits your risk profile. I am not here to help sway you in your risk. It’s yours. It’s not mine. Just make sure you can go to sleep at night when you placed that trade.
So what is the best way to control risk in the trade then, Rob? Well, a couple of things about it. Most do nothing until the “uncle factor” comes into play the uncle factor. Yeah, that’s a Rob term. You got your arm twisted behind you and your head’s down on the mat and you yell, “uncle, uncle,” I give, in a wrestling match, let’s say. That’s it. That’s enough, enough pain, I’m stopping the match right now. Enough pain, you’re getting out of the trade. Most traders never use any kind of stop loss order of any sorts, any kind of stop to exit out of a trade, right? To me, one of the biggest things you can do to help, even in those higher price companies like the Amazons to help minimize your risk, is put in some form of stop loss order.
Now I know, before you guys start slamming me with, “but that doesn’t always work,” you’re right. It doesn’t. It doesn’t. But, what is the alternative? To not put a stop and have no chance of protection whatsoever? Will it not help you have Amazon gaps against you, or whatever the stock is, gaps against you? Absolutely. If Apple closed at 120 and opens at 130 and you were bearish on it, guess what? It went against you. There’s nothing you can do, right? You can’t control that, but you can control limiting your risk in overall in that trade. And, one of the ways to do that is putting in a stop-loss order.
Now, trailing stop orders is another way. So a stop loss order basically says, “stock’s trading at a 100. If it gets to 98, get me out of the trade.” That’s my uncle factor. That’s where I’ve had enough pain. And the chart tells me where to set that. I’m not here to try to help you define and understand that as far as where to set a stop – that’s part of your risk profile – how much you’re willing to risk. And we’ll talk about risk reward in just a second, but utilizing a stop order is just a hard target. When it hits that order, it turns it into a market order and fills you at the next available price. So it’s hidden from the market-maker until the price has triggered. A trailing stop order, literally trails behind the stock or option by X, whatever you determine what that X is, and that’s part of your trading strategy. It works out into risk profile, but you define it as part of your trading strategy itself. So, trailing stop loss, if the stock was trading at 20 and you have a trailing stop of a dollar, that means that the stock went from 20 to 21. Your trailing stop would move up a dollar behind the stop. If your stock went from 21 to 22, your trailing stop and move up to 21 and stay a dollar behind the stock. If the stock came down a little bit, the trailing stop doesn’t move. It’s not an adjustment that stays $1 all the time. It will trail behind it on the way up, and it will hold its ground if the stock is moving against it. In this case, down, for the example that I’m setting.
Now, be sure to trade in your comfort zone. This will help you with controlling risk. What does that mean? Well, first off, you need to define a risk profile for the trade, a risk:reward profile for your trade. Okay. Got it, Rob. What should my risk reward be? No, hold on a second.
What if someone says I’m trying to make a dollar and I’m willing to risk a dollar at the same time. You need to be right six out of 10 times to be profitable in that trade. 60% win rate? Listen, I’m all about it, but why don’t we go for a number that’s not as stressful, that I’ve got to win so many times and be right, something that gives us or helps us become a little more forgiving? For me, a bare minimum in my directional trade setups is this: I’m looking for two times the reward of what I’m willing to risk. What does that mean? If we want to risk a dollar, I need $2 in profit. Well, what if the trade only gives me a .50 in profit and I’m risking a dollar? Then you don’t do the trade. Next, pass. Pass. You don’t have to take the trade just because it’s a trade. “OH, but I could…” No, no, no, no. It goes against your risk profile or just this time. Okay. “I’ll steal the candy just this time from the store, because I don’t have the money with me – just this time.” No, you set your rules and you stick to the rules in your system. If you want a one and a half to one reward, risk ratio, go for it. That’s your risk profile. For me, it’s at least a two for one. I only need to be right on four out of 10 trades in that scenario to be profitable. I’m not saying you’re making a lot of money, but that puts me up at profit level. I’m batting 400, which is killer. I don’t have to back 600. There’s to me, one of the biggest differences.
Amount of trade, how much money are you willing to put into a trade? Define that right upfront. Don’t buy equal contracts, don’t buy 10 contracts or two contracts, buy equal dollar amounts. I’m trading $200, $500, $50,000. Whatever the number is, define that in your trading system. Are you going to day trade versus swing trade? This is what your comfort zone, right? And so what we’re talking about here. What’s your trading strategy? Are you a directional trader, a spread trader, an iron condor trader, diagonals covered calls, naked puts the upside down Flint, rumble, bubble, cake, trader? Whatever it is, decide what the trading strategy is. What implied volatility are you looking for? Are you looking at it and going, “oh my God, this is crazy right now. After all this Reddit stuff, Gamestop is nuts at like a 400 implied volatility!” Does that mean you can’t trade it? No, no, no. I have an arrow in my quiver, a tool in my toolbox that I can take out and still trade that trade. Right? And I talk about this trade all the time. Make sure you get to WealthBuildersHQ.com and go and check out our Power Hour is what it’s called it. Every Monday. It’s at noon. It’s free. It’s one hour long. We go into what’s going on in the market, what we’re trading and so forth. I talk about this type of setup in there every single week while we’re in these crazy times, of course, I’ll stop when the IV goes down on them a little bit, but I liked that high implied volatility for a very specific trade setup.
Trade in the direction of the S & P 500 or the SPX, the market. Why? Because 70 to 80% of all stocks tend to move in the direction of the market. Why not have your trade B in the overall higher percentage? Now I’m not saying they’re on countertrend trades. Absolutely are. Absolutely can make some money with them. Absolutely should consider it. I’m not saying that you should not; just keeping in mind that if you trade with the S & P 500, you have a better chance of being right.
So here’s another one. What is the best method for reducing risk in the market? Okay. Options trading risk is less than risk in trading stocks. I’ll say it again. Options trading risk is less than the risk in trading stocks. You minimize your cash required, you minimize your risk in the trade, you can’t have more risk in the option. If you’re a directional trader, right, go do them on covered naked call thingies, you can, but with the stock and the stock is $10, you could lose 10 bucks. It can go to zero. With the option, if the option on that same stock is $2. You could lose 2. See where I’m coming from? You’ve got a lower risk by trading the options versus the stock, right?
So here’s the thing, never place a trade without first, considering how to control your options, trading risk. Folks, There you have it. I hope you have a great rest of your day. God bless. And I will see all of you at our next update. Take care. See you soon. Bye.