Welcome to The Stock Market Millionaire podcast. This is episode number 25, All You Need To Do Is Make This One Change to Greatly Reduce Your Risk in Trading. Hey folks, Robert Roy here. I want to talk about risk. Risk is a key component of what we do in the market. We definitely want to know how to control or reduce our risk wherever possible.
So here’s the first question we need to cover: is risk only something that inexperienced traders have to worry about. I mean, the very simple answer is no. Everyone has to worry about risk. It really does not matter your level of experience, your profitability versus loss. Every person, every trader, brand spankin’ new, first day ever heard of what the stock market was, to someone that trades a hundred trades a day, you know, millions of dollars, it doesn’t matter. We all have to focus on risk. Risk is extremely important.
Now, when we look at options, is there an acceptable amount of options, trading risk to take? And the answer is yes, there is an acceptable amount, but there’s a follow-up question or a second part of that question. And, if so, how do we figure it out? And, part of it needs to be understanding who you are as a trader, your risk profile, your risk tolerance. You want to make sure that you fully understand your own personal risk to help you understand how much risk you would want to take on. Can you take on more risk than you are comfortable with? Yes. Should you?
Probably not. Because if you think this is the one trade, no, no, no. I know this one, this one is going to go to the moon, and maybe it does, but if it doesn’t is this the one that, you know, put your account in the toilet, right in the trash, if not, it’s just the one that puts your account in the toilet? So be very, very, very, very, very, very careful. We talk about acceptable risk. It really comes down to your own personal risk profile. I know for my own trading strategies what I am willing to risk. I know that iron condor, when the stock gets to here, I’m out of that trade. I know when I buy a call option, if it goes against me and the stock gets down to here, or if I buy a put and the stock goes up to here, I know that it’s time to get out of that trade. But, that’s my personal risk that I’m willing to accept.
Can trailing stop orders, eliminate all risk? The answer is no, they can’t. You know, you have to understand how a trailing stop works. Basically, let’s say we set a trailing stop up by a dollar just to pick very simple number, and the stock is trading at a hundred and it moves up to 101. Well, if we set, when the stock was at a hundred, if we set a trailing stop behind it by a dollar, it puts it at 99. Stocks at 100, trailing stops at 99, we move up to 101, the trailing stop moves up to 100. We move up to 105, the trailing stock moves up to 104. We backed down from 105 to 104.50, my trailing stop, my stop stays in place.
It doesn’t back down when the stock comes down. See, it’s not meant to just go up and down and gravitate and follow along with what the market does. It’s meant that if we get a pull back of X – you define X – if we get a pull back of X, then we’re going to get taken out of that trade. And, that’s what we’re looking for, right? That’s where a trailing stop helps us. So will it eliminate all your risks? No. What happens if it’s going?
Well, there is no backing up. It’s just chugga, chugga, chugga, chugga, chugga, chugga along and all of a sudden the “oops” happens. What’s oops? Bad news. CEO found doing X wrong or something wrong, products not selling, government intervention, China jumping in and saying, “oh, we’re going to just slap SAP SAP to all of the Asian companies right now” and so forth. All of these things, it wouldn’t matter if your stock was at $200 and it gapped down to $170 and you had a trailing stop in place. It doesn’t protect you. It broke your trailing stop and opened at 170 you’ll get filled at the 170, the next available price. So trailing stops are helpful, but there is no order that’s a catch-all that prevents you from ever having a risk or a loss in that trade.
Well, what about just a typical stop loss order? Same scenario. It’s a great order type and something to use that I use all the time, but it doesn’t protect you from everything, but you need to put them on all of your trades. You need some form of stop. Whether it’s a stop loss or stop market, a trailing stop, or one of the a hundred other types of stops that your broker may offer. You need to have some form of exit in there that if it goes against you, you’re completely out of that trade or at least out of the risk portion of the trade.
Now, with all of this, there’s one change that a trader can make to greatly reduce their options trading risk. Now there’s a big debate on this, and for years, it comes down to do you A) take what are known as equal dollar trades, meaning every you take you’re going to spend or invest X into that position. So if you have a $2,000 account, maybe you do one-to-three equal dollar trades. One is too small, two-to-three equal dollar trades. If you have a $5,000 account, maybe you’re doing three-to-five equal dollar trades. A $10,000 account, maybe it’s five-to-seven equal dollar trades. A $20,000 account, maybe it’s eight-to-10 or 12 equal dollar trades. So you’re going with this, let’s say $2,000 account. You decide to do two equal dollar trades. Doesn’t mean you do both at once here.
“I’ve got a thousand in each hand, let’s go spend it!” It’s not what this is about. I find one trade today. I’m going to invest a thousand dollars into that trade. And that’s it. If it means I can buy one contract or 22 contracts, it doesn’t matter. I’m putting the same thousand dollars in my risk in that trade is greatly reduced by not saying, “oh, my gut tells me that this next trade on Amazon or Apple or Baidu or Home Depot or whoever it is, is going to take off. You’re putting equal weight in all of the positions that you look at based on that exact factor of putting equal dollar trades in, right? The other one is equal option contracts. I always trade 10 contracts or two or five or four. When I teach, we teach with equal numbers because it’s easier for people to understand. If we start doing math all the time, it’s just math in spoken word, never works.
We just had a team training that long ago today we’re going through a team training and Amilia was actually doing the training today, And as she’s going through someone that was listening was not keeping up And that’s because she was talking math. She knew the math, but if you’re not seeing it in front of you. You know, if I tell you to multiply 326 by far in 81, but then of course divided by 19, right? Wait, what was the first number? Heck I don’t remember the first number and I just said it. So trying to do math in that scenario doesn’t work. So, equal dollar trades or B) equal option trades, which one works best.
For me, it’s going to be, in my own trading, it’s going to be equal dollar trades. That is what I prefer to see and that’s what I think every one of you need to gravitate to, not in your non-funded trades when you’re first starting, just put equal dollar equal contracts and just get comfortable with doing what? One thing only: hitting enter. That’s all I’m trying to get you comfortable with hit the enter button again and again and again, and again and again. As long as I can get you comfortable with that, then we’re going to be good to go.
So as we look at, you know, the bottom line of this, for options trading for options trading, mitigating trading risk is crucial to your survival. If you plan on being in this game for a long time, you will need to learn how to mitigate that trading risk. Many traders never, ever come to grips with it and wash out. That is why so many new traders wash out of the game within two years, right? We happen to, uh, tend to keep traders longer than most others do going, and that’s because the strategies in the root systems that we teach are very high probability in what we do. And by taking equal dollar trades, you could potentially tip the scale of profitability to your favor, and that’s really what you want to do here, isn’t it?
All right with that, ladies and gentlemen may get a profitable day, stay focused on the quest to becoming a great trader, keep crushing it. And remember, you’re just one trade away. I’ll see all of you at our next episode. Bye for now.