Investing of any kind contains potential risk . There are no investment options that exist currently which contain absolutely no risk potential. Although be advised there are various trade strategies that can be learned that have the potential of becoming risk free trades with time.
Without this kind of knowledge getting started can be very deterring for individuals as often times people are scared to begin investing on the idea that they may potentially lose money. We hear others relating the risk involved in trading to be similar to that of the risk involved in gambling at a casino.
This is a common misconception, because with investing there are various ways one can manage and control what is at risk. Many new investors trade based on emotion as compared to using arithmetic to invest efficiently.
The first step that anyone looking to become a successful investor must understand is that the market is not a magical slot machine. You can not simply insert a trade crank the lever and sit back to watch the numbers spin up and earn you millions of dollars overnight.
The moment I started seeing results in my trading was when it clicked for me that this is a life long skill that I can use to generate income for the rest of my life and not some Mega-Million Jackpot.
For all my veteran investors, you should have this drilled into your subconscious mind by now. Risk Management is the key factor that can determine the overall success of an investor.
I know you may be confused as many believe that to become a successful investor one needs to focus on earning profits. Although that is not wrong, an investor without proper risk management may soon find themselves loosing their entire account value in just one bad trade.
Commonly speaking the rule of thumb when it comes to how much capitol is being risked on a trade is 2-3%. For example, if you have $5000 in your account and purchased $500 of a stock you are investing 10% of your account into that one trade.
Now if the stock begins to go south and price begins to fall having a proper risk management means that once your account loosed 2% of its value which would be $100, you close the trade to prevent any further losses.
Defining what your Risk management price is the easy part. Sticking with your plan is often not as easy as it sounds. Often times our psychology may try to convince us that the price will rally back up. We then find ourselves breaking our Risk Management standards and allowing for us to go beyond the 2% risk. This is where many trader experience large losses.
With a 2% risk management one would have to loose 50 trades in a row consecutively to have blown their account. I am not telling you that this is not possible although I am going to say that it is highly unlikely.
Now that we have covered a bit of the defense strategies lets talk about some of the more offensive strategies that can be made in the market to exponentially earn greater profits. Options contracts are a unique financial tool that allow for investors be able to profit of the move of a stock without having the risk of owning the stock.
On Friday July 12th the U.S. Stock market saw record breaking highs. Delta Air Lines’ stock experience a growth of 2.49% during the day. Their stock price now currently sits at $61.66 which marks an all time high for DAL.
An Options contract for a stock is very similar to a coupon for a product. There are two types of options contracts called Calls and Puts. A Call option allows for one to be able to purchase a specific stock at a set strike price before a defined expiration date. A Put is a contract that allows an individual to be able to sell a specific stock at a set strike price before a defined expiration date.
Let’s take a quick look at a simply Call Option strategy on Delta Air Lines Inc (NYSE: DAL). I am going to go over the difference of trading the stock itself as compared to trading an option for the stock.
If you had purchased 100 shares of DAL at the start of the day and sold all 100 shares by the end of the day your initial investment would have been $6016 and your profits for the day would be $150 before commission and fees bringing you to the grand total of 2.49% growth.
Now lets look at a potential Call Option. We are going to purchase 1000 Call Contracts stating that we have the right to be able to purchase DAL at $61.00 before the date of July 19th 2019. Being that at the start of the day DAL price was at $60.16 this call is considered an Out of the money Call and can be purchased for only $0.34 a contract.
Since we are going to purchase 1000 contracts our initial investment is only $0.34 a contract which comes out to a total of $340. As the market moves during the day and the value of the stock changed by increasing in $0.68. Which is why the value of the contract rose from $0.34 to $1.02 a contract in one day. This is would bring you to profit $680 which would mean you earned 200% in one day on a stock that only rose by 2.49%
So to recap we were looking at DAL with the perspective of price moving up. If we had traded DAL stock we would have invested $6016 for a total of $149 in profits. If we instead traded the Call option on DAL we would have only invested $340 and earned a total of $680 in profits. Both trades took the same amount of time to compete and occurred during the same time frame. Yet the options trade required substantially less initial capital and was able to generate exponentially greater returns on the same price action.
PRACTICING PERFECTLY CREATES PERFECTION
Just like any professional athlete who practices with a coach if you plan on becoming a professional trader I suggest you find mentorship. Finding someone who you can be able to keep you in line and focused will help improve your trading is essential. There are communities that exist currently of individuals who are actively trading the market and working everyday towards enhancing their skills.
Understand that to become a successful investor it will take time and patience. It is a process that will involve getting out of your comfort zone. It will involve you having to humble yourself and learn from those who have done it before. Finding the right teachers and education will save you time, pain and money.
Most importantly aside from the numbers on the graph having a strong mindset is key when trading the market. There market will try to knock you off your game and take every penny in your account.
For more info on how you can get better connected into a network of investors where you can gain access to exclusive trading mentorship and advanced trading software, click on the link below.
2 Replies to “How To Maximize your Reward While Managing your Risk.”