Lessons from the Pros

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My belief is that anyone who is interested in options trading should start small and get a feel for how options trading works. Many traders are drawn to options because they offer leverage and the ability to construct market neutral positions. Trading options with a small accounting goal as a new options trader should be to assume a level of risk in your trades that is boring while you get a feel for how trades work and what fits your personality.

The following list goes through some important concepts a new or aspiring options trader should understand. However, trading options with a small accounting percentage of account equity at risk will frequently be larger.

That larger percentage at risk makes it extremely important not to take significant losses. Options positions can be constructed trading options with a small accounting risk a low dollar amount per trade, but dollars at risk is just a starting point for managing risk.

However, most options traders do not trade in a way that allows positions to reach the maximum loss. Positions are frequently managed so that the maximum loss and target gain differ from the risk graph. The challenge with giving a one size fits all number for the maximum percentage at risk per trade is trading options with a small accounting the number depends on your percentage gains and your winning trade percentage. The Theta Trend system document has a chapter on Expectancy that goes into risk and position sizing in more detail.

Suppose you set up a dollar based maximum loss for a new options position and know what that means as a percentage of account equity. The next step in trading an options position is understanding what changes will bring about that loss. If price only needs to move a small amount to hit your target loss, you are probably assuming too much risk. Options traders are always trading options with a small accounting volatility because it impact their positions.

Using time spreads and longer dated options will increase the significance of volatility. Diversification across markets, expiration cycles, and strategies are all ways to reduce risk. In a small account, diversification becomes more challenging because the margin for trades will take up a larger percentage of account equity. The Butterfly is one of a few options strategies that works well in a small account.

If price trades higher, a second Butterfly can trading options with a small accounting purchased to stretch out the expiration break even lines. If prices trades higher again, the first Butterfly can be rolled up. The goal of the strategy is to keep the market trapped under the expiration break even lines without taking too large of a loss. The benefit of trading the strategy is that the position will generally make money on the downside due to skew.

Many traders like to initiate high probability Iron Condors by selling deep out of the money options. The trades make money a high percentage of the time, but sometimes require adjustments to keep risk under control.

A little more information trading options with a small accounting Iron Condors can be found here. Weekly options provide the opportunity to make quite a few trades every month. However, Weekly Options have some additional risks that make them more dangerous for a small account. Positive Theta Weekly Options positions frequently carry high directional risk think gamma that can potentially destroy a small account. Suppose you sell a 5 point wide, 10 delta SPX vertical with a week to expiration. That vertical will likely be sold for around a.

The problem with that type of a position is that even though you might want to close the position for less than the maximum loss a gap against the position can lead to a larger than planned loss. As a result, a smaller amount of capital should be allocated to strategies that use Weekly Options and that can be challenging or impossible with a small account.

Additional information on trading Weekly Options can be found herehereand here. There are both positive and negative Theta ways to trade options directionally. Positive Theta directional trading allows options traders a way to be only partially right or even wrong on direction and still come out ahead.

The vertical spread allows options traders a way to directionally trade a market without the need to be completely correct on direction. The trade will make money if the market moves up, stays about the same, or even goes down slightly.

The trade will make money as long as price remains above the short strike at expiration. Download the Theta Trend Document for a good overview on positive Theta, directional options trading here. The reality of trading options with a small account is that commissions best online trading 2015 reduce returns and become a significant factor in your trading. Feel free to post any questions you have in the comments below and thanks for reading.

What is planned capital in this context? Say for example that we sell a 10 point wide SPX vertical spread for a 1. In that case, the maximum risk is 9. If our planned capital for the trade was 10k, we could theoretically sell 11 spreads and stay within planned capital. One thing to keep in mind is that planned capital is different from the desired loss. In the vast majority of cases, the loss point should be much less than planned capital.

Obviously we could wake up with the market at zero and that might not be possible, but generally speaking the loss should be much less than planned capital. I only buy puts and calls with at least 2 month expiration. Understand Your Loss Trading options with a small accounting Terms of the Position Suppose you set up a dollar based maximum loss for a new options position and know what that means as a percentage of account trading options with a small accounting. Volatility Options traders are always watching volatility because it impact their trading options with a small accounting. Anticipate Capital Needs and Adjustment Money Diversification across markets, expiration cycles, and strategies are all ways to reduce risk.

Weekly Options Weekly options provide the opportunity to make quite a few trades every month. Hi — it does help, thanks!

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One of the reasons many traders gravitate towards trading Futures is the relatively low start-up cost. We would all like to trade an account that has several thousands of dollars in it, but realistically, most traders have small accounts. These accounts are still tradable, but you must have very strict risk management. When trading an undercapitalized account, you will find it much more difficult than trading a larger account.

When your account has excess funds, you can build a buffer to help protect you against the inevitable mistakes and account drawdowns due to losses. Unfortunately, small accounts do not allow you this comfort level. Larger accounts also allow a trader to be more diversified and flexible in their market choices to trade. Another nice feature of a larger account is you can trade more contracts when the need arises.

A small account might limit you to trading one contract, and when it comes time to exit your trade, it is harder to manage. Because of this, you are faced with the question of, do I get out here or let the market run?

Usually, this turns into an emotional decision for most traders and they do not manage the trade well. We are all aware of the psychological challenges facing a trader, but a small account trader has even more obstacles. Traders with smaller accounts realize they cannot afford to lose much before they are not allowed to trade. Performance pressure will lead to costly errors. These types of traders usually start thinking that they will just take one or two ticks profit and slowly build their accounts up.

Unfortunately, the market volatility does not allow them to place a protective stop that is in proportion to the reward. Soon the market takes back all the small profits, usually in one trade. Even large account traders will have drawdowns losing streaks , but their account sizes allow them to continue trading without much added stress unlike a small account trader. If you do have a small trading account, here is some help for you.

I probably made it sound like small accounts cannot succeed at all in the Futures markets. My intent was to make you aware of how much more care and selection you must put into your trading plan and decisions.

This way you will not become careless and give back all your profits. An advantage that small accounts do have is that they are aware of how close they are to not being able to trade. Therefore, they carefully plan and patiently wait for their trade setups unlike a trader with too much money in their account who will take trades on any whim at all because they feel like they are playing with house money.

Trading Futures is all about using leverage and this allows smaller accounts to participate more easily than using a cash account to buy stock with. Keep in mind that leverage can cut both ways and losses can and do occur. Also, in Futures trading, you can lose more money than is in your trading account unlike a cash account where your losses are limited to the amount you paid plus commissions.

When placing trades, make sure your strategy is allowing you at least a 1: This conservative style trading will allow you to have one winner and then 3 losers before you are back to even again. Apply this rule to day and swing trades alike. Give the market time to reach your price targets and do not cut your profits short. Doing so will ultimately lead to losses taking away your profits much quicker.

Many traders have a have a hard time taking a loss and will let their losses run, or have too big of a stop for their account size. This is also another reason to have a trading plan because it makes you trade consistently. If you follow your plan, it is highly unlikely you will have losses in a row.

Most traders who do suffer these types of losses are the ones who change their trading style after every loss, and therefore, have no consistency. By following them, you will have a much better chance of surviving Futures trading. Do not expect to double your account in the first year of trading. Many traders feel they should be able to do this. In all reality, you should be about break-even at the end of your first year. If you can do this, you will have a good chance of becoming a successful trader.

Most new traders start out making money in their first few trades because they wait for their setups and then take the trade. Then after a few profits, they become impatient and trade every time a market moves. In trading, it is not how much you make, it is how much you keep that is important.

The formula above is the one I prefer because this will allow you to increase contract size as you become a better trader, and decrease it when you start to have drawdowns.

Keep in mind this is your maximum number of contracts to trade and you do not have to trade this amount on every trade. Make sure you have a well-written trading plan, you have confidence in your strategy, yourself, and plan on this taking some time and do not expect overnight success. Disclaimer This newsletter is written for educational purposes only.

By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

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