Possibly the most important aspect to get right in trading is survival. This is number one. Without surviving the bad times we are gone, with no hope. Money management and risk may sound like boring subjects, but read on to see how exciting they can be once you learn the concrete reasons and logic for their use. You may never trade the same way again!
Commodity option buying can be rough for novices. Some see a TV pitch about striking it rich in gold or heating oil. They load up their entire account buying way out-of-the-money options, lose all of their trading capital through premium erosion and then curse the market. They don’t consider to survive they must prepare for the inevitable string of losses when trading at 10% accuracy. We need to survive long enough to be around when that 10% option winner hits big. The other 90% will be losers simply from the probability of the method used.
In this case, it means dividing our trading capital into at LEAST twenty parts to be able to survive the string of losses that probability will surely bring our way, over time. It’s about survival and knowing what type of commodity trading we are doing so that we can adjust the money risked on each trade. If we are trading at 10% accuracy, (option buying) and expecting to make money on the first 3-4 trades, it's pure arrogance.
Then there are some commodity option traders who will overload themselves by buying large option positions and are willing to let them erode away, taking a full 100% loss of the total account. They have no plan to exit if the market does not act properly. Not a good idea. Though, some buy a commodity option and use its full loss as a stop loss in itself. That’s acceptable ONLY if you do it with small positions. But the sad thing is when these guys get a mere double in the option price, they call that a big profit and grab it. Pure lunacy!
How can one be willing to lose their total investment and at the same time take tiny gains while still trading at 10-20% accuracy? The results are predictable. They consistently lose. Their excuse is the analysis is bad, or the commodity markets are poor or they should have gotten into another trade instead. You can point the math out to them, but they do not get it. No matter what they do, the result will continue to be the same unless money management changes are made. By the way, one definition of insanity is doing the same thing over and over while expecting different results. (grin)
The bottom line is that if your commodity trading method generates an average of 20% (at best) accuracy by design, as option buying way out-of-the-money often does, you had better be seeing your average gains four times larger than your average losses. And, this is just to break even not counting commissions, bid-offer spreads and slippage! This means if you think a $2,000 loss is prudent, you had better be averaging $8,000 gains to break even. Just to break even!
You must sit on your hands and let the profits run when buying options. This is over the long-haul where things even out over time. In the short term you may trade better or worse, but over time, probability will put you where you spend the most time. With a $10,000 account, if you're taking $2,000 profits and $2,000 losses when trading 20% accurate, you will probably be out of the commodity option business in less than ten trades. This may sound like fiction, but believe me, many new traders do exactly this, thinking they will win in the end.
Part Four of Five Parts - Next!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.
