The Case For Why You Should Never Manage Risk Once A Trade Is Entered

managing trades

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We all know that classic axiom about investing; manage/control your risk throughout the trade.

But did you know that it could hurt you? Yes, it's true that managing risk could help you lose money!

Taking trades off that are losers before they have the ability to show a profit might be detrimental. In this post, I want to go through some benefits I found recently for why you should never manage risk on defined option spread strategies.

Why You Need To 1st Trade More Often?

We know that to be successful in this business we need to make a lot of trades. Gone are the days when you could make 4-5 trades a month and turn a profit consistently.

Thus, trade size is an extremely important aspect. Trading small and trading often leads to a lot of occurrences that over time will give you that high probability of success you’ve been targeting.

If you trade too large or too infrequent, then you don’t have enough data points to give correctly you the probabilities you’ve been looking for.

I see this all the time with new traders that make 1 to 2 trades per month and are trading 25 to 30% of their capital per trade! Sound like somebody you know? Possibly sitting in your chair right now?

And while it could work for a couple of months, in the long run, this is not a sustainable strategy.

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Risk Management Via Trade Size

Now if you’ve understood that you need to trade often, and you need to trade small, then the case could be easily made that by just trading small enough on your initial entry you are properly managing your risk from the beginning.

Remember, this is only for defined risk strategies. This doesn’t apply to the undefined risk strategies like selling naked puts and calls and strangles.

Trading defined risk strategies, you know your probability of making or losing money from the start. And since you know your probabilities, you have to allow the market to let those probabilities play out.

Here's the biggest point I want to make. . . The case could be made that at order entry you’ve maximized your risk management!

You’ve properly placed a high probability trade with defined risk, and you know how much money you could lose. Now it comes down to strategy diversification like we talked about last week.

Place Smarter Trades Then Forget About Them Completely

In all the years I’ve done coaching, I find that smart order entry is the most important aspect of successful trading.

Those traders who I have coached that properly enter strategies in the beginning, tend to not even have the problem of risk management over the long run.

Does this mean you should ignore hedging completely? Of course not.

Should let trades run all the way to expiration? Maybe. If they show a great profit, take it. If not, let it ride and see if the market probabilities work themselves back in your favor.

What's Your Opinion?

I'm sure that I've ruffled a couple feathers out there, and I'm okay with that and I want to hear from you one way or another. These conversations need to start happening on a more frequent basis.

There are obviously opportunities where you should hedge/close your positions and make adjustments. Rolling spreads, hedging spreads like we’ve talked about in multiple posts before is a viable strategy.

But the case can be strongly made that in the end, your manage risk is best at order entry, not along the way.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.