Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

How I Learned Risk Management the Hard Way


Here's your opportunity to not lose it all.

I repeatedly write about the importance of risk management when trading options. Believe me when I tell you that I understand how much most of you are tired of reading about it. How can I know that? Because I've been in your shoes.

I firmly believe that if you don't pay much attention to what can go wrong and how much can be lost from a single position (or your entire portfolio), chances are very good that you'll encounter an unexpected market move that will take your breath (and cash) away. If you survived the turmoils of 2008, congratulations. That builds confidence. If you're making money month after month with nary a problem, that builds over-confidence. Be alert.

One of the sad things about trying to help others become intelligent option traders is knowing what can happen when things go wrong. I remember my early years as a CBOE market maker. I found it very easy to make money. But sadly, I found it just as easy to see it all go away.

Close friends warned me that my positions were too big and that I was asking for trouble. I was a constant visitor to my clearing firm's risk-management office, but instead of heeding the warnings, I decided that I knew better. I was making good money, wasn't I? Surely I could take care of any problem before it overwhelmed me.

One day in 1984, one of the company vice presidents took me aside and told me that my best friend and I were number-1 and number-2 on the list of risky accounts. I laughed it off with a comment similar to: "It's just a computer searching for impossible situations that could make a big loss possible. Forget it."

To make a long story short, the clearing firm (First Options) unhappily allowed me to continue to carry the positions. It was just a few days later that my account was in deficit. I had lost it all. The explosive rally of August 1984 had done me in. I had been in trouble before, but nothing like this. I had to mortgage my condominium. I was frightened.

I dug in my heels, found trading capital, traded very conservatively, and worked my way back. When the mortgage was repaid -- when First Options had received every penny -- I was greatly relieved. But that was an ordeal to remember.

I was finally convinced, but not cured. I still carried risk, but nothing similar to those early days on the trading floor. What's so sad is that I see it clearly now. There was more than enough money to be made and there was no need to remain naked short so many options. Today, I'm cured. No naked options for me (unless I want to buy a specific stock -- which I probably will never want to do again) and all positions have limited risk.

That's the background. That's the reason I stress risk management. Just as I had to learn for myself, I'm sure some readers will find that they have to learn for themselves. I certainly hope it's a very small number of traders. I refused to listen to people whose business it was to understand risk and how to maintain it at a reasonable level. I'm offering you the same opportunity I had: to be made aware of risk before something terrible happens. I hope I'm getting through to you.

Good trading.
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.






Featured Videos