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You don't need to be the smartest, most talented, most athletic, most popular person you know to be able to make a great deal of wealth in this life.
Being a stock and/or option trader allows you the opportunity for that type of wealth. And you can learn to trade either or both even if you can't dribble a basketball or carry a tune.
Anyone can do it. In fact, trading is the great equalizer.
What Separates Successful Traders from the Rest
Some of the wealthiest people in this world are neither geniuses, amazing athletes, or particularly charming. Just look at Wall Street.
But plenty of traders there can afford to have popular musicians and actors perform for them at private functions, whether it be their wedding anniversary or their daughter's "sweet 16" birthday party.
What all successful traders have in common, regardless of strategy, is this…
They stick to their money management rules.
Now, that may sound boring or even scary…
But don't worry – it's neither.
Whether you trade stocks or options, all it takes is sticking to these four simple rules of money management.
Add them to your rules-based trading approach, and you too will be on the way to Wall Street levels of wealth.
Rule No. 1: Predetermine Your Maximum Risk Level
The first rule of money management is to determine how much of your capital to devote to stock or options trading.
This money is for shorter-term trades and should be kept separate from the capital used for long-term buy-and-hold investments.
With a figure for that shorter-term "trading money" in hand, you'll also want to decide how much of it you want to risk per trade.
As always, I recommend you work with your financial advisor to determine these numbers for your individual circumstances.
But when I educate my students, we run scenarios based on a theoretical $25,000 dedicated to a stock or options trading account. We then risk no more than 2% of this capital ($500) on any one trade.
That's a great place to start, because even if you were to lose everything you invested in any single trade, you'd still only end up losing 2% of your overall "trading money."
Now, it's crucial that, as your trading wins add up and your account increases in size, you keep this 2% per trade rule in place.
No trading system is perfect, and you need to use trading rules that let you weather some losing trades without endangering your whole "trading money" account.
And remember, as the size of your account increases, what 2% translates into will change. For a $25,000 account, 2% is $500 – but once you've doubled your account to $50,000, 2% per trade means $1,000.
Once you've predetermined your maximum risk level, it's time to pick a strategy for minimizing losses…
Rule No. 2: Set a Stop-Loss Approach
A stop loss is a tool that lets you automatically get out of a trade if it starts losing too much in value. In other words, it lets you cut your losses short.
Now, there are a couple of ways to go about using stop losses. The usual way is to risk a set percentage, say 50%, of the money you've devoted to the trade (the 2% of your "trading money" mentioned above).
This is called a "% stop loss" – in the example above, where you're limiting your risk to 50% of your investment, it's a "50% stop loss."
What this lets you do is close your position and recoup as much of your investment as you can if the trade falls 50% or more from where you opened it.
Having a % stop loss in place may just be what you and your account needs to preserve capital on a trade that could otherwise have blown out – and left you with a 100% loss on the trade.
Of course, sometimes what happens is that a trade falls 50%, traders panic and get out, only to see the trade recover and even turn profitable.
Let me tell you, it's happened to me more than once…
That's where the cost-as-risk stop-loss approach comes in. This is where you risk the full amount of your trade (100% of your investment) and leave the profit side of the trade open.
This might sound preposterous, but especially for options – which can swing very wildly in price – it gets rid of the stress of always paying attention to price movements, and lets you capture profits without limitation.
That's where the third rule of money management comes in. Regardless of your stop-loss approach, you'll need to follow this closely…
But traders using the cost-as-risk method should pay extra attention…
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.