Forced Ideal Position Sized Trading

First of all, there are two proven portfolio management maxims: 1.) Never risk more than 0.5% – 2%  of your total account in any one position and 2.) never risk more than 8% of any particular trade at the outset, and adjust upwards.

The first rule is accomplished by diversifying positions in such a way that the max risk is spread across several instruments, or just a few instruments with the remaining capital in cash.

The second rule is NORMALLY accomplished with the use of stop orders… however, we know that the market can gap down, making a stop order null. If a stock has a large enough gap, it will force you to break BOTH rules if you get stopped out.

Enter the RadioActive Method:

We buy the stock and also a put option. The put option may be expensive or it may be low in price. That is determined by the kind of market and kind of issue you’re trading.

Each market, and each stock, has its “signature” of volatility. A quiet market will have lower premiums, and an uncertain market will have higher premiums.

In a very quiet market, because the premiums are so low and the movement is so tepid, going very deep in the money with your put is unnecessary. You can buy a put that’s very close to the money and still keep your risk in that issue to 8% or less, with a recommended amount AT RISK of 5-6%. It will take a very small movement in the stock to make you profitable…and very small movements are frankly all that you can expect.

In a volatile market, you will be FORCED to tie up more of your money in a deeper put option, putting less of your overall capital AT RISK. The saving grace is that when you opt to do the Income Methods, it’s easier to get big chunks of income because the options you sell will be similarly inflated. You might expect BIG swings in a more volatile market, both to the good and to the bad…

Back to “forcing” an ideal position size: If you are one of the packing and shipping companies that has quiet market and commit all of your capital, you will be splitting up your available capital among stocks and puts whose overall cost is lower. That will increase your chances of catching a big mover.

On the other hand…If you are trading a more volatile market, you will HAVE to allocate more capital to each trade to reduce your risk to appropriate levels. You’ll automatically be positioned in less stocks and therefore won’t escalate your losses. This is why I rail so much against those that advocate buying ITM calls for “leverage”…when you have less capital you should be seeking hedged trades, not highly leveraged ones. Try polling folks that used this strategy within the last eighteen months. You’ll find a lot of unhappy folks that were led to believe that they were positioned correctly in a way that would “preserve capital”. In fact, you’ll find a lot of people that got hurt.

“Ideal” risk is different for all traders, according to their risk tolerance. But it goes without saying that if you ARE playing the game…a 400% return is unimpressive if you’re only betting twenty five cents…conversely a $100,000 one-day loss is more than permissible if your portfolio is over a billion dollars. It’s a matter of perspective. The RadioActive Profit Machine will force you to keep your percentage of risk in any particular stock and any particular market to proper levels.