5 Risk Factors That Will Make or Break Your Trading Success

Do this to achieve consistent profitability!

Pratik Thakkar

Nov 18, 2023

Do you want to learn how to trade options like a pro?

Do you want to know the secrets of successful traders who consistently make money in the markets?

Do you want to avoid the common mistakes that can wipe out your trading account?

If you answered yes to these questions, this newsletter is for you.

This newsletter will reveal the five risk factors that will make or break your trading success.

These factors affect how much risk you can prudently take when trading options.

Understanding and managing these risk factors can improve your trading performance and achieve your financial goals.

Unfortunately, most traders ignore or misunderstand these risk factors.

They think that options trading is a game of luck, not skill.

They believe they can make money by simply buying or selling options without any analysis or strategy. They rely on gut feelings, tips, or rumors to make trading decisions. They do not have a clear plan or a system to follow.

These traders are doomed to fail.

They expose themselves to unnecessary and excessive risks that can result in huge losses. They do not have any control over their trading outcomes.

They are gambling, not trading.

Here are some of the reasons why traders ignore or misunderstand these risk factors:

They do not know how to measure and manage risk exposure using the appropriate tools and techniques.
They do not know how to allocate their capital and size their positions according to risk tolerance and trading objectives.
They do not know how to diversify their portfolio and hedge their positions to reduce their overall risk.
They do not know how to use stop-loss orders and trailing stops to protect their profits and limit losses.
They do not know how to review their trading performance and learn from their mistakes.

But don't worry!

In the next section of this newsletter, I will explain each of these risk factors in detail and show you how to overcome them.

The five risk factors that will make or break your trading success are:

Risk Exposure

Risk exposure is the amount of money you can potentially lose on a trade or a portfolio.
Risk exposure depends on your option positions' type, direction, and size and the underlying asset's volatility and price movements.
Risk exposure can be measured using various metrics, such as maximum loss, value at risk (VaR), or expected shortfall (ES).
Risk exposure can be managed using tools and techniques like Option Greeks, risk graphs, or Monte Carlo simulations.

Here are some tips on how to use risk exposure to improve your trading:

Use risk exposure to estimate your worst-case scenario and plan accordingly. You should be prepared to accept and have enough capital to cover that loss.
Use risk exposure to set your risk-reward ratio and determine your profit target. The higher the risk-reward, the better.
Use risk exposure to adjust your trade to match your risk appetite and trading style. You can reduce risk exposure by closing some of your positions, rolling them to a different strike or expiration, or hedging them with other instruments.

Capital Allocation

Capital allocation is deciding how much money to invest in each trade.
Capital allocation depends on your available capital, risk tolerance, and trading objectives.
Capital allocation can be done using various methods, such as fixed amount, fixed percentage, or Kelly criterion.
Capital allocation can be optimized using various techniques, such as backtesting, optimization, or sensitivity analysis.

Here are some tips on how to use capital allocation to improve your trading:

Use capital allocation to balance your risk and return. For example, allocating 10% of your money to trade will leave you with 90% capital for other trades.
Use capital allocation to diversify your portfolio and reduce your correlation. For example, allocating 33% of your capital to 3 non-corelating strategies will reduce your overall risk and increase your return potential.
Use capital allocation to adjust your trades to match your market outlook and trading goals. For example, allocating more money to trades aligned with the market trend will improve your odds compared to contra-trend trades.

Position Sizing

Position sizing is deciding how many lots to buy or sell for each trade.
Position sizing depends on your capital allocation, risk exposure, and option price or premium.
Position sizing can be calculated using various formulas, such as contract size, rupee value, or percentage of equity.
Position sizing can be modified using various factors, such as leverage, margin, or delta.

Here are some tips on how to use position sizing to improve your trading:

Use position sizing to control your risk exposure and profit potential by dividing your risk per trade by the difference between entry and stop loss.
Use position sizing to adjust your trade or portfolio to match your risk appetite and trading style. For example, suppose you are a conservative trader who likes to take low risks. In that case, you should decrease your position size using less leverage, margin, or delta.
Use position sizing to diversify your portfolio and reduce your correlation. For example, suppose you have allocated your money across different strategies. You should modify your position size for each trade based on their correlation. This will reduce your overall risk and increase your return potential.

Stop-Loss and Trailing Stop

Stop-loss and trailing stop are orders that automatically close your position when the price reaches a certain level.
Stop-loss and trailing stop can help you protect your profits and limit your losses.
Stop-loss and trailing stops can be set based on various criteria, such as price, percentage, volatility, or time.
Stop-loss and trailing stops can be adjusted based on factors such as market conditions, trading objectives, or risk tolerance.

Here are some tips on how to use stop-loss and trailing stop to improve your trading:

Use stop-loss and trailing stop to exit your trade when the price moves against you or in your favor. This way, you can lock in your profits and let your profits run.
Use stop-loss and trailing stop to adjust your trade to match your risk appetite and trading style. For example, suppose you are an aggressive trader who likes to take high risks. In that case, you should set a wide stop-loss or trailing stop to give your option more room to move.
Use stop-loss and trailing stop to diversify your portfolio and reduce your correlation. This means you can set tighter stop-loss and trailing stop levels for trades with a high or positive correlation and looser stop-loss and trailing stop levels for trades with a low or negative correlation. This will reduce your overall risk and increase your return potential.

Performance Review

Performance review is the process of evaluating your trading results and identifying your strengths and weaknesses.
Performance reviews can help you improve your trading skills and strategies.
Performance review can be done using various metrics, such as win rate, profit factor, return on investment (ROI), or Sharpe ratio.
Performance review can be done using various methods, such as journaling, tracking, or analyzing.

Here are some tips on how to use performance reviews to improve your trading:

Use a performance review to measure your trading success and progress. For example, you can track your ROI monthly, quarterly, or yearly against your goals.
Use a performance review to identify your trading strengths and weaknesses. For example, you can analyze your trading patterns and behaviors to see what works or doesn't.
Use performance review to learn from your trading mistakes and successes. For example, learn from your wins and mistakes.

In conclusion, these are the five risk factors that will make or break your trading success:

Risk exposure: the amount of money you can potentially lose on a trade.
Capital allocation: deciding how much money to invest in each trade.
Position sizing: deciding how many lots to buy or sell for each trade.
Stop-loss and trailing stop: types of orders that can automatically close your position when the price reaches a certain level.
Performance review: evaluating your trading results and identifying your strengths and weaknesses.

Understanding and managing these can improve your trading performance and achieve your financial goals.

Do this, and you can trade options like a pro and avoid the common mistakes that can wipe out your trading account.

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