Money management is the key to winning in the stock market, especially if you’re trading options. That’s because the size of your portfolio is like a reputation. It takes years to build but just days to lose.
The market can change directions quickly and unexpectedly. Imagine if you were 100% invested during a month when stocks crashed. If you simply owned stocks, you’d be down, but you wouldn’t lose everything.
But because options contracts have expiration dates, you could lose your entire portfolio before you have a chance to cash out. To make matters worse, since you were fully invested, you’d have nothing left on the sidelines to invest and recoup your losses.
The 30% money management rule.
When trading options, don’t deploy more than 30% of your portfolio at one time.
Keeping at least 70% of your money in cash protects you from getting wiped out in a single month. It also positions you to rebuild your portfolio because you’ll have money set aside for new trades.
You won’t often lose 30% in a single month, but it can happen. In those circumstances, you would deploy another 30% (maximum) of your portfolio to catch up.
What happens if you lose your backup 30%?
If you perform sound research and stay disciplined, it will be rare to lose that much twice in a row. But if it does happen, you should spend some time in a cooling-off period.
Don’t trade for a few weeks. Let your mind and emotions settle. Examine your decisions on your losing trades.
Were you trading on data and sound information? Or, did you FOMO (fear of missing out) some trades and chase something that you never should have?
Did your emotions get the best of you?
Boredom is also a problem. As I’ve written before, never force a trade simply because you feel like you must do something.
Doing nothing is better than executing a low-conviction trade. Sure, you may miss some profits. But far more often, you’ll spare yourself from losing a chunk of your portfolio.
Once you’re ready to trade again, you can slowly start to deploy your remaining cash to recoup your losses.
Note: the 30% rule only applies to the money that you have set aside for options trading, not your entire portfolio.
With a stock portfolio, there’s rarely a reason to keep 70% in cash.
Stocks take longer to move (in both directions) than options, so staying invested is key. There are certainly times to move your money out of stocks, but market conditions will dictate when to do that. The Papa Bear strategy that I previously wrote about will you help you identify if/when it’s time to reallocate your stock portfolio.
If you only own stocks instead of options, it will take longer for your portfolio to crash…but also much longer for it to grow.
At The Antagonist, we trade options to hit our financial goals quicker than simply buying and holding stocks. But this strategy also demands that you follow strict money management strategies to protect against losses. That’s why the 30% rule is essential.
Please note, however, that 30% is the maximum amount to invest. During times of high volatility, it may be wise to keep as little as 10%-20% in play.
Conversely, if stocks sell off sharply for a day or 2, but the overall market remains healthy, it can be appropriate to increase your cash deployment. This requires careful analysis of the market and individual companies, however.
That’s one reason The Antagonist exists: to help you find the best trade opportunities while avoiding traps. You won’t win 100% of your trades (no one does), but proper discipline and research will make you much more likely to come out ahead in the long run.
To gain access to The Antagonist portfolios, and to receive trade recommendations and explanations, become a premium member. You can try it for free for 7 days.
Happy trading,
Jason Milton
Note: I’m not a financial advisor, and this article is not financial advice. See the full disclaimer here.