If you are going to trade on a short-term (one to three day) basis, your approach to risk management will not be the same as someone who trades on a longer time horizon.
[Editor’s note: read part one in this risk management series here: How Much Should You Risk On A Trade.]
With my implied volatility signals and medium-term directional signals, I emphasize reward to risk expressed as “capital at risk.” I allocate a certain percentage of my account to any given signals based on the type of signal it is.
It’s Different
But with short-term trading, I need to have hard parameters both from a dollar perspective and time perspective. Time is quite straightforward. My limit is three days. One way or the other, I am out of a signal in three trading days and typically will not hold a position over the weekend.
As far as dollar risk goes, I first have a set amount of dollars I allocate to a signal. So, you would trade an option that is valued at $0.50 twice as big as an option that is valued at $1.00. You have the same amount of dollars at risk. Now you have to determine what your stop loss amount will be and your gain amount will be. Your stop loss limit should be less than your gain. For example, I use a 20% draw down and a 30% gain. Once either of those limits is reached, the trade is exited.
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Do you have questions for Shorr on risk management? Post a comment below? How do you handle risk management?
