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One of the Biggest Mistakes Traders Make
03/24/2014 7:00 am EST
Veteran options trader Bob Lang explains why traders do not have to risk a lot to make a lot, which is a very common misconception.
ROB: I am here with the veteran options trader and we are talking about risk management. I know you have strong opinions about position sizing. Bob Lang, what do you have to say about it?
BOB LANG: It is one of the biggest mistakes that traders make Rob, and it is one of the things that somebody can take a great system and it is completely wiped and destroyed because they are not considering risk management and position sizing. Because options offer such a tremendous amount of leverage, people think that okay, I am going to use that to hit the home run. With that mentality, it is really gambling Las Vegas type like mentality, but we have Las Vegas. You do not need options trading to have the gamble. All you have to do is get on a plane, go to Vegas, and if you want to lose your money, go ahead and do it that way. Frankly, as far as position sizing is concerned and risk management, the options trading environment gives you a great amount of leverage that you do not have to risk a lot of money to make a lot. Again, I have seen more people wiped out and thrown to the side because they took too much risk.
ROB: What is an example of taking too much risk? Is it relative to the total amount of money that you have available to trade?
BOB LANG: I mean for the accounts that I manage, I have clients’ accounts and use my own account and I will risk no more than 1.5% to 2%.
ROB: So if everything goes wrong, you stand to lose a percent.
BOB LANG: On a $100,000 account, I am not going to lose more than $2000 on a trade, that is by design and that is for my own risk tolerance level. I like to take a lot of trades; I like to take a lot of positions on. Think about it Rob, if I put 20 positions on, 2% each, I have only used 40% of my account. I have a lot of exposure. I have a lot of chance to win. I can lose, of course, if I am directional, but that gives me a lot of opportunity to make some money and to be in a trade for as long as I want to.
ROB: I have been hearing a lot of this lately, this whole stuff about non-directional bias, trading options with a non-directional bias. Is that play into it for you at all?
BOB LANG: Not really because I am a trend trader, momentum trader, or position trader, whatever you want to call me, momentum trader mostly. I am looking for stuff that is going to make big giant moves. A non-directional trader is basically taking a bet that something is not going to move and you are going to collect a premium. That is a great strategy; do not get me wrong, I do that as well too on some other stuff, but more in a directional sense. Non-directional stuff, you are going to get small amounts of return for minimal risk. If you look at the prism of risk tolerance, that is more on the risk averse side. You are going to collect a little bit of money, you are not going to have a lot of risk on the table, but still options are giving you a chance to make a great deal of money with leverage. Just use smart risk management tools.
ROB: Well position sizing is a totally overlooked topic of conversation and I am thrilled that we had a chance to talk about it. Thanks Bob.
BOB LANG: Absolutely, thank you.
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