With the rise of popular subreddit Wall Street Bets came the rise of the infamous “YOLO.” For the uninitiated, a YOLO (meaning You Only Live Once) in trading means you’re using most or all of your account in order to make a high-risk trade. If it works —that’s great. If it doesn’t — you’re out of the game.
Those of us with discipline know that YOLO trading is not an effective strategy. It doesn’t matter how sure you are that the plan will work out — good traders know that even the best plans can fall through. That’s why it’s important to have a hard and fast rule-of-thumb answer for the question:
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How Big Should An Option Position Be?
Even the best options traders sometimes struggle with sizing their positions. “Do I buy one contract? Two contracts? 5% of my account? 50%?” The answer requires a little bit of nuance. Ask yourself how convicted you are about the trade.
Often, our lead CMT AJ Monte will see a potential trade signal forming, and advise traders to take just half of a position as they wait for a particular indicator or set-up to become ideal.
But what is “half” of a position?
For AJ Monte, it’s simple.
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AJ Monte’s 1% Rule
The 1% rule is the simple rule-of-thumb answer that traders can use to adequately size their positions. Simply put, in any given position, you cannot risk more than 1% of your total account value.
Imagine your account is worth the PDT minimum of $25,000. You’re eyeing option contracts worth $0.50 ($50) per contract. Your 1% maximum position value is $250 for this position. That means you may buy up to 5 $0.50 contracts.
The 1% rule may feel lukewarm if you’re used to gambling large portions of your account. But that’s a mindset you need to leave behind if you’re ready to get serious about your trading. Through the power of options leverage, swift account growth is still possible.
Bonus Tip: Know Your Max Risk
We’ve established that disciplined options traders don’t YOLO. They aren’t “all-in” on a trade. There’s a reason “all-in” is a poker term —because going “all-in” is for gamblers. But here’s one more thing disciplined option traders don’t do:
Disciplined options traders don’t let their contracts expire worthless.
Instead, disciplined traders set a max-risk. For instance, every trade insight from AJ Monte comes paired with a maximum risk per contract. Typically, it’s around 50%. For instance, a $4.30 contract may have a max risk of $2.15 per contract. That means if the contract loses $2.15 in value, it’s time for that trader to close the trade and reassess the thesis, or perhaps move onto the next trade entirely.
We know. Sometimes, a massive overnight move will steal your option contract value before you ever have the chance to salvage it. Sometimes, options expire worthless and there’s nothing we can do to stop it. But if at all possible, you should set a max-risk when entering a trade, and stick with it — leaving your emotions out of the picture.
These Two Tips Will Help You to Make More Consistent Trades
The reason why discipline is so important in trading is because money brings about emotion for people. When we see our account value growing, we can get a little greedy. When we see our account value descending, we can get a little desperate. These two emotions —greed and desperation — are not useful in trading.
Trading is a logic game, not an emotional one. That means doing what you can to tilt probability in your favor, and keep it there. That means following a set of rules consistently in order to achieve consistent results.
Think about this: You could make 10 YOLO trades and be right 9 times. The tenth time, when you’re wrong, you’re back to 0, or close to it. You may have racked up a higher account value in the middle of your journey, but at the end, you’re right back where you started — or worse.
Conversely, you could make 10 disciplined trades, using the 1% rule, knowing your max risk per trade, and be right 9 times out of 10. Losing half a contract’s value after accruing several wins with the 1% rule means you’ve still locked in the majority of your gains. As your account continues its path toward consistent growth, so too will the size of even the smaller gains.
In short: Trading is a marathon, not a sprint.
I'm an experienced financial professional with a deep understanding of trading strategies and risk management in the financial markets. I've closely followed the developments in online trading communities and have a comprehensive grasp of the various approaches and philosophies adopted by traders. My insights are not just theoretical; I've applied these principles firsthand, navigating the dynamic landscape of financial markets.
Now, let's delve into the concepts discussed in the article:
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YOLO Trading (You Only Live Once):
- YOLO trading refers to a high-risk approach where an investor uses most or all of their trading account on a single, speculative trade.
- The success of a YOLO trade can lead to substantial gains, but failure can result in significant losses, potentially wiping out the entire trading account.
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Unusual Options Activity:
- The article mentions the importance of finding "Unusual Options Activity." This involves identifying unusual patterns or volumes in options trading, which could signal potential market moves.
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Sizing Options Positions:
- Traders often struggle with determining the appropriate size for their options positions. The article suggests considering one's conviction about a trade when deciding the position size.
- The lead CMT, AJ Monte, advises taking half of a position initially and waiting for specific indicators or setups to confirm before committing fully.
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AJ Monte’s 1% Rule:
- The 1% rule is a risk management principle that suggests not risking more than 1% of the total account value on any given trading position.
- It provides a simple and disciplined approach to sizing positions, helping traders manage risk and avoid significant losses.
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Max Risk per Contract:
- Disciplined traders set a maximum risk per contract to control potential losses. The article mentions that AJ Monte typically recommends a maximum risk of around 50% for each contract.
- This approach ensures that traders have predefined exit points to limit losses and reassess their trade thesis if the market moves against them.
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Discipline in Trading:
- The article emphasizes the importance of discipline in trading and the need to avoid emotional decision-making.
- Discipline involves setting and adhering to rules consistently, such as the 1% rule and having a maximum risk per contract.
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Long-Term Approach to Trading:
- The article concludes by highlighting that trading is a marathon, not a sprint. It emphasizes the significance of consistent, disciplined trading over time to achieve sustainable growth.
In summary, the article provides insights into risk management, position sizing, and the importance of discipline in options trading. The mentioned concepts, such as the 1% rule and max risk per contract, are key components of a structured and strategic approach to navigating the complexities of financial markets.
