It truly baffles me how ‘professional’ traders and bankers can prove themselves to be so ignorant of THE most basic, and THE most important aspects of interaction with the financial markets.
As our friends at JP Morgan demonstrated even the apparent pros manage to blow things up with alarming regularity, but the fact is it’s actually really easy to make sure you never lose $2b.
5 Things You Can Do To Avoid Losing $2b.
1. This is the most well-known rule in trading, but somehow it manages to get ignored by people because quite simply, they have a death-wish.
Never risk more than 2% of your account on a single trade.
Particularly for large accounts, there is absolutely no reason to risk much more than 1%. For smaller accounts that are less than perhaps $10k, you might be okay upping that level slightly simply because it’s much easier to regenerate a $10k account through savings than it is to regenerate a $100k account in the same way.
2. Don’t trade instruments you don’t understand.
And this applies ten-fold if you are not adhering to rule 1.
Before you trade a new instrument – particularly a new derivative – you need to know what they are, how they work, and what their relationship is to the underlying stock. Most importantly, you need to know what a movement of one point means to your bottom line.
3. Don’t trade illiquid instruments
There really is zero point entering a position that you can’t get out of. Depending on your account size, illiquid can mean different things to different people but as a general rule if there is any doubt you can get out, don’t trade it. Similarly, if it’s got a chart that’s full of holes it’s best to leave it alone – if most people aren’t interested, you shouldn’t be either.
4. Keep your strategy simple.
You’re long a straight stock position which you’ve hedged with put options, but you’re really convinced your stock is going to sky-rocket so you’ve hedged your hedge with a call option that has a OTM strike and a 30 day expiry. Then to manage the fading theta you’ve written a call to offset that part of the trade, and by the time you’ve done that and named it something nature-based like ‘The Nickel Albatros,’ you’re pretty much done.
Done for, that is.
Because who the heck knows what has to happen for this position to be profitable? It seems to answer every question but in reality it just makes a mess.
If you want to go long, go long and have an exit point if it goes against you. It doesn’t have to be any more complex than that.
5. Handle Leverage Very, Very Carefully.
So you can see it doesn’t take a brain surgeon to avoid a $2b loss, just a brain – it’s just unfortunate that a brain doesn’t seem to be a pre-requisite for high finance.
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