What everyone gets wrong about options trading… How to reduce risk, while adding an extra pop to your returns… In the mailbag: “We need less ideology and more common sense”…
It doesn’t sound like a trader’s office.
But Vic Sperandeo – or “Trader Vic,” as he’s known on Wall Street – isn’t your typical starched suit.
The office in question was in the basement of Sperandeo’s home. And although he traded on behalf of Wall Street firms, he often traded independently with his own money.
And, boy, did he have a good run…
Between 1982 and 2000, Sperandeo didn’t end a single year in the red. And over that time he made average returns of 72% a year.
At that rate of return, $10,000 compounds (meaning you’re earning profits on your profits) into more than $174 million.
And it’s one of the best streaks in trading history.
But what’s really interesting about it is that, throughout his career, Sperandeo wasn’t focused on scoring large gains. Instead, he placed a greater emphasis on avoiding big losses.
And in today’s dispatch, we’re going to show you how you can do the same.
It boils down to having the right mindset…
Here’s how he recounted it in an interview for the classic investment book, The New Market Wizards…
I know this will sound like a cliché, but the single most important reason that people lose money in the financial markets is that they don’t cut their losses short.
It is a curiosity of human nature that no matter how many books talk about this rule, and no matter how many experts offer this advice, people still keep making the same mistake.
Followers of our own master trader here at Legacy Research, Jeff Clark, will be familiar with why loss aversion is so important…
Don’t be put off by the jargon.
Without getting too far into the weeds, there are two types of options – calls and puts.
With call options, you bet that a stock will go higher. If it does, you make money. Puts are the exact opposite. You’re betting that a stock will go lower. If it falls, you make money.
Most folks have the impression that options trading is inherently risky. When they think options… they tend to think of pure gambling.
And it’s true that some folks use options contracts to place foolish bets. But that misses the wider point about why options contracts exist. Here’s Sperandeo with more…
I’d say that gambling is the wrong term. Gambling involves taking a risk when the odds are against you. For example, betting on a lottery or playing a slot machine are forms of gambling. I think successful trading, or poker playing for that matter, involves speculating rather than gambling.
Successful speculation implies taking risks when the odds are in your favor. Just like in poker, where you have to know which hands to bet on, in trading you have to know when the odds are in your favor.
It’s a message Jeff has taken to heart in his own trading career.
In fact, Jeff calls options trading the least risky… and potentially most rewarding… game on Wall Street.
Over that time, he’s taught thousands of ordinary folks how to use options to keep their risks low… but still add an extra “pop” to an otherwise conservative portfolio.
For example, in the dark days of 2007, 2008, and 2009 – when many investors were losing their shirts – Jeff identified 84 opportunities to make money, including 12 triple-digit windfalls… with gains of 133%, 166%, 182%, 225%, and more.
And he did it by taking a leaf out of Sperandeo’s book… and being paranoid about losses.
Jeff describes himself as a very conservative guy. As he puts it, if you want to be a winner, you have to watch your losers. Jeff…
With options, like in poker, your hand is only a small portion of the battle. Betting appropriately for the entire game is really what’s important.
To succeed as a trader, you really need to limit your trading to opportunities that have at least a 3-to-1 payout. A 5-to-1 reward-to-risk ratio, of course, is better. But at minimum, you want to have the potential to pocket $3 in return for every dollar you risk.
Put simply, to be willing to lose 100% of the money you put into a trade, you’d better be expecting a 300% to 500%-plus gain.
It’s a message we’ve been hammering home here at the Cut.
One of the most important ways to keep your downside risk low is to limit the size of your positions.
Exactly how much you put in each position is up to you. But as far as the trading portion of your overall portfolio goes, here’s the recommendation Jeff had for his readers…
You should only have 2% to 3% of the money you’ve set aside for trading at risk on any one trade. We really can’t imagine any combination of circumstances where you should consider putting more than 10% of your trading money on one play. Don’t do it!
To end up like Vic Sperandeo over the long run, you’ve got to stick to the program. Limit the size of your positions. And limit your downside by never allowing a small loss to turn into a big loss.
Traders who follow this have a chance of being winners in options over the long run. Those who don’t do this will be quickly drummed out of the club, taken for every penny.
For more on how to use options to reduce your risk… but add extra oomph to an otherwise conservative portfolio… make sure and sign up for Jeff’s free trading e-letter, Market Minute.
Jeff not only shares his thoughts about the most promising trading setups in the market today… He also regularly shares insights about the strategies you need to succeed as a trader over time.
If you haven’t already, sign up for free here.
Today, some of your fellow readers say they’ve found the answer to the big debate on capitalism vs. socialism that’s been raging in the mailbag.
Could this be the beginning of the end for the longest-running mailbag debate in The Daily Cut?…
Why do people go on and on about capitalism vs. socialism? The truth is that each system has its faults and most countries practice both, but they dress them up differently. Both systems fall foul of abuse of power. The bank bailouts from 2008 are one example from capitalism; people like Adolf Hitler and Joseph Stalin are examples from socialist movements.
We need less ideology and more common sense. We can argue continuously for or against any of the choices we have and never reach a universally useful conclusion. If you want healthy and sustainable capitalism, it must be regulated properly. The first regulations should be to rid the system of lobbyists and the second should be to separate the governments from the big businesses and banks.
The EU system is an excellent example of the incestuous business government relationships where a network of like-minded wealthy individuals holds all the power and influences all the decisions. It is analogous to monocultures in agriculture, where all the plants or animals suffer from the same disease such that one epidemic can wipe the whole lot out – only in the government/business relationship the disease is narrow-mindedness.
– Steven S.
As I see it, communism, socialism, and for that matter, even democracy is not a form of government but are merely enterprises on a large scale. Their primary purpose is to perpetuate their existence. They all use force, fear, and fraud to protect themselves from those who would object to their control.
Those who have studied history know that all human progress has been brought about by individual liberty. Whichever -ism or -ocracy allows for the most individual liberty presides over human progress to the extent that individual liberty is allowed.
Throughout history, intelligent and industrious people have immigrated to the country with the most individual liberty. Look at the countries with the most emigration. It is these countries that deny or forbid individual liberty that deny human progress. Very few people are moving to Mexico for the economic opportunities.
– Ernest A.
Meanwhile, the conversation turns back to freedom of speech and censorship, after Legacy Research cofounder Doug Casey said, “People ought to express themselves in any politically incorrect words they wish”…
Freedom of speech is a fundamental right. Limiting that is another step to socialism and would morph into communism. Would you like to live in fear of everyone around you?
I have seen the results of the aftermath of communism in Russia firsthand. You will be brainwashed, so no problem, you will forget the old days of plenty… or will you wake up before it’s too late?
– Loren M.
Are you worried about socialism gaining traction in the U.S., as Loren M. seems to be? Or do you see merit in the mixed socialist-capitalist system some of your fellow readers have proposed?
As always, write us at [email protected].
April 17, 2019
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