The old adage that an ounce of prevention is like a pound of cure applies to risk management . It is essential to keep your losses small, and it is important to protect your investment capital because it represents your freedom to invest. Warren Buffett has been quoted as saying, “Rule number one: Never lose money. Rule number two: Never forget rule number one.” With this in mind, it is critical that you manage risk.
You cannot always play offense if you want to win. Playing defense is important if you want to trade successfully over the long run. This chapter will describe risk management strategies that should help you in your trading. Some of the strategies were covered in Chapter 1 but are repeated here for emphasis. The first part of the chapter emphasizes the importance of treating option trading like a business, and the second half describes risk management strategies.
RUN IT LIKE A BUSINESS
If you were running a business, you would put together a business plan encompassing trading strategies and detailed plans of how to operate the business and control expenses (prior to ever starting the business). You should develop the same mentality when trading options. Developing a plan and working hard are essential to your success. You should have targeted profit goals, risk management strategies, a philosophy of trading that fits your strengths and personality, and the best trading tools at your disposal. Remember the Wall Street adage that bulls ...