Visions of sugarplums ain’t just for fairytales. Maybe you’ve traded your way to a much bigger account size. Or Uncle Milt left you a huge chunk of change. Whatever the source, you’ve come into serious money. Exciting? Sure. But now what?
Some would consider doubling their trade size after doubling their account. After all, if you’re willing to risk $500 a trade with $50,000, why not $1,000 a trade with $100,000? No wrong answer here. But again, perspective is crucial. Above all, consider your capital’s “utility”…huh?
Simply put, utility measures how much benefit you’ll get from the next dollar. One dollar to someone whose net worth is $100 is a big deal. One dollar to a millionaire, not so much. In trading, potential reward is always tied to risk. If you want more reward, you typically need to take on more risk. The utility you have with that extra trading profit helps determine whether you would in fact take the extra risk.
Twenty-somethings have plenty of time before retirement, so their accounts have time to potentially recover from losses. In this scenario, the utility a younger investor realizes for his potential trading profit might be high enough to encourage more risk. Why? The dollar today will likely buy less tomorrow. To offset the cost of a more expensive future, a young person may take more risk with a profit “windfall.” For someone closer to or already in retirement, taking extra risk could cause a loss from which it may be harder to recover. This could make that potential and incremental profit less attractive. Either way, younger or older, there are potentially smarter ways to adjust incremental risk to fit your lifestyle and trading goals.
Double the pleasure, temper the 'fun'
One possible solution suggests increasing position risk incrementally as your account grows. For example, instead of increasing risk by 100%, maybe you go, say, 25% instead, from $500 to $625, instead of from $500 to $1,000. This could mean doing more contracts, or simply adjusting spread strikes so they’re wider.
If you were, say, to sell four 100/102 put spreads for $0.75 credit, that would have a max risk of $500, not including commissions ($2 spread - $0.75 credit = $1.25 risk. $125 X 4 = $500). If you widened the strikes and sold three of the 99/102 put spreads for 0.95 credit, that would have a max risk of $615, not including commissions.
If you’re comfortable with a 25% increase in risk, you may consider increasing risk by another 25%, and work your way up over time to doubling your risk. If you’re not comfortable with a 25% increase in risk, it’s easy to back off and try to avoid larger losses. This way, your potential profit will be delivering the appropriate balance of risk and reward that makes the most sense for your personal financial situation, without throwing caution to the wind (never a good idea).