DEFINING RISK
FOR TRADERS
Options were
designed as risk-reducing tools, yet most people begin trading options by
adopting high-risk strategies.
Why does that
happen?
·
Overconfidence. Traders tend to concentrate
on profits and ignore the chance of losing money.
·
Some strategies "feel" safe.
When investing a small sum, traders ignore the fact that they will lose
money at least 90% of the time.
·
It is easy to forget that a string of small
losses adds up.
·
Traders do not look at risk in enough detail.
DEFINING RISK
The term "risk" can be
defined from different points of view:
A dictionary tells us that risk
is
·
A situation involving exposure to danger. For
traders, that danger is a monetary loss.
·
The possibility that something bad or
unpleasant (such as an injury or a loss) will happen.
·
The potential of losing something of value,
compared with the potential to gain something of value.
As a trader, I
recommend using the last definition because it forces you to consider
what you have to gain and compare it with what you have to lose.
In other
words, do not make a trade when risk is too high for the potential
gain.