The market’s October volatility (aka “Red October”) was a reminder of why managing risk in your trades is so important. This is one of the most important aspects of trading, but it’s, unfortunately, the downfall of many traders because it’s also one of the most difficult.
There are plenty of ways to manage risk and protect profits, ranging from simple precautions you can take to the most complex strategies. Here are several popular ways people protect themselves and their gains.
A protective put is an options strategy that is essentially like buying an insurance policy on a stock you already own. This involves buying a cheap out-of-the-money put against a stock that you’re simultaneously long. The idea is that if the price of the stock falls dramatically, the protection provided by the put option can offset the losses you may have otherwise sustained by owning the stock.
While protective puts will lower your potential gains, they will also cap your potential losses.
We’ve written before about the importance of having an exit strategy. The reason most traders use a specific exit strategy is to remove emotion from the equation. It’s easy to talk yourself in or out of closing a trade at the moment, but if you’ve already set your exit up ahead of time, the decision has already been made.
This could be anything from a hard stop at a certain price, to scaling out of a position at a certain profit/loss ratio, to defining a target date by which to sell.
This is probably the easiest and most effective way to protect profits. Aside from the usual suspects—market, limit, and stop orders—there are several advanced order types that are designed to give you more control over your trade.
All or None: AON orders are orders that must be filled completely in order to be executed. By removing partial fills from the equation, AON orders allow traders to prepare for only one of two possible scenarios: you either get your entire position at your desired price, or you get nothing.
Fill or Kill: FOK orders are AON orders to buy or sell stocks that must be executed within a few seconds or they are immediately canceled. FOK orders allow traders to take aggressive, quick shots at stocks with essentially a self-destruct timer on the order that prevents a trader from accidentally leaving them open.
Immediate or Cancel: IOC orders are nearly identical to FOK orders except they are not AON orders. IOC orders allow traders to take a quick shot at getting all the shares they can get of a stock at a particular price during a very small window of time.
Good ‘til Canceled: GTC orders are the exact opposite of FOK orders in that they remain open until a trader manually cancels them. GTC orders are great if a trader has a particular target in mind and is in no hurry to buy or sell.
Every trade involves some risk, and none of the strategies outlined above will take that out of the equation entirely. That said, they will help you minimize that risk, protect you from greater losses, and in some cases even protect you from yourself.
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