Risk-Management Advice From A Grizzled Military Veteran

Investors are nervous, which means it’s time to examine our protocols for risk management. So far this year, each of the three major indices — the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average — have all locked in two down weeks, and they look like they’re heading for a third.

The VIX has also jumped back up to 22, a level we last saw at the lows of the mid-December selloff.

The market is down. Time to look at our risk-management plan!

Investor outlook is also starting to sour. The percentage of bulls among individual investors fell sharply last week, according to the American Association of Individual Investors survey.

More bears are joining the party.

According to AAII, the results from the latest Sentiment Survey show bullish sentiment at its lowest level in four months.

The market certainly appears to be entering pullback territory, and many experts are calling for a correction of 10% or more from the market’s highs near 4,800 over the next six months. That would put the S&P 500 back around 4,300, where it was trading back in October.

But before we head down to that level, the market would still need to break below its previous support around 4,550. Declines in December stopped near that level, which previously served as resistance back in early September.

While pullbacks are always nerve racking, a correction at this time would not be unheard of. It has been more than a year since we’ve had one, and after the S&P 500’s impressive 27% run last year, the market is due for a breather. And despite the headline-grabbing selloffs and shifts in investor sentiment, there are a number of technical indicators, like market breadth, that are telling us the bulls are still in control.

For now, I want to remain cautious and watch how things unfold. That doesn’t mean we shouldn’t trade — but it does mean we should consider risks.

Why Risk Management Is So Important To Success In Trading

As many of you know, I spent time in the Army — a place where risk management is extremely important. Risks include death, catastrophic injury, and damage to millions of dollars of equipment.

There are formal courses on managing risks in different environments. But grizzled veterans explain risk management by saying “just don’t do anything different or dumb.” I’ve followed that advice in my military and investing careers.

In a nutshell, this advice is basically saying, “Have a process and make sure you have the discipline to follow the process.” My process for Income Trader is detailed in a paper I wrote a few years ago.

It involves searching for:

– Options that are expiring soon and have a high probability of expiring worthless. Preference is given to the options expiring the soonest.

– A minimum annualized return on investment of at least 10% until expiration.

– A “buy” signal on my Income Trader Volatility (ITV) indicator, which means the indicator is below its 20-week moving average. The ITV indicator is the key to the success of the system. It shows the ideal time to sell options.

To avoid doing something dumb, I stick to my process. This includes trading only when the price is right. For each recommendation, I look at the option’s fair value and I use that to set the upper limit of my recommended “buy” price.

Then I look at where the risk of the trade changes. That information lets me identify the lower limit of my recommended range. I always recommend trading within the range because that limits risk.

Setting the range (and then sticking to it) is an important part of my disciplined approach.

How We’re Using Options To Safely Generate Income

Over the long run, my process works. I’ve been following the same steps in Income Trader since 2013, and more than 90% of my trades have been winners. Each individual year has been a winner, and statistical testing shows that it is impossible for this to be a random occurrence. ITV identifies a real market behavior that has held up over time, through upturns and downturns. There’s no reason for that to change now.

Now, I understand not everyone is comfortable selling options, but you shouldn’t let that fear or nervousness keep you from taking advantage of this tool. Because that’s what options are — a tool for traders. They can be as risky or conservative as you want them to be. It all depends on the strategy you’re using.

Like I mentioned above, my strategy is one of the safest around. In fact, I’m making a guarantee to new subscribers to show how low-risk options can be: If you follow along with my trades and don’t make money at least 90% of the time… I’ll work for you for free. That’s how confident I am.

I recently released a special report that will tell you everything you need to know, including how my readers are making about $748 a week from selling options. Simply follow this link to check it out.