Blowing out a trading account is one of the most awful things a trader can experience. Even some of the best traders in the world have blown out their account because they did not understand how much risk they actually had on. Black swan events that lead to outsized market moves can cause a trader who does not understand risk management to experience a huge drawdown. Fortunately there are several things a trader can do to mitigate the risk of blowing out their account and we will discuss a few of them here.
Having a solid approach to risk management requires a trader to not only understand the risk that they have on in individual trades but across their entire book as well. If a trader is involved in complex options trades this total risk exposure can be difficult to calculate. A trader should be aware of their net exposure to direction, time decay, and implied volatility but the most important risk metric is maximum potential drawdown. For example if a trader is short naked call options in their book they technically have an unlimited potential maximum drawdown on a trading account. This should never be the case. Let’s look at a few things a trader can do to completely remove the risk of a black swan event blowing out their account.
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