The power of compounding when trading options

The power of compounding when trading options

May 18, 2020 | 0 comments

Trading options is a fantastic way to generate profits. As a trader, you can make money off of trading options both during volatile times as well as when the market is quieter, all while leveraging your investment capital and hedging your risk. 

But what if you could put all the benefits of options trading on steroids? To create wealth, no matter what you invest in, using the magic of compounding is key. 

So what is compounding, anyway?

Typically used in pensions and long-term mutual funds, this mathematical formula is a powerful vehicle for wealth creation. Compounding essentially means reinvesting your profits to make even greater profits. The interest or profit you’ve earned on your investment is added to the principal so that interest or profit earned during the next compounding period is gained on the principal plus the already-accumulated interest. Let’s say you deposit $1,000 in your trading account and open 5 positions, each for $100. By the end of the investment term, you made a 70% profit, so now you have $1,350.  You now open 5 positions using 10% of this new earned capital on each. Assuming you again make a 70% profit, the new profit is now $475. See the snowball effect compounding can create?

What does this have to do with options?

Due to the short term frames of options trading, compounding is a very suitable formula. Compounding can help minimize the short-term risks taken when trading options by getting good returns from over the long run. To apply compounding effectively when trading options, you don’t need to take greater risks in order to make exceptional profits; all you need is to allow time for your profits to continually grow while risk remains constant. 

How do I benefit from the compound effect when trading options? 

In order for the compounding effect to work, you need to first make sure that you profit from the assets you are investing in. Obvious, right? To reduce the risk of focusing too much on whether the asset you picked is good, think of your portfolio as the asset. You might have some losers and some winners in your portfolio, but as long as your portfolio as a whole is profitable, then you are in good shape and can harness the power of compounding. You can of course make decisions about eliminating the stocks that don’t help your portfolio grow and add new ones that would.  Now, how do you make sure you have a winning portfolio? By establishing a solid trading system supported by a trading strategy. Once you have a method based on high probability entries, rationally placed stop losses, and a trailing stop way to maximize profits, you have a winning trading system. And a winning trading system, one that generates real profits, is the heart and soul of options trading. 

Establish a fixed percentage of your investment capital to open new positions (we recommend 5%), follow our options trading strategies, and let’s start enjoying the benefits of compounding. 

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