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Theory Behind “Trade Small, Trade Often”

Options Jive

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

We know you've probably heard it a thousand times but today we explain the theory behind, “Trade Small, Trade Often” so you can understand why this is a key part of being a successful trader. This can help every trader.

We believe in the “Law of Large Numbers”. That is why we preach “trade small, trade often” as a core part of our philosophy. The more times an experiment is performed the closer the results will be to what theory predicts. A table of rolling dice as compared to trading was displayed. The table included the number of rolls, number of times the dice rolled a 1,2,3 or 4, the percentage of time and the expected percent. The table showed that we get closer to the theoretical percent, the more we roll the dice. The same concept applies to trading.

A graph of the number of dice rolls versus the rolls that ended up between 1-4 was displayed. The graph showed that by increasing the number of occurrences helps us get to our expected probability. That’s why we say “trade small” because if too much capital is allocated per trade then our occurences number is lower, the law of large numbers doesn’t kick in and we can’t take advantage of our probabilities.

We ran a simulation of various credit spreads entered with an expected win rate of 70%. We ran this for three different scenarios; allocating 1% of account over 1,000 occurrences, allocating 30% of account over 1,000 occurrences and allocating 1% of account over 50 occurrences.

A graph of the balance of an account using 1% of your capital over 1000 occurrences otherwise know as “Trade Small, Trade Often” was displayed. This simulation of using 1% of capital over 1,000 trades showed a slow steady increase in capital. The simulation using 1% of capital over 1,000 trades showed a slow steady increase in capital. The 30% simulation went bust before 1000 trades. That was shown graphically too. Finally, the simulation with the low number of occurrences did not take advantage of the law of large numbers.

Watch this segment of “Options Jive” with Tom Preston and Tony Battista for the takeaways plus other information on the theory behind “Trade Small, Trade Often” and how we can put the “Law of Large Numbers” to work for us.

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