When it comes down to it, there’s two very simple guidelines to follow that allows for your account to have a rising equity curve. And there’s also 2 terrible mistakes that are a couple of the main causes as to why 90% of Traders lose 90% of their money in 90 days (The 90/90/90 Rule).

The 2 Secrets

  • Liquidity
  • Volatility

The 2 Mistakes

  • Illiquidity
  • Excessive Leverage

Let’s Start With The 2 Secrets, Shall We?

Liquidity is essentially a measurement of market efficiency. The more liquidity a Stock, Future, or Currency has, the tighter the Bid/Ask Spreads. Tighter Bid/Ask Spreads means that you can get in and out of your positions easily without immediate large losses.

For instance, let’s say you’re trading a TSLA with a $1.20 wide Bid/Ask Spread. If you entered your position, and immediately thought you were wrong– or worse, your excessively tight stop loss got triggered… I say excessively tight stop loss, because that’s typically the case

You face an immediate loss of $1.20, plus however much TSLA moved against you. Not great… Terrible, in fact. In contrast, a Stock (technically an ETF) like SPY that has volumes more liquidity, and a Bid/Ask Spread of a few cents is much better in comparison.

The issue here though is that TSLA moves a heck of a lot more than SPY on any given day. In other words, TSLA is far more volatile than something like SPY.

Why Is Volatility So, So Important?

Well, how do you make your money trading? Oh, that’s right! When the Stock moves! However, the reality is that Liquid Stocks tend to have tiny ranges. In other words, they lack volatility.

This could be an upside, or a downside depending on your trading goals. So here’s the paradox:

Illiquid Stocks tend to be much more volatile, when compared to their Liquid counterparts, but they are riskier.

What’s a Trader to do?

Well one way is to trade Liquid instruments while increasing the amount of Leverage, and thus gains. But that can turn deadly, pretty quick.

What happens when a wild event happens, and the normal range, in your Liquid Stock that you love to trade so much, doubles and you’re on the wrong side of the trade? See what I mean?

Excessive Leverage has no place in a profitable trader’s strategy.

None. Nadda. Zip. You won’t find it anywhere. That said, you will still find a healthy (keyword healthy) amount of leverage in most profitable trader’s strategies. Look, I’m not knocking leverage. Leverage certainly has a place, and when used with caution and respect it’s a wonderful thing.

It’s what takes a small account into a larger account much faster. And a larger account into an even larger one in a shorter period of time.

However too much leverage will take any account to zero in a blink of an eye.

So what’s a healthy amount of leverage? That’s for you to decide, but here’s an article that can help you make that decision. Typically anything less than 20x, preferably less than 10x, and mostly less than 5x is an acceptable guideline for leverage.

Anything more, and your Risk of Ruin is too high that you just can’t come back. Period. Now Mix excessive leverage With illiquidity And too much volatility, Aaaaaand…

Let’s Recap

  • Trading liquid instruments allows us to easily get in and out of trades without losing out on the Bid/Ask Spread too much
  • Volatility allows for a trader to make more money, because the Stock, Future, or Currency moves more, and therefore more money can be made
  • Illiquidity is not a trader’s best friend
  • Illiquidity mixed with an excessive amount of leverage will crush even the best traders.
  • When used appropriately (i.e. generally less than 10x), leverage can be great at helping grow an account faster
  • Too much leverage, and your Risk of Ruin is imminent.

The Question Is…

“How does a trader balance leverage, volatility, and liquidity?”

Well there’s a few ways this can be handled. One way is to understand the Options Market. I know, I know… We’ve all heard that Options are risky, that they’re “not suitable for the average investor”, blah blah blah.

I’m not saying they’re not risky. I’m saying driving a car is risky, if you don’t know how to do it. You don’t have to trade Options to know how they work. But how exactly Can They Help You Strike A Balance Between leverage, volatility, and liquidity?

Well for one, you can increase your leverage while simultaneously limiting your downside by buying Options. This is because you can only risk what you paid for the Option– if you’re buying them that is. There’s a whole plethora of strategies that involve selling Options.

These are strategies that allow you to have a win-rate of +70%, consistently generate income, and… Allows you to leave a lot of stress, worry, and hopelessness at the door. But that’s neither here nor there.

But it is here.

When It Comes Down To It, Trading Boils Down To Two Things

Picking the direction, and knowing how far it’s going to move. Direction can be difficult to predict, however… There are a few simple to use tricks, that you can start using immediately– Like, as in right now… to predict how much something is going to move.

And this is where an understanding of Options comes into play. Again, you don’t have to trade ‘em to make them useful. You see, Options can help us predict how much a Stock, or Future (really, anything with an Options Market) is going to move over a given period of time.

Yep… You read that right.

Isn’t That Exciting?

That would relieve a lot of stress. That alone might allow you to stop letting those winning trades turn into losers. If we know how much something is going to move over a certain period of time, we can then gauge our expectations as to how much we can make.

How many times have you had a winning trade, and you thought “This is it! This is it! This is going to make up for all of my losers. This trade is on fire! Look at it go!!”. And then… You gave it all back.

That Didn’t Have To Happen.

You know better than that. Or do you? Maybe if you knew the expected range for the day was $2, and the fact that the Stock had already moved $2.20 wasn’t a clue…? But how on Earth would you know ahead of time that the Stock’s expected range was going to be $2?

If you knew how Options worked you’d already have an answer to that question.