Smart Thinking About Capital Levels and Simulation

Seth FreudbergGeneral Comments, Options Education, Seth Freudberg's Blogs, Trading Psychology2 Comments

One of the great things about our growing Options Tribe community is the number of experienced spread traders that are actively participating and communicating their thinking to us. This free exchange of ideas is what the Tribe is all about: the more that people share their perspectives and approaches, the stronger we all become as traders.

Recently, I received an email from one of our members, Richard, who made some interesting comments about how he psychologically prepares himself for a critical issue in options spread trading which is the establishment of capital levels committed to a trader’s monthly spreads in an amount larger than the trader is accustomed to committing on a monthly basis:

“I’m now at the point where my monthly income-positions (using the Vertical/Calendar strategy) are generating some serious money in my paper trading account and small, but meaningful, consistent dollars in real money. Each month I place a real money trade which is set at 10% -25% of the size of the same paper trade. I use the paper trade as a way of getting myself psychologically acclimated to managing much larger positions without emotional distortion clouding my decision-making.”

I think that is pretty brilliant myself. What Richard is doing is giving himself the live trading experience necessary to thoroughly understand the trading vehicle and strategy he is employing—with real capital under real market conditions.

Yet at the same time, he is thinking ahead to the point in time when he will want to judiciously increase his capital level. He wisely recognizes that, while his ultimate increase in capital levels may have almost no effect on the market, it will have a very large effect on himself.

So let’s say that hypothetically, Richard has drawn a line in the sand with his real money trade of a maximum loss of $1,000. That means that  in most cases he will stay in the trade even if his P&L is down $950. He recognizes that in many cases, a trade will recover and provide a very nice profit, if you allow it room to “breathe”. If he is running a paper trade, at the same time, which is five times larger than his real money trade, then he is allowing himself to visualize staying in the trade with a P&L down $4,750. at the same time his real money trade is down $950. He gets a glimpse of how he would react being down that much on the trade. He also establishes in his memory banks the simulated experience of a trade being down that much money, recovering and then ultimately providing a solid profit as the trade progresses. He is simulating the experience of larger capital amounts being at risk while simultaneously having the crucial experience of live trading the strategy and learning the real market realities of trading that strategy in that vehicle under real conditions.

In our options training course, we ask our trainees to do a large volume of back testing and paper trading prior to the live capital trading experience. At SMB we believe that simulation and visualization is an important part of the learning process for traders. But there is no getting around the emotions of live capital trading.

What I love about Richard’s approach is how he has combined  both simulated and paper trading into his trading regimen–each with its own valuable purpose. Great job, Richard. I’d recommend this to other Tribe members and I’d like to thank Richard for this contribution.

Seth Freudberg

Director, SMB Options Training Program

The SMB Options Training Program is a program designed for novice and intermediate level options traders who are seeking an intensive training process to learn how to trade options spreads for monthly income. For more information on this program contact Seth Freudberg: [email protected].

2 Comments on “Smart Thinking About Capital Levels and Simulation”

  1. I agree with this completely. In the past I have switched between paper trades and live trades. Every time I would get comfortable trading paper and was consistent, i would switch to live and almost instantly lose. I don’t think it was because my trading strategy/plan wasn’t workable, but instead because I was used to being financial unattached from my trading results. The sudden change had an effect on my psychology every time. For the past 6months I have done both together. I take a size that my account should take in my paper account and I trade a very small size in my live account for the same reasons as were mentioned here. It works very well. I have recently quite trading the paper account for now and am performing much better as a result in my live account.

  2. I am reading your blog and wondering how your trading is going ? have you managed to make a profit ?

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