If your goals is to average $800 per day trading and you lose $800 your first day, what do you need to make the next day to in order to average $800 per day over the 2-day period? Some people would think $1600 but the answer is actually $2400. That's right, you have to make $2400 just get back to your average of $800 per day. This easily shows you how important loss control is. Losses need to be kept small and winners need to be as big as possible. Today, we will discuss money management.

Minimums and Maximums

First of all, what is the minimum amount of trading capital you need? I suggest at least $10,000, but $20,000 would be much better. The reason is that after commissions and bid/ask spreads, it becomes difficult to make money.  For example, if you are paying $20 round trip per trade and you place 50 trades per year, you have to gross 10% just to break on commissions (for a $10,000 account). That doesn't include other expenses like software and 5% bid/ask spreads. On the other hand, with a $50,000 account, you would only need a 2% return to recover your commission costs in the same example. Basically, the larger the account size, the better.

Next, how much of your portfolio should be you put into each trade? You should not exceed 10% of your portfolio. Doesn't  that cap your upside? Yes it does, but the first concern for a trader should be survival. All traders enter losing streaks. If you put 20% of your portfolio into each trade and have 6 losers in a row, you can kiss your account good bye. These losing streaks are unavoidable and 10% or less is the way to go. One thing to keep in mind if it's your first time trading: If you lose half of your account in 1 month, you are likely to quit and thus will not benefit from the learning process that occurs during a 6-month period of trading. Also, if you lose too much too quickly, you may not be giving yourself a long enough time period to be proven right. So keep it at 10% and under.

Some say that too many cooks spoil the broth. Well, too many positions can spoil the portfolio as well. 3 positions can even be a challenge to watch but more than 7 positions is too many when it comes to options. You have to be on the lookout for gaps in either direction, earnings announcements, and stops among other things. So keep your number of positions between 3 and 7 whenever possible.

Final Rules

Option Stops should be 20%-30%. If your stop is at 8% for example (which is what William O'neil recommends with stocks) your option is likely to be down 8% at some point every other day. You will be shaken out almost every day. Keep your stops at 20-30%.

Recap the day. Go over how you spent your day. What went well? What did not go well. Be as objective as you can. Remember that if you don't learn from your mistakes and make the necessary changes, your ineffective techniques will become outdated just like an old computer.

When your option gains 100%, sell half of your postions. Our studies have shown that this technique is highly profitable in the long-run and also can boost your confidence in trading.

Price Headley is the founder and chief analyst of BigTrends.com.