In a very sad set of circumstances, a 20-year-old college student from Illinois took his own life this week following an error with his trading account.
Alexander Kearns had begun trading a leveraged options account out of boredom during the COVID-19 lockdown.
This essentially means that his broker was extending him credit, giving him the power to trade larger position sizes than his equity would have allowed. Due to a technical glitch in the platform, Alexander believed that he had gone into $730k worth of debt on his account. As a result, he chose to end his own life.
The news is deeply upsetting for obvious reasons. But for the many in the financial trading community who understand the pain of losses, and the ample amount of tools available to mitigate them, this tragedy stung even deeper, as it might have been avoidable.
Had the young man had the appropriate knowledge and guidance, as well as access to risk management tools, he might have known that debt that large would have been impossible to accumulate.
So what lessons should new traders learn from this tragic incident, to help protect their funds, minimize their losses, and trade more responsibly?
Choose Your Instruments Carefully
Options trading is a more advanced form of financial trading than simply trading in the spot or futures market.
Options are varying in complexity but certainly represent a more volatile instrument than the spot market.
New traders should, therefore, develop a deep understanding and familiarity with the markets and instruments they choose to trade. Especially before they move into options trading.
Watch Out for Leverage
Leverage is a double-edged sword. The ability to command larger positions sizes than your account equity would allow on an un-leveraged basis obviously opens the potential to achieve larger gains.
However, leverage also increases the risk of suffering larger losses which might be disproportionate to your account size.
This means that you could quickly lose your account and risk going into a negative account balance. That means you would owe the broker money.
Negative Balance Protection
Opting for an account with negative balance protection is one of the best things new traders can do.
This policy, provided by the broker, ensures that a trading account cannot go into negative territory. It protects you from ever losing more than your equity or owing the broker money.
Negative balance protection is highly advisable. And while it’s not applicable for all instruments and trading types, it is well worth considering when choosing who you are going to be investing with.
Understand How to Manage your Risk
One of the key factors that new traders need to understand is how their risk sizing impacts their chances of success. Many new traders wrongly believe that aggressive position sizes will help them quickly grow their account.
However, as with leverage, this is a double-edged sword. Trading at 5% or 10% per trade means that an entire account can be lost within just 10 or 20 trades. And that is highly likely to happen for most new traders.
Alternatively, trading at 1% per trade means that 100 consecutive losses would need to be suffered to destroy an account. Therefore, you lower the risk of such an event and have greater chances of success.
Focus on Risk-Reward
Instead of trying to use aggressive risk sizing to capture gains, traders should focus on harnessing the power of positive risk-reward.
This means focusing on strategies and trades which offer multiples of your risk as reward.
For example, using a trade setup that targets 3 x your stop loss, meaning 3 x your risk. If you risk 1% per trade and make 3% on winning trades, you will stand a good chance of steadily growing your account.
Always Use Stop Losses
Tied into that last part is the necessity and importance of stop losses.
Using a stop loss means you are guaranteed to be taken out of the market at a certain point. Therefore, you can predefine your own loss.
This allows you to keep a uniform risk and manage your account with detailed planning. It also means that you avoid the disaster scenario of suffering a total account loss if the market moves against you.
Stay Away from Risky Trading Conditions
While black swan events are impossible to predict, many traders suffer losses just as extreme from engaging in high-risk behavior. This includes attempting to trade news spikes with highly leveraged positions.
Other traders suffer unnecessary losses simply from trading in poor liquidity conditions. An example of this would be attempting to place trades overnight or near the close on a Friday when spreads typically widen.
Learning to trade only in favorable conditions is a sure-fire way to improve your chances of success.
My thoughts are with Alexander’s family during such a sad time. I hope this article can be of use to new traders who are just coming to the market and learning the ropes. Account losses and negative balance situations can be extremely distressing situations to suffer.