Account Management

 

Account Composition

Winning isn't just about top line Account Value; Account Composition is a tremendous factor in your long-term success. As you trade this system profitably, you'll balance Account Value, Position, and Cash. 

Account Value - the top line on your brokerage app. It is the constant calculation of all of your positions added together. 

Position + Cash = Account Value

Position / Position Equity - the current market value of the shares and/or options that you own.

Number of shares you own * Current share price = Position

Cash / Cash Position - the amount of cash that you could withdraw from your account.

Account Value - Position = Cash

If you use margin (leverage) then your position size can exceed your account value. I do not recommend using margin for this strategy or for beginning your trading journey. Being consistent in building Account Value is far more critical than the immediate gains that you could see with margin. With Robinhood, margin is not available without Robinhood Gold.

The Relationship Between Account Value and Position

These are two different figures that you’ll need to keep track of as an investor or trader. We’ll need to build up the concept so please read and re-read these statements (even though they seem obvious) because when you’re trading real money in your account, these will make a significant difference.

Scenario: 

  • Your account value is $1000.

  • You buy 100 shares of XYZ for $9.50 each for a total of $950

  • Your position in XYZ is $950 and you have $50 in cash. Add these together and you’ll see that your account value is still $1000.

  • Your position of $950 will change as the market value of shares in XYZ will increase or decrease. 

  • You will still have $50 in cash regardless of your position in XYZ increasing or decreasing in value.

  • Every $0.01 (one cent) change in XYZ’s share price will affect your position by $1.00

  • Your Account value will also change by $1.00 for every $0.01 change in XYZ’s share price.

  • Let’s say your position goes down in value from $950 to $800. Your account value will be $850. You still have $50 in cash.

  • Let’s say your position goes up in value from $950 to $1100. Your account value will be $1150. You still have $50 in cash.

Strategic Application of Account Value and Position

Can you see how deceptively simple these concepts appear? Your position goes up and down while your cash remains the same. In practice, a higher account value does not always mean that you should withdraw money. Withdrawing money could require you to reduce your position (sell shares). 

There are times when selling shares makes sense but generally we want to use the shares as an asset to generate cash.

As we progress in this course, we’ll learn how to generate cash weekly to our account value while trying not to reduce our position. This is powerful stuff, keep going!

Risk Management

A consistent trader’s first priority is risk management. Risk management makes you wealthy over time.

Do not use margin. As you decide how much money to deposit into your trading account, know that executing this strategy is similar in risk profile to owning an equal value of stock in a company. So ask yourself if you’d buy those shares and let it ride without trading this strategy.

Bear Market Scenario

In the event of a transition to a bear market, American (and some global) markets would see a continuous decline greater than 20% in share prices for longer than 6 months.

In a major decline of your stock price: 

  • You will see your shares become less valuable and a correspondingly lower value in your trading account.

  • Call contracts become less valuable because they’re tied to share price. This means that selling calls weekly would generate less cash than when the share prices were high. 

If you properly follow this strategy  then you’ll fair slightly better than the rest of the market. Here’s an explanation of that statement. 

Within this downturn scenario, you still have the same number of shares of a publicly traded company (that’s your asset). Selling calls weekly constantly builds your cash position and you will continue to build your cash position regardless of share price.

If you’ve been adding to your cash position every week, when markets recover then you will be at exciting all time highs in your trading account.

Oh shit! Bear Market Cheat Sheet

  • Keep your assets intact (Drops are often a bad time to sell shares)

  • Build your cash position every week by selling calls

  • Stay cool

Personal Risk Tolerance

The biggest reason to properly manage risk is this: You will not properly execute your strategy if you bet too much. 

Every person has an emotional risk tolerance to losing (or gaining) money. Mine started at about $300 per day and now it’s about $15,000 per day. When my account changes by +/- $15,000 in a day, I observe my discomfort and I have the urge to deviate from my strategy. You will find your level and your level will increase over time. Do not start trading with an account value that exceeds your personal risk tolerance.

Manage Risk with Position Size

Before you evaluate a specific trade, develop a position size that is inline with your Account Value, Risk Management Principles, and Personal Risk Tolerance. Position size is up to you. These are my guidelines. 

  • If you’re going to Sell Puts, then you can size your position to 90% of your account value. 

  • If you’re going to Sell Calls, then you can use 80% of your account value to buy shares. 

You can choose to place less than 80% in one position or spread the 80% of account value around to multiple stock positions. 

Using options for risk management

*More information is available on options in the corresponding content section.

These position sizes are fixed for any stock that you choose to trade. It’s not a conservative approach to begin Selling Calls with a cash position smaller than 20% of your account value. The remaining 20% cash will be useful in the event that you’ve sold calls and your position requires cash to maintain. Remember in this scenario that your account value still went up so you can choose to exit or reduce your position size to match the same amount of exposure to that trade. 

Selling calls against your shares does not require additional cash. Your shares are held as collateral until your option contract is ‘bought to close’ or the contract expires. 

Funding your Account

As you determine how much money to allocate to your trading account, there’s historical and logical support to trading twice as much as you would be comfortable “losing” in a major market meltdown. 

Historically share prices are unlikely to drop 25% within a week or 50% at all. Historically share prices for growing companies recover to new highs at some point in the future. That’s not a rule, just a perspective.

The Risk Management principle that I’m presenting is to fund your trading account with 2 times the amount that you’re ‘willing to lose’ in a major market sell off. 

My ‘2x’ guideline is a good place for you to start your funding considerations. Your scenario and your personal risk tolerance are both different. ‘Willing to lose’ is actually a terrible way to describe money in the stock market because our asset (shares) remains intact when share value goes down.

Of course, I’ll leave it to you to fund your trading account at the amount that is inline with your personal risk tolerance. 

If you feel stress or hesitation around funding your account, start smaller.

You can always add funding after you have successfully demonstrated your ability to execute these strategies.