How professional investors approach the markets…

Porter: Doc, before we move on to the strategies you use in Retirement Trader, I want to talk a little more about how professional investors approach the markets.Can you share some of the big ideas you learned about risk and trading philosophy at Goldman Sachs?

Doc: Sure. The most important thing I learned early on is that defining risk is absolutely critical.

In finance, risk is measured a bunch of different ways. But the two simplest measures are price and variability.

Price is fairly obvious... Paying $0.50 for an asset that's worth $1 is far less risky than paying $1.50 for that same asset. And assets that are highly variable – where prices move up and down a lot – are considered to have a higher risk profile than assets that are more stable.

The general philosophy at Goldman was to make money for the firm while taking on as little risk as possible. And so regardless of the trade, our goal was always to maximally reduce the potential risk of that trade.

At the same time, when you're sitting at a desk at Goldman, you want to make sure you're making money for the firm steadily and regularly.

So to use the familiar baseball analogy, we were generally much more interested in hitting "singles" than hitting "triples" or "home runs."

Just like in baseball, the guys who swing for the fences and try to get home runs are also often strikeout leaders. That's OK... they're an important part of a team.

But you would much rather have them be "cleanup" guys, batting fourth or fifth in your lineup, while guys who hit singles – like Rod Carew of the Minnesota Twins back in the day – are batting leadoff, to get on base to score.

That's not to say professionals don't ever speculate. Goldman was OK with a lot of stuff, so long as the trade was fully planned out and you knew the risks along the way. Once you broke certain parameters that you said were highly improbable, you had to close the trade.

In general, if Goldman was going to make a big bet on something, you would try to find a way to create a floor for your downside. And using the right options strategies is a way to do that.

Again, regardless of the trade, the philosophy was to keep your losses as small as possible, and to continually try to decrease those losses of capital.

Porter: What else is responsible for Wall Street traders making money so consistently?

Doc: There are a few other things at play. One of the keys is being contrarian... not following the "herd."

For example, if someone is sitting at a trading desk at Goldman today, they're seeing that everyone is selling high-yield bonds, and everyone is talking about the selloff in high-yield bonds. So they're thinking it's probably time to start looking at buying them.

This is the whole idea behind Stansberry's Credit Opportunities... the idea of "don't throw the baby out with the bathwater," where you're looking for those bonds that aren't as risky as the market is pricing them, and you're buying them to make safe money.

Another important aspect is asset allocation...

Unlike individual investors, professionals almost always have their money spread out over a bunch of assets, so risk and return is stratified and diversified across different categories of risk.

Porter: That's a great point...

In my experience working with investors for 20 years as a newsletter publisher and newsletter writer, I can tell you there are generally two types of folks who use our letters.

There are the folks who are rational and professional, and then there are the folks who are just the gunslingers.

If you talk to a professional investor and he has more than 1% of his portfolio in a position, that's a big, heavy deal. But if you talk to an average individual investor and he has less than 10% of his portfolio in a single position, it's a small position.

Doc: That's true... In fact, this is one of the biggest differences between professional and individual investors.

Finally – and this is where options come in – one of the other secrets of Wall Street traders is selling "time"...

Earlier I mentioned the idea of "time decay" – that's the reason it's extremely difficult to make money as a buyer of options.

But remember, there are two sides to every trade... If the odds are stacked against the buyer of an option, it means the odds must favor the seller of that option.

By selling options, you're using time decay to your advantage. And done correctly, it's a powerful way to consistently and safely hit "singles," day after day.