Abandoning your favorite option strategy? Reconsider

An excellent post by Jared at Condor Options was also picked up by Abnormal Returns. [If you are not familiar with the work of Tadas at Abnormal Returns, it's worth the visit.  He finds the best blog posts, and it's more than I can find time to read.]


Jared suggests treating a strategy as you would a favorite stock: Buy on dips:

"If you’re trading a strategy with a long-term record of solid
performance… a great time to increase
your exposure to that strategy is after the strategy has suffered a
losing period.

In other words, given a strong and consistent strategy,
you should buy that strategy on the dips."

That is an interesting suggestion based on mean-reversion.

When investing, and more often when trading, we tend to buy on dips.  We remember price levels at which we had previous success when buying a certain stock. Technical analysts consider this practice to be 'buying at support.'  It makes sense.

However, I confess that I've never done that.  When a strategy is not working well, I tend to cut back, rather than expand position size. 

"A strategy that has performed well over the long run should never be
abandoned after a decline, unless there is overwhelming evidence that
something about markets or the strategy has changed so fundamentally
that the strategy will never work again."

When there is a solid, fundamental reason for abandoning a strategy, then do it.  But when the decision to change strategies is based on an expectation of further losses (with no solid basis for reaching that decision), that's an emotional decision.  Jared goes on to say:

"Based on my own experiences mentoring and educating option traders, I
think that the most important factor differentiating unsuccessful
novices from those who survive long enough to become experts isn’t that
the latter group knows more about the option Greeks, or is better able
to analyze implied volatility, or anything like that. The decisive
factor, as trite as it sounds, is that successful traders are willing to
base decisions on information rather than emotion
."

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Visit the new Options for Rookies Home Page, with links to new material, including my thoughts on an options education.

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