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Trading and Logical Thinking

The truth is: we do not always reach logical conclusions.

The problem is: we always believe our conclusions are based on sound logic.

The result is: we have no incentive to look for a way of improving how we conduct our business or live our lives.

This is costly for traders. Consistently profitable traders don’t have to be concerned with this situation because they are probably making good decisions. It is very much against the odds for a trader to be ‘lucky’ over an extended period of time.

The problem is more serious for traders who earn very little, or who lose, money. The need something better. The very real problem is that it is difficult to convince people that their thinking is flawed and that their decisions are less than logical. It is human nature to believe that we think logically and reach good decisions based on that logic.

We all understand when we require lessons to learn something new. Sports are a perfect example. Individuals take lessons from professionals. Could it be true that people are so willing to accept help in improving their golf (tennis, bowling, baseball etc) skills because there is no logic involved. By that I mean they are willing to accept help in performing better in a physical endeavor than in an intellectual one.

If we cannot play golf well (and I cannot), we can take lessons that teach us to hold and swing the clubs more efficiently. We understand that holding the club correctly involves a decision. We have a bunch of possibilities and we must choose one that works. However, we cannot be expected to know how to hold the club without being shown. When it comes to trading, once we understand the concepts of a strategy, we tend to believe that we manage that strategy effectively. In other words, we believe that we are making good decisions as the trade progresses. If we are not making consistently, then we tend to assume the problem lies anywhere, but never in our personal inability to make good, logical choices.

I can also learn which club to choose for a given shot. Consider how similar this is to choosing an option strategy based on given market conditions. This is a situation in which we are willing to learn form someone else.

I can be taught the importance of follow through. And taking lessons is in no way demeaning. We accept the fact that the professional knows more than we do and willing pay for instruction. The follow through in golf is very similar to knowing when to exit a (winning or losing) trade. yet most traders prefer to go their own way and believe they are always making decent decisions.

However, when logic is concerned, people seldom admit that others are superior. This is not a matter of intelligence. It is merely the ability to sort through alternatives and make a good choice. It is personal. It feels bad when others tell us that we made a poor choice. Yet, we feel no disgrace when we are told me made a poor golf shot.

The Point

If we are not achieving good results as a trader, it may be that our thought processes are flawed. Once we believe we learned how to trade (from experience, reading, seminars, personal lessons, etc.) we believe that we are capable of executing what we are taught. We believe we reach logical conclusions, based on the available facts.

The fact that traders (just as anyone else) can have blind spots and fail to recognize the flaws in their thinking means that there is not going to be an improvement in the results until the the decision-making process is improved. That takes being aware that there may be something wrong with what we are doing, even when we cannot see it for ourselves.

We must be open to the idea that each of us is completely unaware that we believe some things that are just not true.

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Managing a Losing Trade

There is more than one way to look at every situation. My individual perception may be different from yours. Part of the time there may be room for interpretation because the ‘facts’ are soft and may be considered from different points of view. At other times, the facts are undisputed, but people have different interpretations. Here is one example.

Do you have a loss?

Let’s look at a simple situation. You invested $10,000 in the stock market. Today you can sell those positions and collect $7,000.

Question: Did you lose $3,000?

I find it quite surprising that many people believe that they did lose money while a segment of the population believes there is no loss yet.

Yes, there has been a loss

Here’s how I look at it:

    –The market values this item at $7,000.

    –If the account is with a broker, you may only borrow money based on that $7,000 valuation. Your belief that the stock in your account is worth $10,000 is imaginary.

    –If you receive a margin call (based on a loss on a different investment), your broker will show no tolerance for your argument that the account is really worth $10,000 and that it’s not fair to value it at $7,000.

    –If you want to withdraw cash from your account, your broker will not allow you to take more than $7,000 (assuming 50% margin), even though you believe they should let you take $10,000.

    –If this were a house and not stock, your bank would not give you a $10,000 mortgage based on your estimated valuation. They would base the loan on a $7,000 valuation.

Pretty much the whole world recognizes that an investment may have been worth $10,000 at one time but that $3,000 has been lost and the current value is only $7,000.

No, there is no loss (yet)

The argument in support of believing there is no loss is this:

    –If I don’t sell my asset, I cannot have a loss.

    –A loss only occurs after I exit the trade and have no chance to recover

The large group of people who accept those arguments do not recognize reality. This is important to us because it affects how we think — and thus, how we act.

Almost all traders accept the truth that managing risk is an essential part of being a successful trader. Those traders also share the opinion that it is unacceptable to incur a large loss and that it is necessary to take some defensive action when a position is losing money and has become too risky to hold. That defensive action is (more often than not) to exit the trade, take the loss, and move on to another trade when the time is right.

However, people who believe that they have no loss currently (even though they may admit to being at risk of losing money) may stubbornly refuse to take defensive action. If they believe that closing the position is the act that creates the loss then they will hold onto risky positions, hoping that the loss will disappear. The reason this is a very poor way of thinking is that they tend to hold bad positions when successful traders understand the importance of getting put of losing trades (accepting the fact that the money has already been lost) and reinvest (at the proper time) the money into a better (less risky, more chance to earn a profit) trade.

The innocent-sounding mindset that has people believing that a loss is not a loss until it becomes realized (i.e., position closed) keeps them locked into less than satisfactory positions. And that cannot be good for long-term results. Then there is this point: If the position does recover and the $3,000 loss disappears, they feel vindicated and ignore the fact that other positions would have earned double or triple that $3,000 over the same time period.

Rethink your position if you believe that a losing trade has not yet ‘lost’ money.

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Rookies Stuff 03

One of the basic problems for traders everywhere is the notion that any time that you lose money, you must have made a mistake. If you make a trade that should be profitable 90% of the time, then it must be true that the same trade will be unprofitable 10% of the time. Yet, when one of those occasional losses occurs, the trader is sure that he/she did something wrong.

We trade in a statistical world. The odds-on favorite wins most of the time. But not every time. Thus, if you cannot discover a true mistake — if you cannot find something that the evidence told you not to do but you did it anyway — then the chances are good that you were unlucky this time, and that you made no mistakes.

Here is a bit of my trade philosophy that I believe would benefit any trader who adopts it:

When the time comes to make a decision, examine the evidence and make the best decision that you are capable of making. If it does not turn out to be the winning decision, that’s okay. If you consistently make good decisions, you will be a successful trader.

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Staying Real

Have you ever been hit with a string of successes such that you gain so much confidence that you believe you can do anything? This can occur to a baseball player with a month-long .450 batting average. It can happen to the professional golfer, or to the tournament bridge, poker, or backgammon player who wins a lot of cash over a short time.

It can happen to the schoolteacher who tries something new gets through to her students – enough to see the difference.

Those are all happy results, with very little downside.

Trouble

It’s not always so easy for the trader. We all want to do well. We all want winning streaks. But I wonder how many develop a sense of genius, believing it is their skill that makes them win so often? And it may be their skill, honed with much practice. However, are these winners able to recognize when it’s mostly the result of fortunate circumstances? That’s the big question.

At Options for Rookies Premium, I’m working with several newer traders at the moment, and those who are using cash have been doing very well trading iron condors. My abilities as a teacher and strategy coach are going to be tested. I love that they are winning, but wonder if getting their trading careers off to such a good start is a healthy long-term thing.

We talk about position size and study various risk management ideas. That’s good.

We talk about iron condors, we follow specific trades from start to finish, we have live discussions. One of the common topics is profit potential. We admit that the discussion is theoretical, but the long-term profit expectations keep rising. Confidence does that.

The bottom line is always the same from my perspective. It’s easy to make money when trading options Most traders are going to make a lot of money. The problem is that the majority of those traders are going to discover just how easy it is to lose money. as a result, most new traders never find success. Even those who make a lot of money let that cash get away when they fail to take the time to think about risk management.

Getting everyone to have reasonable expectations is the goal. How about you? Are you a realistic trader?

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Trading Success: The Key

We all hear the phrase “options trading isn’t for everyone,” and my guess is that almost everyone thinks of that as a disclaimer, so that traders who lose money do not sue their brokers. One reason that the words in quotes are repeated so often is that they are true.

It is possible for every person who trades options to make money. But that is not going to happen.
It is possible that you will win the lottery. That’s not going to happen either.
Anyone can get lucky and anyone can get unlucky. That goes for options traders as well as for everyone else.

When those words are repeated, you must believe them (please): Options are not for everyone.

There are various reasons why some people cannot succeed when trading options (or anything else). Those who panic easily or are never satisfied with profits and always want more are not likely to do well with options. The nature of the game requires good strategic decision-making, and when emotions play a big role in your everyday life, they are likely to have a large negative effect on your trading results.

That’s why I believe discipline is so important. Other factors are important as well. Some people just cannot grasp the fundamental basics of how options work. We have to understand that. Many times a learning disability prevents the student from learning the lessons. At other times an obstacle must be overcome. But not everyone can learn to do all things.

That brings me to psychology and how important it is on how well a person can trade. The following blog post from Chris at My Simple Quant is so well done that I don’t want to excerpt it.

This is an important story to understand. It is reality. It applies to you. As a new trader you may not be in position to make plans or develop trading systems, but just looking at the big picture is enough to increase your chances of success.

A Drawdown in Emotional Capital





The last few trading weeks have been very difficult, a lot more difficult than they had to be. I am suffering a drawdown. The % drop bothers me but it really isn’t that bad, nothing catastrophic. I am still up on the year, so my finances are not out of whack. But the emotional capital drawdown I’m suffering feels enormous, like 5 times larger than actual monetary drawdown. I feel this way because I did not follow my own trading rules. I don’t mind losing money when I follow the rules, that’s part of the game. But to trade successfully under these rules for 18 months then abandon them, what the hell was I thinking?

Honestly, the threat of nuclear fallout kind of messed me up. The issues in Japan felt different to me. This wasn’t a debt problem or a fat fingered flash crash. This was a 9.0 quake with 7.0 aftershocks; this was a tsunami completely wiping out an entire city; this was 6 nuclear reactors melting out of control. This really was the end of the world! Ahhhh!!!! -exhale, pause- Well, of course it wasn’t.

I think I became the media’s whipping boy. Twitter and Cable TV and the web all got in my head. Maybe it was the gravitational pull of SuperMoon turning me into a certifiable lunatic. My brain ‘went rogue.’ I think it warped some neurons or something. I just wasn’t thinking straight when I decided to liquidate everything the morning of March 15, 2011. I booked a pile of losing trades that would have been net profitable had I followed my rules. I also chose not [to] take many profitable buy signals that morning too. My system is designed to buy fear. I became a system trader to avoid this crap! It is extremely frustrating to know I did the exact opposite of my plan. I buckled under the pressure. I choked. Then of course I did a few revenge trades and lost more money. It was a throwback to my irrational trading days circa 2004 – 2007. It was a step back on my current trading journey. Heck, it’s taken me over a week to get beyond the denial and write about it. So this troubling time has really made me do some introspecting. I think some good lessons have come from it.

  • Accept that it is all in the past and there is nothing I can do about that it. Really, it’s over with. Just move on.
  • It is only money. I can earn more. I am alive. I do not have radiation poisoning. Stop stressing! Now laugh.
  • Step away from the computer more man. I got on Twitter/StockTwits in September 2010 and my addiction has been progressively getting worse. It peaked (or I hit rock bottom) with the Japan quake. I could not step away from the information for more than 5 minutes. It was bad. That definitely contributed to my deluded mindset. Twitter is a powerful trading tool but I was abusing it.
  • This touches on the previous point, but: Do not focus so much of after hours futures activity. Monday the 14th really started it all for me. When the Japanese market dropped 17% that night, Twitter seriously flipped out. I flipped out. It was pure PANIC! That was probably the craziest Twitter stream I have ever witnessed. If anyone was online that night, you know what I’m talking about. Even Dr. Phil Pearlman did a Stocktwits.tv episode about the panic. I am really glad he did that show; it really is worth a watch here.
  • Work out, get exercise. James Altucher talks about this. It makes sense. I’ve worked out my entire life, but since September 2010, I’ve maybe gone to the gym 5 times. That is not good. Working out releases endorphins and the whole process is a good way to burn out any toxicity in your body. I’ve gone everyday this week, the positive change is significant.
  • Beware of trading hubris. Stay humble. Always. I am not a professional yet. I am still prone to make mistakes. I am not perfect.
  • Trust yourself. Trust your system.

Trading is such a psychologically challenging profession. Professional athletes need their bodies to be in supreme shape; professional traders need their minds to be in supreme shape. When the body is injured, it needs to be rehabilitated. I pulled my mind muscle; I need to rehab. So I’ve been more cognizant of my mental health. It’s always been a primary concern for me, but I’ve strayed lately from that focus. It’s funny how some of the esoteric, vague $STUDY tweets actually make some sense when you’re in crisis. I know I’m not the only person who’s going through something like this. I will learn from it. I will be a better trader because of it. After all, it’s only money.

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Pinning stocks at expiration

There’s an excellent site that delves into research papers to find answers for questions raised by readers (CXO Advisory Group). Recently the topic was: Stock Price Pinning at Options Expiration?

A reader asked: “Do you have any research on the phenomenon of ‘pinning’ during options expiration? The theory is that there is a Max Pain price where options sellers stand to lose the least [MDW: It’s called Max Pain because it’s supposed to cause much pain for the buyers], and that they manipulate prices towards these levels.” A search of the Social Science Research Network (SSRN) separately for “pinning” and “expiration” yields the following studies, in descending order of number of downloads:

“Stock Price Clustering on Option Expiration Dates” from August 2004: “This paper presents striking evidence that option trading changes the prices of underlying stocks. In particular, we show that on expiration dates the closing prices of stocks with listed options cluster at option strike prices. On each expiration date, the returns of optionable stocks are altered by an average of at least 16.5 basis points, which translates into aggregate market capitalization shifts on the order of $9 billion. We provide evidence that hedge re-balancing by option market-makers and stock price manipulation by firm proprietary traders contribute to the clustering.”

We cannot argue with the facts, but interpretation of those facts is another matter. Max Pain theory suggests that market makers can pin stocks to the strike. The authors of this paper suggest that is exactly what happens. Their ‘evidence’? A $100 stock moves nearer to the strike price by $0.165. That’s not pinning by any definition of which I am aware. I understand that academics do research and the discovery of that small price shift is ‘evidence’ for them. However, in the real world of trading, it’s not that significant when you consider:

  • The pinning bet must be made in advance
  • The trader must pick the correct stocks because an average of 16 basis points is not very large
  • The trader must choose the right strike price
  • The strike that is closest right now may not turn out to be the correct strike price

Thus, the evidence that ‘proves’ pinning exists does exactly the opposite. It proves that it does not happen.
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Trader’s Mindset Series I. How Much can I Earn when Trading Options?

Over the past week, I've encountered a group of questions and comments from traders that tells me that traders have a certain way of viewing the world.  These each represent part of the Trader's Mindset.  I've already responded to some of the questions, while others remain on the 'to do' list.

Today I'll tackle one of those questions:  How much can I expect to earn when using options?

I plan to reply to each question and will group them as part of the Trader Mindset Series.  Taken together, they represent how one  trading professional, but psychology amateur, views the psychology of how trader's think.

***

I understand the thought process behind today's question, but it always disturbs me.  It's just the wrong question.  It would be better to ask any of these:

  • How much time should I expect to devote to my options education before expecting to earn money?
  • How much cash do I need before opening an options trading account?
  • Do most new option traders find success?  Or do most give up?
  •  I've never traded stocks or anything else.  Will that make it difficult to learn to trade options?
  • Should I learn to trade options or pay someone else to trade for me?

These questions  demonstrate that the person who wants to become an options trader recognizes that this is not a gimmie, and that some time and effort must be expended before rewards can be expected.  The commonly asked question: 'How much can I earn?' suggests to me that the person asking 'knows' success is easy, and that the only thing holding him/her back from joining the game is wondering whether it's worthwhile. 

I seldom, if ever, receive a question along these lines: 'What does it take to succeed?'   It's always similar to: 'I'm going to succeed.  How much can I make?'

***

A recent letter from Jo:

Hi Mark,

Is it possible for an ordinary person to generate income from trading options if they are able to sustain themselves for a few months without a job while they learn the ropes? How much can one hope to earn through trading options on the conservative side, and how long does it take to become an expert on average?

Is it necessary to purchase special software for options trading (technical indicators and such)?

Thank you,

Jo

***

Yes.  It can be done.  You can generate income.  However, when you 'need' the money for living expenses, it often places too much pressure on the investor/trader to succeed, and succeed right now.  That added pressure can will lead to poor trading decisions.  I know you understand. And that's why you plan to have 'a few months' cash in reserve.

The good news is that you recognize that profits do not begin from day one.  The not so good news is that you are asking whether it's reasonable to learn enough to make a living – during those few months.  The first answer is that every student has a different ability to learn and some just have a better aptitute and can understand how options work more quickly than others.  So yes, it is possible to produce earnings within that time slot.  But not everyone can move that quickly.

To succeed, you must understand what you are trading, and that means taking time to learn options basics. You should have no trouble understanding that options are different from other trading vehicles.

But I must warn you that some traders never get the special characteristics of options and mistakenly believe that they can be traded as if they were stocks. Options are different.  Not difficult to understand, but they are different. 

If you are brand new to trading, that means there is even more to learn, including basic things such as how to enter an order, how to use your broker's trading platform, the different order types (market, limit, stop etc.).  Someone with stock trading experience is already familiar with those items.

Discipline

In addition to how options work, the trader must possess (or be able to develop) certain personality traits.

Jo, if you are willing to learn how options work, and if you believe you can demonstrate the traits listed below, then you may very well be able to succeed.  No guarantees.

I do want to mention one important point.  if you expect to make money (income) by buying options and then selling them for profits, let me tell you that this is an almost impossible path.  When earning an income stream, the methodof choice is to adopt specific option selling strategies – all with limited risk.

Anyone can trade.  Anyone can enter the arena and place his/her bets.  But to have a chance of making money on a consitent basis, the trader must have

  • Discipline
  • The ability to recognize risk
    • how much money is at stake for a given trade
    • the probability of losing money
  • Patience to learn before trading
  • Patience to practice what you have learned, usually in a paper-trading account
  • Ability to control your feelings.
    • Fear leads to panic, which results in terrible decision making
    • Greed has you taking too much risk for too little reward
    • Pride has you refusing to recognize that you made a bad trade and must accept a loss
  • Recognize that a few successful trades does not make you a star trader
  • Understanding that you cannot make money every month
  • Understanding that low probability events do occur – just as statistically predicted
  • Recognize that a 90% chance of winning means there is a  very real 10% chance of losing
  • Accept the fact that you cannot make much money when you only have a small sum to invest
  • Knowledge that luck plays a role, and your job is to manage risk when luck is bad


Now, to your Question: How much can you make?

If you trade high risk strategies, you have a chance to earn a large sum (10+% per month), but that comes with a very high probability of going broke.  High rewards come with high risk.

If you are more conservative (as you are), you may try to earn 'only 2-3%' per month.  That's a very good return. Most professional traders cannot earn that much.  Brett Steenbarger once told me that the best professional traders earn 'in the low (emphasis on low) double digits' per year.  That sounds right to me.

Going by that, earning 1% per month is a realistic target.

However, to give you a better answer, I must ask: How much cash do you have for trading?  This is a key question that most beginners ignore.  They assume they can earn the same amount of money, no matter how much cash is in the account.  This is a huge fallacy. Why?  When you begin with a small sum, the risk of ruin, or the probability of going broke, is very large.  When you have extra cash, you can withstand a string of small losses and still stay in the game.

Also: When you have a small accout, if you have outstanding success and double the account in one year, the total dollars earned is small.  It does take money to make money.

Thus, I repeat, how much cash do you have?  If you have $10,000 and can do an excellent job and earn 2% every month, that's a grand total of $200/month.  That will not take you very far.  I assume you would want to earn a minimum of 10 to 20x that amount.  To do that you would have to take big gambles.  There's a chance that you could have a nice win streak and quadruple your money in a year or so.  But the most likely outcome of seeking such huge returns is the loss of all your capital.

Yes Jo, you can do it.  If you have the patience.  If you take the time to learn and are not rushed into trading.  And if you have sufficient capital to give you a realistic chance.  If you lack the capital, you can still learn and trade part time.  If you grow the account, if you save more cash over the years, if you show the talent and discipline, you may eventually have enough to try trading full time.

I wish I could offer better encouragement, but trading is not a business for everyone.  Being a successful investor can be very rewarding over the years.  Trading full time is different.

 

Becoming an Expert

On average, far more traders go broke than become experts.  Very few become experts. This question depicts another trader mindset that I believe demonstrates no conception of reality.  How long does it take to become an expert?  A lifetime. 

Experts are few and far between – assuming that by 'expert' you are referring to someone who knows how to make money and then actually makes it and keep it.  With that definition, few are experts.

Trading is a game in which you are continually learning.  And that's important because markets change over time and if you still do whatever it is that you are an expert at doing, eventually it will no longer work and you will cease being an expert.

It is not necessary to become an expert. You do not have to earn more than the next guy.  In my opinion, you can do well (earn decent income) if:

  • You have the ability to understand how options work.  This is not difficult, but some people just don't have the head for it
  • Trade with discipline and overcome emotions.  Fear and greed are harmful.  It takes a while to overcome those and trade with confidence
  • You take the time to practice.  That means using a paper-trading account with fake money.  But to gain useful experience, you must  believe it is real money and trade accordingly
  • If you don't have to win right now, you need the time/patience to learn.  I don't know if a few months are enough.  That depends on you

Technical Indicaors

No.  I have NEVER used technical indicators. I know that some traders are very skilled in doing just that.  But they do not learn overnight, and anyone who tells you it's easy to learn is not telling the truth.

I use no trading software, other than risk management software supplied by my broker.

 

I suggest getting started by reading or atteding some free seminars.  If you like what you read and hear, if you understand what you see, then go for it.  Plan to spend some time in the education mode.  Especially if you set a few months as the time limit.  There's no time to waste.  I wish you good trading.

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Trade What You See

Here is a terrific piece of information from Charles Kirk, author of The Kirk Report.

Remember this – in trading it isn’t about who is right or wrong. Instead it is all about who can make money and take advantage of the most opportunities in the present.

Opinions are terrific things, but in most cases, you would be wise to set them aside and trade the market you see rather than the market you think you should or want to see.

That pretty well describes the right attitude for a trader. Don't be stubborn.  Don't try to outsmart the market.  Trade what you see.  For short-term traders, this advice is not only 'good' but it is easy to follow.  If it turns out that what you thought you saw is inaccurate, it's no big deal to exit the trade (yes, with a loss).

Making money from current opportunities is how successful short-term traders play the game.

The problem for me, and other option traders who own positions that take a few weeks (or months) to play out, is that it's not so easy to reverse direction.  Sure, we can exit trades when our market view changes, but the whole idea behind market-neutral trading is to avoid having a market view and thus,  avoid trading what we see (or think we see).

I do agree with Charles' comments.  However, not every trader can adopt that philosophy.  Why wouldn't everyone 'trade what they see'?  I can think of two good reasons

a) When I own a position than I plan to hold for two months, I fully understand that 'what I see' may change several times during that holding period.  Trading in and out of iron condor positions is commission intensive, but more than that, slippage (overcoming bid/ask differentials) is expensive and is something to avoid.  If I want to make a short-term trade, the iron condor would never be the trade of choice. Thus, if I already own the condor, I'm not anxious to alter the trade when the position is well within my comfort zone.

b) It's not always easy to interpret what you see.  If it were, no short-term traders would ever go broke and the failure rate among new traders would be closer to five percent than 95 percent.

Note: Nothing prevents me from buying a call or put spread (or even naked options) as a market play, but when my primary trading style is to own positions that take more time to come to fruition, I cannot pretend that I am a day or swing trader.  I'm as much of an 'investor' as a trader when dealing wth iron condors.

 

Should You Trade What You See?

How can these two trading schools be reconciled.  Or can they?  In my opinion, traders fall into two distinct camps.  It's based on how long a position is held.  In other words, day traders and swing traders represent one group and those who hold positions longer represent another. 

Traders with a bias do trade what they see.  Investors do the same, but they are not going to be changing their minds too often.  In fact, one of the biggest problems for investors is refusing to pay attention to what they see and they continue to hold positions that clearly should be closed.

From my perspective, there is a separate and distinct class of traders. We neither trade with a directional bias nor go in and out of positions quickly.  I classify myself as an options trader, and not simply a 'trader.'  By that I mean that I work to earn money by adopting option strategies that work over time, rather than in looking for strategies that pay off when the underlying makes a predicted move.

I concede that these option plays do have a market bias.  But that bias is 'neutral,'  That's another way of saying that I have no clue what the market is going to do next and I'm taking the position that nothing major is going to happen.  I do trade what I see.  However, I don't see anything.  I see a strong trend, but never know whether it's going to continue or reverse direction.

Thus, people like me trade strategies that prosper when time passes and the markets do not make big moves.  We may buy insurance as protection against monster moves, but that insurance is bought as a protection play, not as a prediction play.

If I thought I could do as Charles suggests and trade what I see, I would do so.  But I know I cannot see well enough to find success that way and accept the fact that to earn money, I must be an active risk manager and control risk as time passes.  This methodology must lose money part of the time.  However, if the trader is careful and especially when the trader is not stubborn, profits easily outdistance losses over any extended period of time. 

 

Psychological factors

There have been times when I was disappointed by losses. The best way to achieve a more satisfactory result is to find a better strategy for the current market.  It may be a good idea to exit any existing iron condors – but that's not the point to emphasize.  Begin to trade what you believe you see.  If it feels like a bull or bear market, you are not required to go along for the ride.  However, there is no reason not to modify your methods to account for the market that you see in front of you.  That may be as simple as modifying your usual strategy to sell more put spreads or (better) fewer call spreads.  It may work to select farther OTM call strike prices.  Don't fight the market.  If you don't want to embrace 'what you see,' at least make some concession to it.

Trading what we see is not easy for the rookie options trader, nor is it that easy for me. I've been a market-neutral, don't-trade-your-opinion trader for more than three decades, and it's not easy to trade what I believe I see.  However, it's easy to set a stop loss and exit any trade.

This is just one additional example how psychological factors play a big role when trading.  It's a real choice: go with your favorite strategy, or recognize that this is not the right time for that play and find another. Find a trade that does well under current market conditions.  It seems perfectly obvious to do that, but it requires the ability to break what would have been referred to as 'discipline' if you depart from strict market neutrality.  Don't force yourself.  No single idea works well for everyone.  In fact, when in doubt about how to proceed, sitting on the sidelines is never a bad idea, as long as it does not become a permanent habit. 

As always, it's ok to cut position size or paper trade to experiment with specific ideas when uncertain about using your preferred methods at any given time.

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