Tag Archives | bad money advice

Options Trading: The Role of Luck

Bad Money Advice is a worthy blog.  Penned by "Francis X. Curmudgeon, the alter ego of a bitterly unemployed hedge fund manager in the suburbs of Boston, Massachusetts," the blog is designed to publicize the fact that so much bad advice is readily available that he feels the need to combat it.  In his words,

"the main topic here is the advice given by others and how bad it is. And
not just any advice. I mean to talk about advice on a single subject of
almost universal interest: money."

In a recent post, he discussed the role that luck has when investing.  Most traders have a great deal of confidence in their ability to outperform the markets, but the unsophisticated retail investor must play the cards dealt. 

"Consider somebody born in 1916 who turned 65 and retired in 1981. In
the 20 years before his retirement the stock market averaged a return of
only 6.57%, just 1.07% ahead of inflation over the same period.
$100,000 invested in the market on his 45th birthday would have been
worth $357,026 at 65.

Now consider someone born 17 years later, in 1933. Over the 20 years
before his retirement in 1998 the market averaged 17.32% a year. (That
happened to be its best 20 year period since 1890.) $100,000 invested on
the last day of 1978 would have grown to $2,440,288.

The difference between $357K and $2.4M is tremendous in terms of
retirement wealth and lifestyle. And yet all that separates these two
people is the year in which they were born. And those years are not even
that far apart. The 20 year investment periods actually overlap."


As traders, we don't rely on the cards dealt to us.  In fact, we are constantly reshuffling the deck.  Nevertheless, any time you deal with probability, statistics must be considered. 

Whether we buy or sell options, we undertake a trade that is based on probability.  Over the longer term, chances are high that statistical predictions will be validated and that a 70% probability event will occur roughly 700 times out of 1,000 events. [Reminder: unlikely events, or the tails of the probability distribution curve, appear far more frequently than predicted].  However, on a single trade, luck plays a role. Or as one definition of the term provided by Wikipedia:
"luck is probability taken personally."

Unless you want to depend on having good luck – a very poor investment strategy – it's important to take matters into your own hands.  That's why it's so smart to practice good money management (size trades properly) and good risk management (control losses). 

As regular readers know, risk management is a constantly recurring theme at Options for Rookies.  Unless you have very good luck, trading without a proper respect for risk, and constantly being aware of and managing risk, there is little chance you can succeed as a trader.  It's a difficult enough profession without taking more risk than is prudent.

Risk management is vital for survival – even when you trade/invest without being a professional.  I wonder if Francis X agrees.  I trust he does.

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What Other Bloggers are Saying

For anyone interested in becoming a full time trader, this blog post by Charles Kirk (The Kirk Report) offers an excellent insight into the trader's world – pros and cons.  Here's a sampling:

PROS

As an independent trader, I set my goals and I'm in charge of my own
destiny. I don't rely on any other person for how much money I make or
how I make it. Other people's opinions of me are irrelevant to my own
destiny. At the end of the day, bottom line trading results (not office
politics) are all that matters.

It is always interesting and I'm NEVER bored

I can live and trade from just about anywhere in the world.

Trading independently offers level of personal freedom that isn't
present in most jobs.

CONS

You've got to bring your A game to the table each and every day. There
is no sitting in a cubicle playing solitaire, visiting with facebook
friends…

Past success means absolutely nothing. You are only as good as your next
trade

There will be little to no respect or understanding for what you do for a
living. People will assume you're a "day trading gambler."

There's much more

***

Frank Curmudgeon (Bad Money Advice) offers an interesting perspective on the 'flash crash' that occurred two months ago (May 6, 2010).

"Regulators announced investigations.
Pundits theorized. Both houses of Congress held
hearings. And two months later we are no closer to finding the
person or persons who screwed up to cause this."

The exchanges canceled all trades made between 2:40 and 3:00 at prices
more than 60% from the price at 2:40. 10,000 trades for 1.4 million
shares were busted…  Breaking extreme trades sets a bad precedent that may make things worse
next time
.
His perspective tells him that:

What nobody seems willing to say out loud about the events of May 6 is
that, by and large, the market worked the way it was supposed to.

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In the July issue (available July 19, 2010) the regular feature 'Pro & Con' will be renamed 'Wolf Against the World.'

I'll be taking a stance and publish more than one response that contradicts my position.  Join the debate by suggesting topics for future discussions.

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