Most traders have a directional bias. Some have a volatility bias. Getting either of those right can result in significant profits. And that's especially true when the market undergoes a strong move in either direction or when volatility makes a big move higher or lower.
Regardless, I learned to trade from a market neutral standpoint and have been proud of myself for sticking with that neutral outlook. However, a question from a reader made me exit my stupor and consider the question: What's so wonderful about trading without a market bias?
Well – I told myself – I don't care which way the market moves. I'm in good shape either way (depending on my position and the size of the move). Who could argue that this isn't the best place to be? The answer to that question is every trader who makes money by leaning long or short.
But, I'm reconsidering, and looking at different aspects of my neutral bias. Why is it better? Why is it safer? Why is 'neutral' any less of a market bias than long or short? The sad truth – or at least I'm wavering about it being the truth – is that it isn't any better. I've been brainwashed my entire career. Is that possible?
Traders with a market bias hold positions that suit that bias. I like to
describe my bias as non-existent, but the truth is, adopting an iron
condor strategy is best for traders who believe that the market is not
about to make a big move. Having no bias, I'm 'hoping' for a
range-bound market, rather than predicting one. That forces me to consider the questions: Believing that hope is not a
strategy, how can I trade iron condors? How can I choose a strategy that depends on having a range-bound market? If I am not confident that the market will be trendless, aren't I adopting a strategy of hope?
That is one scary thought.
I must rely on skillful risk management to survive. Without the possible big win that those with a market bias can score, I trade strategies with limited profit potential. That's fine because they come with limited loss. But I am very much dependent on holding losses to modest amounts and managing my positions well.
As a market maker (1977 through 2000), it paid to remain neutral. That allowed me to participate in all order flow (buy bids and sell offers) without being afraid. When I was caught short and stubbornly refused to buy stock, I was in trouble when more call buyers entered the pit. [This was a problem because every market maker who sold those calls was going to bid for stock, pushing the price higher. Thus, not being caught long or short had a monetary advantage. Obviously I had the right direction part of the time, but being neutral left the market maker ready to take advantage of any order that enters (what was then called) the trading pit.]
When I worked for a trading firm, they insisted on traders being as neutral as possible at all times. Not just delta, but all the other Greeks as well. That made sense because our goal was to trade for an edge. Using proprietary models, the idea was to buy Greek neutral spreads with a theoretical edge.
I'm trained to be neutral. It was drummed into my head since 1977. But now, 10 years after leaving the trading floor, I'm wondering if there's any advantage to being neutral. Why can't I choose an iron condor with a bias? Or adopt a bullish strategy in the first place? Why should I allow a slow, steady unidirectional bull market be so difficult to trade? Why don't I open my iron condor by selling extra put spreads or farther OTM calls or do something with a bullish bias (add some call kite spreads)? I don't have a good answer to any of those questions.
I always believed neutral was the least risky choice. And it is when you believe the market has an equal chance to move higher or lower on any given day, or over any given short period of time. But why should I, or anyone else, believe that?
The news is horrible, and the future looks bleak to me – with high unemployment and all signs pointing to a commercial real estate bubble. Businesses are not growing, real crises loom large (Greece) – but who cares? Not 'the market,' It just marches ever onward.
This is a bull market (which may end before this is published) and why shouldn't I trade just a little long? What's wrong with that idea? I don't know, but I am unable to do it.
Can anybody answer? I've traded with no bias for so long, that it just feels right. As indicated above, If asked, I'd claim to be a bear. But I cannot afford to wager on that bias, especially when being long has been the winning move for a year. Why is it so difficult for me to trade long? I have no answer. For now, I rely on the (flawed?) safety of market neutral.
Lessons of a Lifetime: My 33 years as an Option Trader