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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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