Tag Archives | successful traders

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


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

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Risk Management. The First Line of Defense. Introduction I

I recently posted a (very) short course on risk management.  After due consideration, I decided that this aspect of trading is so important that it's worthy of a much more detailed discussion.  For anyone who trades with 'guts' or 'feel' or by the seat of his/her pants, you may believe this is an unnecessary discussion.  If you talk to successful traders, you will discover that almost every one of them will tell you that risk management is essential to long-term success.  I'll go further than that:  If you are neither a skillful risk manager nor a very lucky trader, your trading career is not likely to last a long time if you are unaware of, and thus, ignore, risk.

That's the rationale behind this series of posts which continues the discussion, in depth. As I write, I don't know where this is going, but I know where to begin. At the beginning.

This gives me the opportunity to write about my philosophy of trading. I've developed some ideas over the past 33 years of trading options. Some are universally accepted – which means I didn't really develop them, I borrowed them. Other ideas represent my point of view, which in turn, came from my experience as a trader. Risk management ideas from this perspective should be useful because it offers detailed suggestions as well as specific guidelines. [Some of these ideas are presented in Lessons of  a Lifetime, my recent e-book]

I encourage you to think about the suggestions made here. This is not physics or chemistry in which someone can lay out the laws that have been proven to be accurate by experimentation and testing.  I offer ideas that seem logical to me. They represent the truth as I see it. However, the advantage for you is that you can think about these ideas, try them, modify them, and then you may elect to disagree with them. It's real life science in which you experiment with an idea, and then adopt it or reject it as you develop your own theories about how best to manage risk.

My task is to see that you come to recognize the importance of risk management and to get you thinking in a manner that will serve you well.  Your task is to ask questions, think about what you are doing, and not blindly accept every suggestion being made. 

Learning to pay due respect to risk is easy once you get clobbered a time or two.  I'm suggesting you save yourself that ordeal by taking risk and money management as essential parts of trading.

Learning to limit risk (at all times) is similar to learning about, and choosing a specific option strategy to trade. Successful traders don't adopt a single trading idea (strategy) and use it forever. Different market conditions are far more friendly to certain strategies (and a strategy is merely selecting which options to buy and sell to form a position) than others. As conditions change, the intelligent trader is flexible enough (i.e., not stubbornly adhering to a method that is clearly not working) to select alternative strategies and reduce position size. Similarly there are many ideas you can put into play when keeping risk under control.

I recently asked a well-respected trading coach whether I was over-emphasizing risk management to the beginner, wondering whether it would be better to allow that rookie to gain some experience before making the effort to understand why risk management is so important. The reply was 'no' – I was not overstating the importance of risk management. In fact, he told me that the rookies' trading career would likely be very short if he/she did not get on board with managing risk almost from the start of trading.

The truth: I enjoy writing instructive posts, but I'm not writing for myself. I want to help you learn to use options profitably. I want you to avoid mistakes I made – and believe me, ignoring the importance of managing risk is at the top of the list of my trading sins. If I can help you steer a smooth course through the jungles of trading, then your life will be a lot less stressful, and happier. With that purpose in mind, I'm beginning a detailed foray into the world of risk management.

This is not going to be a mathematical treatise. Indeed, it's not only targeted to rookie option traders, but also to anyone else who has not paid enough attention to managing the risk of owning option positions. And for those who do have a decent understanding of how to keep risk in line, there should still be useful tips. With that in mind, let's get started.

There is much ground to be covered, so please have patience.

To be continued


New Trader FAQs: Experienced Traders and Market Pros Answer the Questions New Traders Ask Most Frequently

New Trader FAQs contains answers to more than 50 questions provided by knowledgeable sources, including yours truly. These are experienced traders and market professionals.

The complete list of questions

Most of the questions have multiple answers, offering different perspectives for tackling a specific problem.

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