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Trading Plans: Profit vs. Loss

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I’ve stressed the benefits of writing a trade plan for each trade. This seems to be one of those things that is easier to ignore and many question the worth of such plans.

Before entering into any trade – especially a trade with limited profits, it’s important to know just how much can be earned so that it can be compared with the maximum possible loss. Without having an idea of the profit potential, there is no sensible method for deciding whether to make the trade. The thought process may resemble this:

Considering how much I can lose if things don’t work out well, and taking into consideration the probability of losing that much, is the potential profit (and the chances of earning that profit) worth taking the risk?

Let’s take a look at an example – one that I’ve used previously.

The trade: Buy (I know, most people prefer to use the term ‘sell’) a 20-point iron condor and collect a cash credit of $4.00. The underlying asset is a broad based index, such as SPX, NDX, or RUT.

Maximum theoretical gain: $4.00

Maximum theoretical loss: $16.00

We could look at the delta of the short options, or use a probability calculator to give us an idea of how likely it is that the position would finish safely out of the money. We could determine the probability that one of the options would become an ATM option (‘probability of touching’) during its lifetime. In other words, we have some idea of the statistical chances of success/failure.

To determine if you want to own this trade, you should not look at those $4 and $16 numbers, unless you know that you are going to hold this trade all the way through expiration. That would be a terrible idea and is a slap in the face to those of us who believe that risk management is essential to making money when trading.

For traders who do hold, these $4 and $16 numbers are real and the trader achieves one of these result in the vast majority of situations. A small percentage of the time the gain or loss is different, but that requires that the settlement price be within the borders of either the call or put spread. [When the short option is out of the money, then the profit is $4. When the long option is in the money, then the loss is $16. If neither of those situation obtains, then the final settlement price is between the strikes and the 20-point spread is worth anywhere between $0.01 and $19.99.]

Exercise risk management skills

For those of us who know we will neither allow the options to expire worthless nor allow the loss to reach the maximum, we must estimate a maximum profit or loss. Sure we all think of the chances of earning the whole $4, but the risk involved makes it a poor decision – for my comfort zone. I’ve often discouraged readers from seeking every last nickel from a trade.

The point of this post is to alert plan writers to the fact that the theoretical limits are not realistic and you are far better served to enter profit/loss targets that are realistic according to your own guidelines. I would probably use numbers such as $3.50 as the maximum gain and perhaps as high as $8 for the maximum loss. Note: that is a personal trading style, not a recommendation.

In reality, I never seek that maximum gain, while other go after seek every penny. There is no arguing with the fact that leaving money on the table is not the path of the expert trader. However, deciding how much profit is enough, and when the reward no longer justifies taking any risk, is something that comes with experience.

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The Big Loss

At his blog, Joey offers his perspective on the top reason that so many trader wannabes are not, and will not, become profitable traders (downtowntrader). His post is titled:

Learn to Lose Money to Make Money

Excerpts:

The majority of people reading this are not profitable traders. If I could single out the most common culprit for sabotaging your trading it would have to be not being able to take a loss. This is especially prevalent amongst new traders… out-sized losses are what cripple your account and push you into the negative column. You will never be a successful trader, EVER, until you learn how to take a loss.

The problem is that many traders equate a losing trade with making a mistake. This is simply the wrong way to look at it. A trader should judge his trades by grading the process, not the results. There are simply too many unpredictable variables impacting whether a trade is successful or not. [MDW: I’ve said this repeatedly]

Doubling down or holding on to a losing position for fear of taking a loss will eventually lead to your ruin. This will work at times… However, the problem is that the few times it doesn’t work out will lead to huge losses. Some stocks DO go to zero and stocks dropping over 20% in a day are not really uncommon.

Stocks don’t always come back and even if they eventually do, you could have been better off looking for a better opportunity. You wouldn’t keep your money in a shoe box so why keep it in a stock that’s going nowhere? Traders should focus on the process and in striving for perfection in the mechanics of a trade instead of worrying about the results. Make sure you have a plan and execute it flawlessly every time. This means only entering a trade for which you know you have an edge and then exiting at a predetermined price or condition when it goes against you.

If you take your losses religiously and focus all your effort on minimizing the mistakes in your trading process, you will undoubtedly improve as a trader. In fact, it would be damned hard to be a losing trader if you truly embraced this simple rule. Remember that taking a loss doesn’t mean you were wrong. The probabilities simply didn’t work out in your favor.

Joey is talking about stock trading, but his observations apply to option trading as well. Most of us have the ability to be profitable, and those who last a long time must show some income for their efforts. But there is something about human nature that makes it difficult to accept a loss, or even recognize how dangerous a given trade has become.

A trade plan places the number in front of your eyes: the dreaded maximum permissible loss. Most traders fail to use the trade plan in the first place, and then a certain portion of those who do refuse to accept their earlier decision as the correct step to take. It’ so tempting to try to get back to even, when all you are doing is gambling.

Trading is a game of statistics. When you have an edge, you will win. When the edge disappears, as it inevitably must for some trades, then giving up and not fighting the statistical truth is the only winning action.

This philosophy is not hindsight speaking. If you regularly limit losses, many times it would have been better not to act. But that’s not the point. The point is the only way to avoid the big loss is to take that loss when it is small.


As I was finalizing this post, Darren echoed the same theme at his blog: (Attitrade-ProactiveTrading)

By simply writing out my target and stop (amongst other things) before placing a trade I became more mechanical in my trading. If my loss target was hit I moved on to the next trade then processed the losing trade later in my journal. Losing sucks but what really sucks is losing more than I should by not following my rules. The mental baggage that will be carried from knowing better yet lacking the discipline to do so, my friends, is the real damage from a loss.

I know that it’s difficult to take advice offered by others. We all feel we must learn our lessons by ourselves. Let me assure you that I would be a whole lot better off today had I bothered to pay attention to the great advice offered to me. Now it’s your chance to learn from those who have been there – or were smart enough never to have gone there.

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Trade plan for the rookie

Trade Plans

I’ve posted about trade plans more than once. However, it’s an important topic and this time let’s discuss it from the perspective of a rookie trader.

It’s advantageous to write a trade plan for every trade and to keep that plan updated. As time passes or when the position changes (because of an adjustment) it’s time for another update. Why? The primary purpose is be certain that a trader understands why the trade was made. More importantly, the plan makes the trader think about situations when it’s no longer viable to hold the trade as it stands. The experienced trader will recognize the need for taking steps to reduce risk. The inexperienced trader may become frozen with fear or uncertainty. Having a trade plan that applies to the current situation offers one reasonable trading solution. The plan may be the decision to exit, reduce size, or make a specific trade to reduce risk. Having a solid trade idea in times of stress makes a huge difference to the confidence level required to pull the trigger on the trade suggested in the written plan.

Please recognize that it is not a winning strategy to enter into a trade just because it feels right – when you have no ‘real’ reason (other than your gut) for making the trade. [NOTE: If your gut has a good track record, then it’s right to pay attention to it.] If you are making a directional play, ask yourself whether you are truly bearish/bullish for a good reason. If it’s a non-directional play (such as an iron condor) does the reward justify taking the risk? If you have any reason to believe that a volatile market is approaching, then it is an inappropriate time for iron condors, writing covered calls, or other premium-selling strategies.

To decide if the risk vs. reward numbers for the trade are attractive, a trader must have both a profit target AND a maximum loss target (your own worst case scenario). Reminder: Just because a trade strategy comes with a built-in maximum loss, there is no reason to become lazy and allow the position to slowly reach that maximum. The plan must be realistic and based on having the discipline to take that loss – when the time comes.

Example:

Trade a 20-point iron condor by collecting $4.00 credit

The maximum gain is $400 and the maximum loss is $1,600. In reality, you would probably exit before $400 is earned. Thus, the profit potential is less than $400. It’s important to know (fairly closely) the real target.

I hope the maximum loss is less than $1,600. If it is, you must decide how long to carry this trade before exiting. By writing that number into your plan, you become aware of that number. For more experienced traders, the number may be flexible. If there is a good reason you can allow a slightly larger loss. However, the trap that must be avoided is deciding that the loss has become so large that you may as well gamble with the position. Long term success comes to traders who avoid the big losses.

As the trade progresses, you may want to make minor changes, but the experienced plan writer understands that it’s worthwhile to have a written plan – just in case action is needed when the market is volatile and you, as an inexperienced trader don’t know what to do. The answer is to do exactly as the plan describes. It may not be the best possible solution, but it is a well thought out plan, and is going to be a reasonable choice.

Why bother?

The negative side of plan writing must be mentioned:

  • It takes time
  • It requires thought
  • It’s not as much fun as making trades that feel right at the time
  • It takes discipline
  • You may not want to adhere to the plan when the time comes

The rookie plan writer

I understand completely. As a true beginner with no trading experience, making these plans is virtually impossible. How can you have any idea when it may become uncomfortable to own that specific position? How can you know how much profit to seek or at which level to limit losses?

The answer is: You cannot know. However, you can make a reasonable estimate. It takes trading experience to get a good feel. However, you can take a stab at it. Make a guess. Obviously when you are at this stage of your trading career, one of the things you are learning to do is to write a trade plan. Thus, it is clearly understood that the plan is not very valuable as a plan of action and that you may not trade as the plan directs.

Nevertheless, altering the plan to something better – assuming you have the time to do it – is a learning process in itself, and the next plan you write will be a better version. You not only learn to trade, but you also gain experience in writing plans. It won’t be long before those plans become valuable and truly assist in the decision-making process.

One good method for gaining experience is to write plans for trades in a paper-trading account. Think about it: It requires extra for each new trade, but the purpose of paper-trading is to learn something useful. If you not only gain trading experience, but also gather plan-making experience, it’s a double win. As always, there are no guarantees, but a successful plan writer has a better chance of succeeding when real money is at stake. And that’s the bottom line, isn’t it? Doing everything you can to recognize risk and avoid blowing up your account has to be a top priority. And that possibility is almost never given much thought by the overconfident rookie trader.

Keep the plan simple and only make it more detailed as you move ahead with your education. For your initial plan, include profit and loss targets. The next time try to estimate the stock price at which an adjustment may become necessary.

Clarification: When speaking of risk in this context, I almost always refer to the risk of mounting losses. However, when a position has been working well and profits have been accumulating, there is always the risk of losing those profits. That’s a true risk. One of the factors to consider is reducing trade size, exiting the trade, or adjusting to lock in some profits. Risk refers to any position that doesn’t feel right. If profits could easily vanish, that’s just as much of a risk as the chance that losses can suddenly increase. In either situation, it is your money at risk, and a good trade plan insures that the chances of losing that money are minimized.

That’s the rationale behind getting a lot of practice before entering the game with real money.

Paper trade. Open a practice account with your broker (or at an online site) and make some trades. Manage those trades. As you see more and more different situations (please take notes in a trade journal), you will begin to see things with your own eyes. I can tell you what to look for, but seeing for yourself is far better as a learning experience.

It’s all too easy for the rookie trader to assume that plans are too complicated or that they are for the more experienced trader. However, if you expect to become one of those experienced traders, becoming concerned with risk and writing trade plans go a long way toward keeping you in the game long enough to gather that experience.

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Options Education: Course for Rookies

Options education is a topic that is near and dear to me.  I spend much time and effort helping readers understand how options work, rather than merely presenting a "do it this way" instruction manual.

The better that a trader understands the principles behind making intelligent trades and trade decisions, the better prepared that trader is to continue making good decisions on his/her own.

Options education is offered in several formats.  There are books, webinars, expensive weekend courses, individual (or group) mentoring, to name the most popular. 

Some people avoid the education process and prefer to pay others to suggest specific trades.  This is a non-starter for me.  I believe the trader must understand the trades being made and the rationale behind the trade.  Consider this:  How can someone pick trades for you and each of his/her other customers when that person has no idea of your investment goals, your risk tolerance, your investment time horizon etc?  It cannot be done.  Trusting your hard-earned cash to such 'trade pickers' is foolish at best.  It's okay to get suggestions, and then make the final decision on your own, but a basic understanding of options is required to make that judgment.

Blogs are a good source of information, with some, such as Options for Rookies, having education as the primary goal,  and others offering intelligent (or otherwise) commentary on a myriad of options-related topics.

Some information is free.  For example, most brokers provide education, usually in the form of written lessons or webinars.  The options exchanges also provide information as does the Options Industry Council (OIC).  Most blogs offer free content.

Other education requires payment of a fee.  Some courses are very expensive.  Some  are available at a more moderate cost.  The quality of the teachers, courses and the material taught runs the gamut from high to low quality and it's difficult to know what you are paying for, in advance.

I am preparing to enter this arena in a more formal manner.  My primary purpose is to fill what I see as a void. Potential option users ought to be able to

  • Get a good feel for options and how to use them
  • Decide if options trading fits into their investing style
  • Decide whether the investor can use options to hedge current and future investments
  • Understand risk and reward potential when using options
  • Learn all of the above at a very reasonable cost

We all acknowledge that options trading is not for everyone, but it should not cost an arm and a leg to discover whether options are a suitable investment tool.

And once the newcomer decides that options offer attractive opportunities, he/she should have an opportunity to get a sound, practical education at a reasonable cost.  The problem is that this newcomer does not know where to turn for help and is easily captured by television infomercials, full-page newspaper advertisements, or other hype on the Internet.  Impossible promises of success are touted, and the beginner has no idea that such promises are not going to be kept.  One such example is the 'promised' return of at least 10% every month.  As a result, many people who want to learn to use options pay large fees and are lucky if they find reputable teachers.

There's not much I can do to overcome the hype, but for people who make an effort to research education opportunities, I want to offer a basic course (plus other courses) that gives the new trader a better than average chance to succeed.  We've all heard the stories:  most beginning traders fail to make the grade.  I'd like to help increase the rookie's odds of becoming a winning trader, and to that end am developing a basic course for those option rookies.

If you are a regular follower of this blog, or if you have read The Rookie's Guide to Options, then you are aware of my teaching style, which includes the following:

  • Details
  • Explanations that make it easier to understand the basic concepts of options
  • Emphasis on risk management
  • Using examples
  • Repetition when necessary for emphasis
  • Replying to all questions

My plan is to construct a course that continues to do all those things.  Plus voluntary homework and optional tests.

I'm using today's post to request input from anyone willing to contribute. Suggestions, comments, questions are all welcome.  Please use the comment link below (all suggestions will be considered).

 

The beginner courses

I will begin by designing one (or more) course for rookies.  What should this course look like?  Here are some thoughts:

I. A multi-week, comprehensive course that provides a thorough introduction to options, including enough information for students to begin trading with confidence.  It would include all the material below, plus more.

  • Written lessons that look like lengthy blog posts or short book chapters.  Each focusing on a specific topic.
  • Video webinars that similarly cover one specific topic
  • Occasional live Question and Answer sessions.  The difficulty with 'live' sessions is that it's impossible to find a time that is suitable for everyone. A recorded session will allow those who cannot attend to view the content.
  • A special page (for course takers only) where questions, based on the course, can be posted.   'Regular' questions can still be asked through the Options for Rookies blog

Should the course include time for individual mentoring?  The feasibility of this idea would be based on the number of students in the class.

How long should this course run?  How many lessons? Currently, the plan is 13-weeks with four or five lessons per week.  Comments?

These last two items affect the cost.

 

II. Shorter courses, each dedicated to teaching one specific aspect of option trading

  • A thorough discussion of one specific strategy, soup to nuts. Inlcuding what to look for when initiating the trade, risk management suggestions and making plans to exit the trade.  One obvious course is: iron condors.
  • A general introduction to several strategies.  Enough to get you started using these methods (preferably in a paper-trading account), but  much less in depth treatment that the iron condor example mentioned above.  The benefit of this course is to give a rookie options trader a 'taste' of what can be done when trading options.  This course is truly not designed to be used as the gateway to trading.  It's designed to provide a better idea of where the student's interest lies.  Risk management would be discussed only briefly. 
  • How to design, write and maintain effective trading plans
  • Risk Management for option traders.  An introduction
  • Synthetic equivalents and how to use them
  • My philosophy of trading, as developed over the past 34 years

Intermediate Courses

III. What would an intermediate level course contain?

to be continued…

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Quiz

It’s been almost one year since I last published an options quiz.  Time for another. 

Your participation is appreciated becasue it helps me gauge which material is most appropriate for readers of Options for Rookies

 

1)

 

2)

 

 

 

3) You decide to trade some Weeklys and open an iron condor position by selling an out of the money SPX put spread (1100/1110) and an out of the money SPX call spread (1220/1230).  All options expire in one week.  SPX is trading at 1160. [Corrected to 1160]

By Tuesday of expiration week, ONE of the following events occurred:

To reply, choose ‘other’ and enter (for example) a,b,c,d

 

4) Let’s assume you have been bullish and earned a significant profit on your investment portfolio since May 2010. You are concerned with protecting your profits. 

Please consider cost, how much protection is gained, and the possibility of earning a lot more money if the market undergoes another major rally


 

 

5)  Poll: This question is directed to you as a trader/investor.  I am not looking for a theoretical reply, but am asking which of the following worked for you. 

 

 

Thanks for participating

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“Your book is well written, comprehensible, coherent and detailed.  I was especially pleased with the absence of useless chatter.”  VT 

 


 

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Exiting a Winning Trade

Mark,

Thanks so much for your site and your book. Both have been invaluable
to me as I've learned IC trading over the past few months.

My question is: Can offer any guidance on when to
close a profitable position. I'm getting familiar with my comfort zone
and when to get out when my shorts are being threatened, but I'm not
quite sure when to exit a position when things are going well.

I tend to
be too quick on the trigger to exit a good position because I want to
lock in my profit.  I think I'm missing the really valuable time
decay from weeks 6 to 3 ('till expiration). (I am not comfortable holding
any closer to expiration than about 3 weeks)

As an example, I have an SPX IC open for Oct 1000/1010 puts 1180/1190
calls. I opened it 8/18 for a credit of 3.20. Both sides are still open
and it's current mid-price is 1.65. So I could close now for a
profit of 1.55 (or a bit less depending on where I can get filled).

However, I'm 72 points (6%) from the short call and nearly 100 points
(10%) from the short put, so I'm still well within my comfort zone. How
long would you let a trade like this ride.

Kyle

***


Hey Kyle,

Thanks for the kind words.

We have a different way of looking at things.  In my opinion:

1) It does not matter when you made the trade
2) It does not matter how much you collected when making the trade
3) It does not matter how much profit you have now

Yes, I know that it's easy to disagree.  And you are with the majority who believe profit is the crucial number.  My recommendation is to try to join the minority.  There is no doubt in my mind that paying attention to original position cost will eventually cost you dearly (because it guides you to poor decision making)

What matters is that you own this specific iron condor today, and the price is near $1.65.  Are you comfortable holding this position TODAY at this price?  Does the current risk and potential reward (going forward) still fit within your comfort zone?  Would you consider opening a new trade at this price TODAY?

If your answer to any of these questions is 'yes', sit tight.  Ask yourself the same question every day until the answer is 'no.'  That's the time to exit.  How strongly you feel about that 'no' tells you how aggressive to be when exiting – i.e. how much to bid.

As the months pass, and you do this frequently, you get a good sense of how frequently to ask that question, and at approximately what price (assuming you have the luxury of waiting) you eventually decide to close.  NOTE:  Different market conditions (more or less volatile) will alter your plans.  But when you have a plan, you have a big head start on solving this dilemma.

Also be ready to close just one side when it reaches a certain price before a certain date.  For me that's 15 to 20 cents for the call side or the put side (of a 10-point RUT iron condor).  I'm very eager to pay that with 4 weeks to go, but still willing to pay that 15 cents – even with less than 2 weeks to go.  But, I'm conservative on this point.  People who have not been hurt badly by allowing cheap options to remain open when it costs so little to cover – seldom understand.

When you make the trade, try to make a trade plan that tells you when to exit. Write down how much you hope to earn when things go well.  I understand that right now you don't have enough experience to know that price.  But make a guess.  That guess does not have to be written in stone.  You already have a send of timing as to WHEN you plan to exit.

After a bunch of trades, these trade plans will be easier to create.  And they can be flexible.  But it gets you to thinking about exiting.

This is very important.  I've said it recently, but it bears repeating for all new iron condor traders:

The past several months have given iron condor traders ideal trading conditions.  Unless you sold front month options that were not too far out of the money, iron condor traders have had the luxury of opening positions and exiting when they want to exit. 

The one and only reason that you feel you are 'missing valuable time decay' is because you have not owned an iron condor position when the markets were volatile.  Holding would have been the winning decision in your previous trades. THAT DOES NOT MEAN THAT HOLDING WILL BE THE WINNING DECISION WITH CURRENT OR FUTURE TRADES.

Are you aware that at the most volatile periods during the 2008/2009 debacle, the markets were so volatile that they were averaging a 5% move every other day? How would you feel if SPX moved 50+ points every other day?  Would you feel that holding longer was still easy money?

We both understand that holding offers more time decay and more risk.  We know that exiting early feels wrong when the market just sits there and does nothing.  But, if you plan to open a Nov or Dec position after exiting, your new position will earn a profit when the market does nothing.  It's truly a matter of which position you want to hold and which gives you more comfort.  If you seek maximum profit from every trade, you will make extra money for awhile.  But at some point, you will discover the wisdom of not being greedy. But, that $1.65 still feels too high to pay right now.

Here's a guarantee:  As I noted above, the past several months have been almost perfect for iron condor traders.  However much you are making now – it will not continue.  You will earn less, or even lose money during some months.  i don't know when market conditions will change.

It's your results that make you feel that you are exiting far too early.  When you have seen more active and volatile markets, you will look at this situation differently.  Experience comes with trading.  The fact that you do want to get out at some point prior to expiry tells me that you understand how risk works – at least to some degree.

Back to the problem:  For my comfort, the current price is too much to pay.  I'd want to pay less.  I don't know how much less.  It's a day to day, or week to week decision. One thing that may help you decide:  If a new position looks so temping that you want to own it NOW, that could be a reason for exiting the current trade and opening the new [assuming you cannot hold both at the same time].

Schwab_through_LONGO

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What is a good trade?

Options for Rookies New Home Page



Mark,

What do you consider to be a good trade? It seems a lot of this post
is about making good trades regardless of money gained/lost. But how
does one define a good trade? Adhering precisely to your plan? Honoring
risk management accurately? It seems quite possible to present
exceptions that would make a "good" trade seem like a bad trade.

How do you characterize a trade as good?

Thanks,
Burt

***

Burt,

Ultimately, trading is all about making money.  To do that, you must make trades that are statistically valid.  That means taking risk, reward, and probabilities into consideration, the trade is worth making.

First, when talking about a trade, we are talking about the action of entering an order and getting filled.  That is making a trade.  It's a good trade if it meets certain conditions and is a poor trade if it fails to meet those conditions.

If you decide to make an adjustment, that adjustment trade can be ranked as 'good' or 'bad.'

However, the whole process of making the trade, i.e.,opening, holding and then exiting can also be considered to be 'a trade.'  That is not what I am discussing here. That is one reason why profit and loss are not considered.  Thus, if we want to discuss whether it's a good trade by the second standard, much more must be discussed.  For example, you asked about sticking with the plan and exercising good risk management.  Those are very important to long-term trading success, but have nothing to do with making a trade by the first definition. Yet each is very important to 'making a good trade' by the second, more inclusive, definition.



1) A good trade is one that you want in your portfolio.  It is not a random trade idea recommended by someone else, nor is a borderline trade that you wanted to try – just for the fun of it.

2) A good trade is always sized properly.  That means a worst case scenario doesn't result in a loss that is greater than you are willing or able to handle

3) A good trade has enough of a reward that it is worth seeking.  In other words, it cannot be too small to be worth the effort.  Selling OTM options for 5 cents, paying a commission, tying up margin, and waiting one month to collect what remains of that nickel is not a sufficient reward

4) That reward must be worth seeking when considering a) the probability of earning the reward and b) probability and size of the potential loss. 

If you make a trade with a 70% chance of earning $100, a 20% chance of losing $900 and a 10% chance of losing $300, this is not a good trade. Why?  On average, every time you make this trade, your expected loss is $140.

If you have a 70% chance to earn $300, a 20% chance to lose $700 and a 10% chance to lose $200, it is a good trade because your average expectation is to earn $50. 

To me, a 'good trade' is one that fits within your comfort zone, has a profit worth earning, has an acceptable level of risk, and the numbers (statistics and probability) justify the trade.

A good position (and that means the trade at a later point in time) must meet all the criteria of a good trade.  There is no point holding a position that you hate or one that you would never considering opening as a new trade. [I concede that there can be a middle ground where you neither love it nor hate it and don't know whether to hold or exit.]  A good position must be managed well, and as you mentioned, adhere to the trade plan.

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Do you know a Trading Mistake when you see one

I found an interesting quote from Barry Ritholtz

"Good traders know that opportunistic speculation is a process. Ignore
any one single outcome, focus on the methodology that can consistently
avoid catastrophic losses, manage risk, preserve capital. A good process
can be replicated, a random spin of the wheel cannot.

…if we expect to be wrong, then there will be no ego tied up in
admitting the error, honoring the stop loss, and selling out the loser —
and preserving the capital."

This mindset does not only apply to speculation.  It applies to all aspects of trading/investing.  I've seen many beginners do something that does not turn out well, and immediately decide that he/she has discovered a trading rule to be used for a lifetime.

We all make decisions that could have turned out better.  Many times such decisions are not 'mistakes' in the true sense of the word.  It's a mistake to make a large investment in a business when you know nothing about that business.  It's a mistake to turn a small loss into a large loss by being stubborn. 

But it's not a mistake to make a trade and then see the stock market behave in a manner that was not anticipated.  Believing that you can consistently predict where the market is moving, and when it will get there – that's a mistake.

I know someone who failed to take a profit on one trade , watched that profit disappear, and has now devised a trading plan based on always taking profits when they reach that same percentage gain.  He has seen far too few trades to make such a decision.  That's a  big mistake.

We all know traders who wrote covered calls, watched the stock rally, and forgetting the reason for writing the call in the first place, they get greedy and repurchase the call – only to see the stock move back to its original level.  Sure a trader can change his/her mind and decide to buy the call, but most people do that to 'correct the mistake' of selling the call in the first place.  It wasn't a mistake.  It was a reasoned trade that gave a winning result, but not the maximum result. Buying that call option with no rationale other than 'it was a mistake to sell it,' is a mistake. 

As a result, some people decide to 'never again; write a covered call.  That's an unreasonable conclusion based on a need to earn top dollar on every trade, and something that I categorize as a mistake.

When devising a trade plan or formulating a trading style that is expected to last your entire trading career, decisions must be made on more than a single event.  Each trade offers another learning experience and data point that can be used.  But no single trade should be used as the basis for a permanent trading plan.   Gain experience, don't jump conclusions, and as a result, you will be in better position to devise a trading plan that is based on your own personal experiences. 

Please don't assume that every time you lose money that you made a mistake.  But don't always blame it on bad luck.  Analyze your trade decision and decide whether it was appropriate.  When you make a mistake, that's a learning experience.  However, it's important to recognize the difference between a true mistake and a situation in which a trade didn't work.

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