Tag Archives | trading mistakes

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


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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Exercise and Assignment: Rookie Mistakes

Certain questions never go away

I suppose that’s true because there are always new people beginning to undertake the study of options. Those rookies ask the same questions that many of us raised when we were just getting started.

Today I’m reviewing some of the most basic aspects of options, and am offering a short explanation as to why they are true. One note of caution: This post is for beginners, and if something is true 99.999% of the time, this is not the place to discuss the rare exceptions

These items all relate to the exercise/assignment process.

Let’s begin with a question submitted to Tyler at his blog (Tyler’s Trading).

1) “I know the probability of being assigned before expiration – while there is still time value left in the option – is very slim, but is there still a chance?”

The option owner has the right to exercise that option at any time prior to expiration. That means that anything is possible and that option owners can make mistakes. However, it is best to assume that any option with any time premium will NOT be exercised. Sure, you may get that surprise assignment once or twice over the years, but not often enough to give it much thought.

In fact, when assigned on a (covered) call option with remaining premium, consider it a gift when you can repurchase the stock and re-sell the call. Or, you may prefer to get an early start and sell an option that does not expire in the front month. That gives you that extra premium as a gift (as long as it’s more than enough to cover trading expenses). That is capitalizing on someone’s mistake.

This gift happens more often than anyone would suspect, especially before a dividend. Traders who should know better, exercise an option – just to collect the dividend – and then have downside risk that is far to large for the reward. And the person assigned the exercise notice takes the gift, buys stock and re-sells that option, thereby collecting a premium that is larger than the dividend.

2) Why it’s so very wrong to exercise a call option any earlier than necessary (when puts are very deep ITM, it’s reasonable to exercise the put. This is more true when interest rates are higher.)

When you own a call option, all you can lose is the value of the call. That’s one reason traders may prefer to own calls, rather than stock. The call owner pays a premium in time value when buying the call. Exercising cancels all remaining time value. Why would anyone throw away that time value? Once you exercise, you own stock and can get clobbered when the stock price tumbles. Not exercising costs nothing. The call owner participates in upside movement, and there is ZERO reason to accept all that downside risk in exchange for NOTHING. Early exercise of a call option is a very bad idea.

The one exception (worth discussing now) is that it may pay to exercise early to collect a dividend. Much of the time, it’s still wrong to make this exercise. Do it only when there is ZERO time premium in the option and its delta is 100.

3) For reasons that astound me, some rookies believe that the call owner always exercises when the stock rises and hits the strike price of the option. If you among the tiny minority who believe this is true, let me assure you that it is not. Not only does exercising destroy the large time value in the option (time value reaches its maximum when the option is at the money), but the entire cost of the option is wasted. All the trader had to do instead was place a buy stop order to buy shares if and when the stock hit the strike.

That costs zero and the option is far from free. Even better, if the stock never hits that target buy price, the trader loses zero while the option owner sees his investment become worthless.

Many mistakes are unavoidable as we grow as traders. However, there is no reason to make either of the mistakes listed above.

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Trading Mistakes: Did You Make One? How can You Tell?


Sorry to be off topic a bit. But the only way I learn is by putting
money on the line, making mistakes and not doing THAT mistake again. Got
caught in a squeeze, extricated myself with considerable difficulty.
Licking my wounds right now.

A few days ago when you or somebody else said
"Waiting for expiration is so retail" is absolutely right. What
shenanigans they play, I gotta hand it to them. Had a sleepless night 2
days running yesterday & day before wondering if I would be
assigned. I should have taken the 70% of premium.

Chalking this to

Is this why you dabble in RUT only? I was thinking of dabbling in




Hey Amit,

You are never off topic.

I trade a single underlying for only one reason – a reason that may not be applicable for others.  If I get into trouble, if the market is going nuts, I want to have as few decisions to make as possible.

Even if planned advance, three underlying assets may be responding to the market situation differently.  I don't want to take too much time to put out fires.  I want to be efficient and quick.  Thus, one underlying asset.

Yes, it's a bonus that RUT is a European style option that settles in cash. SPY options are American style and settle in shares.

Per your opening paragraph: I want to play Devil's Advocate: 

Your plan is not efficient because:

a) How do you determine when a mistake was made?  Because you lost money or could have made more money with a different decision?  This is a terrible method for deciding if the action taken (or not taken) was a mistake.

Just because exiting at 70% of the maximum profit would have been a good idea this time does not make it a reasonable strategy.  I surely hope you agree with that statement.  The only thing you learned is this:  This time, this one time, exiting at 70% would have worked best.  

Now examine 99 similar occurrences, and when you have 100 examples, then you can decide on an exit strategy.  That means you must keep a trade journal and record each trade.  Keep tabs on what action would have achieved the maximum profit.  Keep track of your actual decisions.  Eventually you will have a clue about what to do.  Act accordingly when trading.  Just remember that no valid conclusions can be drawn until there are a significant number of data points. Be ready to modify your methods as you gain experience and have many more trades under your belt.

b) You can draw no valid conclusions from a single data point.  Doing so is dangerous.  In fact, it's a mistake.  If you want to avoid a mistake, here is an opportunity to avoid one.

Suppose riding the position to expiration would have worked this time.  Does that mean you would feel differently about waiting for expiration to be 'so retail' (nice phrase; not mine)?

c) It takes repetition and statistical evidence before you can draw valid conclusions.  This is even more true for inexperienced traders who don't have a background of many trades to use as a filter for the decisions being made.  Do not decide that something that resulted in a loss is a mistake.

d) You should recognize a mistake when you make one: You took too much risk.  You traded too much size.  You traded too little size because this situation was special and 10 to 20% more contracts would have been justified.  You got too greedy. You were far too cautious for no good reason. You ignored your trade plan for no valid reason.  You felt uncomfortable with position risk (more sleepless nights?) and did nothing to alleviate the risk.  Those are mistakes.  Even if the result is a huge profit, these are mistakes.

e) If you sell premium, you will get caught in squeezes.  Your job, as a risk manager, is to anticipate the squeeze and alleviate some of that pain in advance.  You may decide to reduce the effects of a squeeze by reducing position size.  You may exit the trade and eliminate the risk of a squeeze.  It locks in a loss?  Who cares?  You know some trades will lose money.  Minimizing those losses is NOT a mistake.

Your job is not to hold on to a bad trade stubbornly, hoping for the best.  Your job is manage risk well.  Succeed at that, and most of your 'mistakes' will disappear.

You will take losses.  The market will move in a manner that does not suit your hopes or expectations.  These are not mistakes unless you missed the obvious and refused to take appropriate action.

Sometimes, the market will behave in a manner that suits your positions.  That makes you neither a good trader nor a genius.

Recognize the facts:  You will win some and lose some. If you manage risk well, you are doing your job.  If you lose money despite taking good, appropriate action, you did the right thing and it is not a mistake.

One more point: Unless you are short OEX options, why are you afraid of being assigned an exercise notice?  Early assignment reduces risk and is often a gift.  If that assignment would result in a margin call that you cannot meet, then your positions are far too large. Assignment is nothing to fear.



Coming in the July 2010, to be published next Monday: July 19, 2010

Interview with Charles Cottle

Book review: Volatility Trading by Euan Sinclair

Bill Luby discusses the suggestion that volatile markets are coming

Guest article by Tyler Craig – Adjustment Trading

New Contest.  Win a year's subscription to Barron's

Lot's more

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