What Counts as a Trading Mistake?

I am a rookie to options. I think in all my previous endeavors to
invest, I learned the most from my failures or mishaps.  So, if you
option gurus can share your mishaps or failures in option trading with
readers, it will be a tremendous help to all option rookies.

Sean

***

Thanks for the idea Sean, I know this was a suggestion for the new magazine, Expiring Monthly, but I thought I'd offer my opinion on this topic.  I am unable to provide what you seek.

If I tell you that I made a specific trade and lost $10,000, what can you learn from that information?  There is no 'lesson' to share.

To understand why the trade is considered to be a mistake, and not one of those losses that must be accepted as the cost of doing business, you would have to understand the details of:

  • Why the trade was initiated
  • The market conditions under which the trade was made 
  • How risk was managed and whether adjustments were made
  • The rationale behind each adjustment decision
  • The rationale behind a 'no adjustment at this time' decision
  • The decision to exit and why the trade was not held longer
  • How much risk was involved in making the attempt to earn the profit
  • The boundaries of my comfort zone and how it affected trade decisions

All you would know is that I consider the trade to be a mistake and how much was lost.

There is nothing to be learned from that.  How can you extract a lesson and consider it to be part of your options education?

I don't have the detailed records of all my trades that would allow me to even attempt to dig out the information that I would need to explain everything.

And if I did have access to the information, the explanation would be the length of a book chapter. 

My purpose in telling you about such an incident would be to help you learn something.  I don't believe in trivial explanations – not if the purpose is to enable the person asking the question to understand what went wrong, why it went wrong, and how the risk could have been managed more efficiently.

A collection of such trades may make for an interesting book.  However, lacking the necessary records, I cannot write that book.  Sorry.  Perhaps someone else can supply a better answer.

***

As a rookie, don't you think it's more important to understand what an option is and how an option works before being concerned with the mistakes of others? 

If you don't have a CLEAR understanding of how options trade, I don't believe you could understand an explanation of the mistake well enough to learn anything from that explanation.  That's the bottom line.

I believe you can achieve much more by learning the principles, not the specifics of a given trade.

There is no lesson  to be learned from
'mishaps' unless you have a very clear understanding of the error – why
it was an error – and why the erroneous decision could have been avoided.

One more point:  When you 'learn by your mistakes,' I hope you don't make the grave mistake of grouping all losing trades into the 'mistake' category and all winning trades into the 'good idea' category.

I hope you understand one single point  – that you do not judge a trade to be a 'mistake' by whether it made or lost money.  It's a mistake when you should not have made the trade for good, basic reasons. Sometimes we get lucky and poor decisions are rewarded.  At times a very high probability trade loses when the unlikely event occurs.  That's the trading world.  You win some.  You lose some.  Avoid mistakes (trades for which the potential reward is not worth the risk involved) and understand what you are trading.  Do that, and you should succeed.

I am NOT a guru.

608



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2 Responses to What Counts as a Trading Mistake?

  1. Andy 02/09/2010 at 11:21 PM #

    Mark,
    I was reading Jared Woodard’s ‘rules of condor trading’ and came across an interesting rule: do not close a trade earlier than 10 calendar days before expiration. While this rule seems to be more of an individual preference, it does seem to be one solution to a problem that you’ve mentioned: an index is twice as likely to touch one end of a condor than finishing there at expiration. This presents a dilemma for me when deciding when to close a trade; for example, should I be more lenient as an index becomes closer to the money when there is more time before expiration?
    Jared seems to bypass this problem entirely by letting the condor ride until expiration day nears… thus, the condor may go in and out of the money but no adjustments would be made until the final week.

  2. Mark Wolfinger 02/09/2010 at 11:41 PM #

    Yes, an individual preference.
    I note that Jared is a successful iron condor trader and I trust his opinion.
    1) Does ‘do not close’ means ‘never’? I’d like to know the answer to that one.
    2) If sized properly – so that the maximum loss is acceptable – this may be the winning strategy. But for me, I prefer not to deal with iron condors that are ITM. Again a personal choice.
    3) If you exit an IC when it’s essentially ATM, you are going to pay a price near $5. That means you have as much to gain as you have to lose by waiting.
    Thus, the decision to exit to prevent a large loss still makes sense to me – but there is no reason to believe there is a mathematical edge in doing that.
    4) One reason I exit rather than hold: If the market has already moved this far, the probability is that it will continue to move in the same direction.
    5) But psychology enters the picture for me and this is my rationale: I feel far ‘worse’ paying $8 or $9 or $10 to exit than I would feel ‘good’ about paying $2 or $1 or zero.
    I want to avoid the pain. That may be mathematically unsound, but there is value in not placing yourself under more stress than necessary.
    6) To your question: More time translates into less negative gamma – so that already makes it a better decision to wait when more time remains than with less.
    7) There is a lot to be said for going for the big win. It really is a comfort zone decision. One thing you can do is clsoe half as you do now and leave the other half position in place.
    It won’t take too many months before you see which is more comfortable. Don’t be swayed by the results until you have a year’s (two is better) worth of data.
    Jared adds: “Just to clarify, in the newsletter we’ll often exit trades during the week or two prior to expiration. Your #2 point is really important – and I do size positions pretty conservatively, such that a maximal loss in any one trade is not a serious matter (relative to likely gains in other positions).”