Lessons from the Option Battlefield

I’m coming up on my 2 year anniversary with Investools and trading options.  As part of that, I’ve been reviewing all of my trades, trading rules, success rates, and operations.  Some very interesting (OK, not ‘that’ interesting but interesting in a ‘Dorky’ kind of way) patterns have emerge from obvious to insightful.  For instance:

1) Paper trading did very little for me.  My patterns of trading completely changed from paper trading to real trading.  What works better for me is to trade a small number of contracts.  The pricing on Think or Swim is a huge help and would have saved me thousands of dollars in commissions. 

2) The search for the perfect system is a fools errand.  It matters very little what system you use, only that you use a system without fail or exception.  This is particularly important for me.

3) If I follow my rules I make money.  Almost without exception, the only time I ever lost money was when I didn’t follow my rules.  Try this yourself…. Sort your trades by largest loss to smallest loss and deconstruct your trade to see in how many of those trades you followed your rules.  I bet its less than 10% (mine was less than 5%).

4) Technical analysis gives you an advantage, but is not perfect.  In the beginning I was so convinced of the advantage of certain technical indicators (think MACD, STOCH, RSI, candles, etc)  that I ignored other less important indicators like price (DOH!).  Put it another way, price trumps everything else.  In order of importance from price, I would say support and resistance, volume, industry / sector, and overall market.  I have my studies divided in two; one set of studies for trending stocks and another set of studies for non-trending stocks.  When in doubt I drop to price and volume only.

5) News does not help.  Almost all of the great traders are not on Wall Street and maintain a respectful disconnect with news.  So I greatly reduced my exposure to news, market reports, and commentary and my trading improved instantly.  Even if I got the news right and early, that didn’t mean that it was a reliable predictor of the market’s response. 

6) Don’t try to master everything at once.  Pick one technique such as conservative credit spreads, iron condors, strangles / straddles, diagonals, etc. and master it.  Work it until you are consistently making money month to month and then and only then start mastering a second technique.  Today I only use 3 techniques; credit spreads, iron condors, and diagonals.  I don’t feel any need to add additional techniques.

7) Be careful of how you treat your winnings.  I noticed that I would use my normal techniques to create winnings and then use those winnings to put on higher risk trades that I would never put on with my normal capital.  Then if those trades moved against me I would rationalize that I “was using winnings anyway” and it was OK if I lost those funds.  Don’t do that.  Treat all winnings as capital and hold to it with everything you’ve got.

8) Trading is not entertainment.  Be careful not to trade because you are board.  When you are board get up, go for a walk, read the message boards etc, but don’t trade for entertainment.  Good trading is a boring activity akin to working in a factory.  (Albeit a high paying factory!!)

9) Its easy to put on a trade, its much harder to exit.  Spend at least 70% of your time defending your trades.  In times of sudden shifts, trade defensively only. 

10) Strive to ride a trade for only 60% of a movement.  A great trader is never the first in and never the last out.  In a 100% move, trade to capture the move from 20% to 80%.

11)Remember, the holy grail in trading is to become a consistent trader.  It’s a lot more important to make 3% a month consistently than to shoot for 10 -15% a month and fail too often.  Make your money hitting singles and doubles and you will eventually see occasional home runs.

12) It doesn’t take a lot of time.  Once the initial learning is complete (about a year for me) I spend about 10-15 hours a week trading.  Any more or less than this and my performance suffers.

I hope this helps others out there!

Good luck and good trading,

Mojo

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My Trader’s Pledge

This is a pledge and affirmation I say each day before I enter the market.  I use this to center myself and to guide my trading.  Here it is:

Over the next 6 and 1/2 hours the best traders in the world will come together to form today’s market.  I must be respectful of those traders and the market all the while not being intimidated or afraid.  I will use my training and skills to the best of my ability.  I will manage my trades moment to moment and not be unduly influenced by the past or my perception of the future.

The market and its prices are an ever changing insane expression of everyones’ hope, fear, pride, and greed.  The market’s future movements are unknowable and it will hunt the least discipline traders first, knowing these are the weakest in the pack.  Once the market has moved against me, I must react quickly and step out its way. 

It is not my job to be right, it’s only my job to protect my capital and live to trade another day.  Only after surviving can I ever be victorious.

I am grateful for the priviledge to trade in today’s market, grateful for the technology that continues to level the field, and grateful for the freedom and opportunity afforded to each of us to acheive.

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CLOSE: WYNN Bullish Diagonal +3.9%

After opening up WYNN for a short term scalp trade as a bullish diagonal, we was stopped out today for a credit of +17.20.  Our cost basis in the trade was -16.55 so all together we pocketed a total of +.65 on a risk of -16.55 for a total two week ROI of .65 / 16.55 = +3.9%.

We’re disappointed in this trade because in hindsight we should have sold the ATM Aug 100 for deeper downside protection by selling more time.  Ah, well…  we will update our trading rules and move forward.  Here’s the chart from WYNN today:

Considering that WYNN itself was down 3.5% today along with DOW dropping 311 pts we shouldn’t be too upset.

Mojo

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GOOG is looking tempting

*** SEE UPDATE BELOW ***

OK, call us crazy.  Google (GOOG) is looking pretty tempting.  Notice how its been sitting on the support at 510 from the past resistance and highs at 11/22 and 1/16?  Here’s the chart:

We’re thinking about putting on a bullish trade.  Maybe even Bullish Diagonal.  We will watch the bars looking for a breakout to a daily high and probably take down the Sept 470 Calls for around a debit of $51.00.  More to come….

Mojo

UPDATE - OK, we’re in on GOOG.  BCO Sept 470 for a debit of -51.00.  We believe this market open will fade and GOOG will start to retrace north to cover the gap down.  We will look SCO Aug 530 for a credit of $8.00 or better soon.

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Mojo’s Laws

Mojo’s Laws

The following are the laws that I hold true.  These laws were won from hard fought and often expensive lessons from the field of battle in both business and investing. 

1. Always have an unfair advantage.  Never compete on a level playing field in business because the other guy may be more willing to sacrifice his health, wealth, and family to beat you. 

2. Play into your strengths.  Each of us has many strengths and many weaknesses, recognize yours and focus on your strengths.  Hire others to compensate for your weaknesses and let them do their job.

3. Don’t try to teach a pig to sing. It only upsets the pig and irritates the neighbors.  This is about accepting people for who they are and also for who they aren’t.  Keep yourself and your people focused in their strengths and make room for them to be themselves.

4. As an investor your primary job is to not lose money. Always be managing your risk and working to preserve your capital.  Investing isn’t just about risk vs. reward.  It’s about risk vs. reward plus probability of success.  If you only focus on risk vs. reward you would never invest in anything other than a lottery ticket, where you would risk $1 to make $83,000,000. 

5. As an investor your secondary job is to make money.  No investment is completely safe.  Once you have done all you can to conduct your diligence, follow your investing rules, mitigate your risk and then pull the trigger.  Speed is of the essence.

6. Pigs get fed and hogs get slaughtered. Don’t be greedy.  This is a good southernism that cautions you to not be too greedy in setting a deal or a contract.  Even if the other side accepts the terms, they’ll feel taken advantage of and it’s unlikely they’ll be doing deals with you again in the future.

7. If you find yourself ‘hoping’ with an investment, get out. Hope is for suckers.

8. Bad news does not get better with age.

9. Control what you can and mitigate everything else.  We often operate under a much larger illusion of control than what really exists.  Understand this, appreciate it, and use it in business.

10. Rich or Right.  By rich, I mean rich in joy, laughter, health, relationships, time, and money.  Life gives us many opportunities to be rich or right.  Say for instance choosing between continuing an argument with your best friend so that you can be “right” instead of giving way and allowing the other person to be “right” so that you can maintain the richness of the relationship.  This is HUGE!

11. Don’t confuse motion with progress.  A lot of us get caught up in this one.  Just because you are moving and making effort doesn’t mean you are getting anything done.  Set specific and measurable goals each year, each quarter, each month, each week, and each day.  At the end ask yourself “Did I finish this?” 

12. There’s a huge gap between knowing and doing. I’ve known how to lose weight for most of my life but just knowing it didn’t help until I started doing it. Don’t confuse knowing and doing, they are miles apart.

13. You know that you’ve completed your past when your past and your future are completely incongruent.  Most people spend the majority of their lives simply repeating their past.  For instance, if you were born into a poor, under educated and dysfunctional family you will likely create that same situation for yourself and your family.  Once you’ve completed your past (that is, recognized that your past is your past and that it no longer has to define who you are) then you are free to construct whatever future you chose.

14. Always be learning. Have an insatiable quest for lifetime learning.

15. Presumption of success. Have an irrational certainty of success.

16. Live into your expectations.  Life, people, and places tend to live into your expectations.  If you think that going to your in-laws for the holidays will be horrible, it probably will.  If you think going out with your buddies will be great it probably will.  Neither your in-laws nor buddies generate these results.  Your expectations do.

17. Everyday become a little faster, a little smarter, a little better.

18. It’s better to fail quickly than to succeed slowly.

19. Anytime you can learn and earn, you are doing very well.

20. Half results mean nothing.  Real life gives you no credit for trying.  This is not grade school, stop looking for gold stars for trying to get something done.  Either do or don’t.  There is no try.

21. Hope for the best and plan for the worst.

22. 30% getting in and 70% getting out.  Most traders spend 90% of their time trying to perfect the entry.  Don’t.  The magic isn’t in the entry, it’s in the management and exit.  Spend no more than 30% of your time looking for trades and no less than 70% of your time defending / exiting your trades.

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I Believe

I believe in the lord and that he has created a perfect universe that us humans constantly screw up.

I believe in the basic good of everyone and that each person should be given a chance.

I believe that your thoughts generate your speech, which generates your reality.  The words “can’t”, “always”, “never”, and “but” have done more to halt the progress of people than any other single force.

I believe that children should be raised by stern, loving parents who spoil them with affection and prepare the child for the path and not the path for the child.I’m a frustrated Republican who loves the environment, believes that health care costs are out of control, that women have the right to chose, and that we should halt the war in Iraq while supporting our troops.

I believe that a parents’ job is to raise healthy, happy kids who become contributing members of society.

I believe that the biggest gap between the poor and the wealthy is their thinking.  I grew up poor but my mother gave me rich thinking.

I believe that perfect moments and miracles occur every day and it’s our responsibility to stop, look, and listen to see them.

I believe that there is no greater sin than squandering talent and no greater triumph than overcoming your past.

I believe in the unbridled joy of a child’s laugh, the healing power of the mind, and that we are 100% responsible for all of our successes and all of our failures.

I believe that most people live life at the affect of their circumstances and not a life of possibilities.

I believe that you should approach each and every day with great vigor, enthusiasm, and integrity.

This is what I believe…

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Trading Philosophy

I believe that the absolute number one key to successful trading is discipline. Discipline to develop your own trading rules and the discipline to follow those rules without hesitation.

In a class of 400 people, all exposed to the same trading rules, setups, and instructors, you will only find a handful of people that will become successful traders.  I believe this is mostly related to discipline.Every trader develops a personal style that works for them.  My style tends to be mostly in the high probability trades (in the 60%+ range) with limited reward and larger risk.  It’s not unusual for me for risk $9 to make $1.

For those of you that are overly focused on risk vs. reward, I believe that you’re missing a large part of the equation.  In order to be a proper investor you need to compute three requirements: risk, reward, and probability.  If you leave out probability and only focus on risk vs. reward you might as well just play the lottery day after day.  Where else can you risk a $1 with a potential reward of $83,000,000?

Here’s an example of probability and risk vs. reward.  Let’s say your buddy will pay you $2 for every time you flip a coin and it comes up heads, and every time it comes up tails you pay him $1.

After say… 100,000 coin flips, you will have made the following:

50% (probability of heads vs. tails) x 100,000 flips = 50,000 heads x +$2 = +$100,000

50% (probability of tails vs. heads) x 100,000 flips = 50,000 tails x -$1 = -$50,000

Combined you made +$50,000 over 100,000 flips or +.50 a flip.  Or a positive expectancy of 1.50 for every dollar invested.  Does that make sense?

Now knowing this, do you think you could find anyone to play this game with you for long?

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Now, what if you had a trading style where you would win 60% of the time and make +.50 and 40% of the time you would lose -.50.

Over 100,000 trades you would:

60% x 100,000 trades = 60,000 wins x +.50 = +$30,000

40% x 100,000 trades = 40,000 loses x -.50 = -$20,000

Combined you made +10,000 over 100,000 trades or +.10 a trade for a positive expectancy of 1.10 for every dollar invested.  Does that make sense?

Would you be willing to play that game???

That’s how I trade options.

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