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Thursday, March 28, 2024

My Trading Policies

I’m making this a first draft of a perma-post (like the Valero Rule) as I am concerned about people making trades like mine for long term holds when they generally are not…

Entering a position:

I do not enter a position when it is moving the wrong direction or if the market/sector is moving the wrong direction. The items I post are watch items and I do not initiate every trade (who could keep track?), and I rarely take a full position right away.

Generally, out of the list I share with you, I look for ones that go the WRONG way and then (after I check news and other factors to make sure my assumptions weren’t wrong) see if there is an opportunity to jump in as a contrarian, getting my options cheaper than I planned.

Entering a position I generally have a goal, say 100 contracts that I want to buy for my watch price or less. I usually put in a bid a dime under the ask and hope for a pullback on my first 10 contracts then wait to see which way they go. If it takes off the way I thought, I buy 10 to 30 more (depending on confidence, my target price, why it is moving (news)…) at which point I usually will wait a day to see where it shakes out.

If a position goes my way quickly, this method means I only get 1/2 or less of what I intended but the profits usually make up for it. If it goes my way slowly, I build into a full position over the next few sessions.

If a position goes against me quickly, I only lose say 20% of 10-30% of what I intended to bet so I’m not devastated. At this point it gets complicated because I rechart, recheck and generally rethink but sometimes I will wait a bit (an hour, a day, a week) and add to my position at the lower price, reducing my base cost.

As a rule of thumb, if I’m not willing to put in more money when I am 20% down then I kill the trade entirely. At that point, I either move on or target a new entry, perhaps at 50% down but with options I often need to move into the next bracket by then (like the LVS trade where I started with $50 puts, which got smoked, and ended up with 150% of my original target in $55 puts).

Always be aware of the premium you are paying for an option and how the time value of the premium deteriorates every day. If, for example, you buy TXN calls 1 month out for a $1 premium, you are automatically losing .05 per session in time value. Unless you have a very good reason to think the stock will gain more than .05 every single day for the next month, you are just letting money drip away from you!

My goal in buying an option is almost never to hold it to expiration. Generally I am playing for a swing in the equity price (or just the implied volatility of the contract) that will net me 20%.

The 20% rule:

If this is an equity trade, this is a 5% rule where I set a 4% stop but I almost never trade equities…

Once a trade nets 20%, I immediately set a stop at a 15% gain. Making 15% on a short trade is a lot of money!!! Whether you make $5 or .05 per contract, 15% is still 15% and you need to be able to live with that.

For the purpose of my blog, I generally have no interest in a position once it makes (or loses) 20%, the trade is over if it goes down from that spot!

If the contract keeps going up I will usually set a 5-10% trailing stop. At this point I am done with the position and am actually anxious to get my money back so I can move on to another trade as I am unlikely to make another 20% on this one.

Depending on how I feel about the trade at, say 30%, I will often set a sell price at 35% and hope to cash out. It is similar to when I am losing a trade – I ask myself if I would put money in at this price? If the answer is no, then I sell to some other sucker asap!

The 50% rule:

At a 50% gain, I am looking to get my cash out right away. I often feel like a thief for making that kind of money so I look to absolve myself with cash! If the stock even twitches at this level I get out and, unless I am 100% confident in my position, I do not leave it open to chance in the overnights.

Almost without fail, once a position goes to a 100% profit I take 1/2 off the table and set a very tight stop (10%) on the balance. At that point it is free money and I may let it ride for some time unless I need the cash for a better opportunity.

Bracketing:

If I am in a wildly successful position, say the CME $420s go from $5 to $12, I will look to take the profits and rebet my initial amount ($5) on the next available bracket (probably the $440s by then). This is assuming, of course, that I would, in a vacuum, make that trade from scratch given the new circumstances. Again, this gives me a free ride with a 40% profit already cashed out and I can relax.

Also, the $440s will not deteriorate as fast as the $420s will if the stock moves the other way, ie. a $10 drop will only cost me half of my position in an out of the money call whereas it would have put me back to scratch had I kept my initial position.

Exiting a position:

No one ever went broke taking a profit or a small loss! Learning to lose is probably the most important part of trading. When I’m wrong, I’m wrong. I get out and move on, end of story.

Like many times in my dating life, I am looking to get out of a relationship with a stock almost from the minute I find myself in one! As soon as I take up a position because I love the opportunity, I immediately become hyper-critical of every little thing it does and I am looking to leave it for a newer, more attractive opportunity. Perhaps this is cruel but I’ve never gotten a late-night phone call from a stock asking why I left it so I assume it found another buyer as well…

In day trades I generally put in a sell order in as soon as I take the position. If the momentum is strong in my favor I may raise my stop but if I buy something at 10am and someone is offering me 20% more at noon, I tend to take it! That kind of action is usually what Mr. Greenspan calls “irrational exuberance.”

I have bought a contract, sold it, bought it again, sold it and bought it again all in the same day on many occasions (you have to trade electronically to do this, brokers can’t take it).

Just like a relationship, I find it is best to just end it, not drag it out. I usually offer up my whole sale amount right at the current ask, not bid and give it a little while. Never, ever, ever put in market orders. Never, ever, ever, ever…

Did I say Never? Never, ever, ever…

OK, moving on. Never put in market orders – THEY will steal your money every time. Set a price you are willing to buy or sell for and stick to it. If I want to buy INTC $20 calls for .35 I will usually bid .30 and see what happens. If I get it, I am already 17% ahead of where I would have been. After a while or a short while if the stock is moving on me, I will give up and pay the .35 but I will feel better about it as I know no one is giving the stuff away for less.

If I put an offer in for .35 and I don’t get it and it goes to .45 and I put in .45 and I don’t get that I usually wave bye bye as that train has left the station. You need to rethink what you were trying to do at that point because if I had bought it for .35 and it hits .50 that quickly, I am sure as heck gonna take my 40% and run! That means you may be the proverbial bag holder at this point.

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OK, that is enough for now, please ask questions, post comments so I can refine this post and make it as useful as possible for people.

– Phil

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Bonus Section:

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The Microwave Oven Rule of Behavior:

I am going to tell you something that I feel makes me a good trader. It is a Nobel Prize quality theory so make sure I get credit:

People love to make random decisions and stick to them like they were directly given it as a commandment!

How does this relate to microwaves? Well, aside from the fact that our brains are constantly being fried by the things every day (ever drive on the highway and see one of those dishes aimed right at you? Do you know birds die if they fly too close to them?), this is what I observe.

You put something in the microwave, say pizza, and you put in a time, say 3:33 (or maybe you are a whole number person and do 3 or 4 minutes). Now, unless you are a chain store pizza buyer your pizza slice is probably not always the same size or maybe it has different toppings etc but you probably put in the same number every time.

Theory number 1: People tend to repeat behavior, especially if it was successful.

So the light goes on and the little thing spins and you are either a watcher or a walker (as you may have guessed, I hit the button and leave the room) but either way you usually end up standing by the oven with 20 or 30 seconds to go waiting for it to stop.

Here’s where the Nobel Prize committee has to recognize me:

Theory number 2: Everyone likes to think they knew (not know) something.

Now you are standing there watching the pizza spin and looking at the timer.

You may think it is done.

You may know it is done (you see cheese boiling)

You may be hungry.

You may be in a hurry.

But you will wait and you will watch the little numbers count down until you hear that beep. Go on, try it – I dare you to open the door with 3 seconds left!

Theory number 3: We stick to arbitrary prior decisions despite new information to the contrary.

You pick a random number of seconds to cook food and then, despite observations to the contrary or a change in the situation, you stick to your original decision – In fact you are trapped by it! It is very, very hard to ignore your own advice, even though you didn’t intend it to be advice to your future self at the time – just a number you picked on a whim. Your future self always defers to you because he/she thinks you are the greatest thing since sliced bread.

This is what happens to people just 3 minutes after a decision is made, what about trade decisions that are made days or weeks ago?

Ah hah, so it does go back to trading (I bet you thought I was losing it!)….

Rather than reresearch, reread, rethink, reexamine our targets, we tend to treat them as set in stone. Learning not to do this will make you a much better trader (and also help you to finally redecorate the living room or clean out your desk or whatever).

Old decisions were made by the old you. The new you has learned things since then (even if it was just 3 minutes ago). The new you is older and wiser and more experienced and has had the benefit of reviewing your GUESS (because that is all it was) in light of real world circumstances and the new you is ready to make a proper decision.

Often the new me can’t imagine what the old me was thinking when I made a trade or set a target (or gave that girl my phone number) but since I know how often the old me makes mistakes, I have no problem overriding my decisions even if it means a complete reversal!

If you can do that, you can beat the market because 95% of the people you are trading against cannot let go of those arbitrary targets they set for themselves when circumstances were different.

When Google, for example is upgraded to $450 but it stutters at $420, SELL! Open the door and take the pizza, it’s done!!! If it isn’t (you take a bite and it’s still a bit cold) then get back in.

That’s right, the old me bought Google at $390 when an analyst said $450 and the stock went to $420 in 2 days and I feel like a genius so I start counting my $60 profit and thinking about what I will do with it.

The next day it flatlines at $420-$418 and volume drops but the old me said $450 and I was right before and I said I have another $30 coming to me….

This is terrible logic!!! Why are you listening to the old you? (I know, it sounds kind of schitzo) You’ve had 2 days of observation yet you are willing to ignore that in order to slavishly follow, not even what you thought, but what some analyst thought 2 days ago (and he was probably listening to the old him).

You are you from the future. Full of knowledge that the old you wishes he had at the time.

HOMEWORK: Watch Back to the Future part 2 where Biff steals the sports almanac and gives it to the old him. Listen to what he tells himself.

Also, watch Deal or No Deal (NBC) with the Microwave Theory in your hand and think about how you make decisions.

Let me know if this is helpful of if I am losing it – I always like to know how the old me is doing!

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