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Watching Out for Risk

Many of my blog posts are inspired by forum discussions I have with other traders because thoughts had by others are often thoughts I once had too. Today’s example is about risk.

Over a year ago I was compelled to respond to “Pete,” a guy who had some definitive, optimistic words for trading strategies he claimed to be using. He posted a number of times before I responded with the following:

> If there’s potential reward then there is no such thing
> as zero risk.
> Your posts have full of phrases like:
> –“consistent weekly profits”
> –“‘gravy’ forever into the next generation”
> –“the coast is clear to keep it and make premiums
>    until it runs up again”
> –“those who stayed are rich and retiring”
> –“sounds to me like profit all day long and all
>    the way to the bank”
> –“this is a triple grand slam with insurance.”
> Where’s the one about trading being like an ATM
> machine that continuously spits out cash?
> Nothing about trading or investing is free, nothing
> is guaranteed, and nothing here is ever worth the
> kind of exuberance you seem to project with your
> posts. There’s risk inherent with everything and
> if you trade too large aiming to be too greedy then
> you will one day learn the hard way by getting
> blown out of the game for good.

Pete responded by asking me what I felt could possibly be wrong with some of the trades he was putting on. I replied:

> I’m not going to specifically analyze the pros/cons
> of your trade because we have other wonderful
> traders here who routinely share such insights
> Hopefully they can help with some of your analysis.
> Based on my real-world trading experience, though,
> focus on what I said in my last post. It’s at
> least urban legend (if not definitive truth: nobody
> knows) that over 80% of all traders lose money.
> Personally, I think the #1 culprit is unrealistic
> expectations. If you enter the markets thinking
> you’re going to make too much per month then
> you’re going to get beheaded. Your phrases that I
> quoted all suggest just that.
> Hence my caution: learn how to determine the real
> risk, watch your back, and be careful. If you don’t
> see the risk then walk (or run) far away.

I think this is good advice for everybody and that includes, first and foremost, myself. I try to remember this stuff each and every day.

Catastrophic Loss (Part 3)

In Part 2, I gave some background about what led to my latest catastrophic loss.

One thing I find tricky about the trading business is that catastrophic loss often looks foolish in retrospect. When I contemplate what happened to me in August, it seems absolutely absurd! Hindsight is always 20/20, though. More often than not, I’ve found sharing these stories with other people to be met with a lot of head nodding. We’ve all been there and many stories are commonly held.

One thing that makes my catastrophic losses difficult to stomach is the fact that I trade in a discretionary manner. With a systematic trading approach, I can see exactly where the profit and loss falls with regard to numerous other copycat trades. Discretionary trading means every trade is different and I have no context. Making things worse for this particular case is the fact that I’m quite sure the current drawdown would have been much lower with a more systematic trading approach. In this pursuit that is already boring at times, discretionary trading does help keep me engaged. However, when that means constantly battling the market and becoming emotionally drained, I can end up more vulnerable to catastrophic loss should a true market challenge present. Case in point: August 2015.

The emotional impact of catastrophic loss can be devastating. In the past, I have felt depressed and unwilling to get out of bed in the morning. I have felt like a failure and seriously considered going back to work as a pharmacist (e.g. “throwing the baby out with the bathwater”). I’ve felt gun-shy and very fearful about getting back into the market. I know one other guy who trades full-time. I heard from him a few weeks ago and asked how he managed the correction.

“I took a huge hit,” he said in his message. “I’m going back to work a real job.”

Talk about catastrophic loss and devastation! I was shocked and despite repeated calls, I haven’t heard back from him since. I’m not at all surprised he hasn’t wanted to face it and share his story. Most people don’t.

Covered Calls and Cash Secured Puts (Part 39)

Once upon a time (one month ago), this space focused specifically about CCs and CSPs. My last post waxed eloquent about some optionScam.com aspects of the industry. Next I want to combine these two branches of inquiry and focus specifically on Rich MacDuff’s SysCW.

One of the biggest problems I have with SysCW is the exclusion of portfolio considerations. The SysCW tutorials and book include tens to hundreds of examples of successful positions.

Some were easy.

Some required more management.

Some involved dollar cost averaging (DCA).

Taken one at a time, MacDuff found a way to make every single position go back to cash profitably. For me, this was the primary appeal of SysCW: management strategies exist to handle most any situation imaginable.

Indeed, SysCW does offer tools to successfully manage most any situation… when looking at positions one at a time.

This is not the case when full attention is paid to portfolio considerations and that, in my opinion, is where SysCW begins to break down. What happens when another 2008-like crash occurs and all positions lose significant value? MacDuff has argued I can close profitable positions and use that money to aid losing ones. By definition, though, correlation goes to one in a severe market crash. No profitable positions are likely to exist in a violent bear market.

In Systematic Covered Writing (2011), MacDuff introduces DCA as a position management tool. Perhaps a market crash will require DCA and to do this I need significant cash on the sidelines. If I have significant cash on the sidelines then I will not realize 15%+ on my entire portfolio, which is what MacDuff repeatedly insists to be possible with the SysCW.

Something just doesn’t add up [yet].

I will continue this discussion in the next post.

Portfolio Considerations of a Trading Strategy (Part 7)

I concluded the last post by claiming portfolio considerations are often overlooked because discussion of trading strategies is much “sexier.”

To evaluate this claim, I should first address whether it is even true. Ryan Jones writes in The Trading Game (1999):

> Money management is thought by many to rival only accounting in its boredom.

At least I am not the only one who perceives traders to preferentially enjoy discussion of other topics like trading strategy. Jones continues on to say money management is misunderstood. Money management is truly exciting.

In most contexts, “money management” can be substituted for what I have been calling “portfolio considerations.” Some believe that strategy (e.g. position setups, adjustment guidelines, and stop-losses) and money management (e.g. position sizing, portfolio risk management) are two different components of trading.

This traditional, almost intuitive division between trading strategy and money management enables commercial interests and fellow traders to focus on the former while overlooking the latter. While they may be separate, a successful business plan cannot exist without both!

Jones argues that $1,000,000 in profit may be generated using a conservative money management approach by earning $100,000 trading a single unit, contract, or option. This can be done in five years by:

–Making $20,000 profit per year
–Making $1,667 profit/month
–Making $384 profit/week
–Making $75 profit/day

What would it take to make seventy five bucks per day?

–Three ticks in the S&P 500
–Less than three ticks in bonds
–Seventy five cents on 100 shares
–Six pips in a currency market

None of these seem to be altogether too much, do they?

Ryan Jones has presented an example where “money management” is responsible for $900,000 of $1,000,000 total profit.

What is dull and boring about that?

Could the true power of money management just be misunderstood and/or unknown?

Portfolio Considerations of a Trading Strategy (Part 6)

In the last post I left off by planning for the cash position ($12,000) along with the iron condor position ($8,000). This makes for multiple simultaneous positions. I can imagine a trading group discussing this. However, other portfolio considerations must be made to evaluate this trading strategy that probably are not appropriate for public discussion.

For example, I may not feel comfortable discussing the need to pay a $1,500 mortgage every month on top of $5,000 in living expenses. Suppose the backtest showed this position to average $150 profit per week, which is $7,800 per year. Am I comfortable increasing this position 10-fold to potentially make $78,000 per year? I would need $200,000 in the account for this purpose. This is a portfolio consideration.

Rather than scale up this particular position, perhaps I seek other trading strategies for diversification or hedging. How much can I expect to make from those strategies? How much cash do I need on the sidelines for those strategies? Am I able to fund all of them? These are portfolio considerations.

Zooming out even further, how much of my total net worth do I feel comfortable having in my trading account? Perhaps I only feel comfortable allocating 70% of my net worth to trading and the other 30% to bonds, real estate, etc. I should also probably have a small checking account readily liquid in case of emergency.

All the portfolio considerations described in the last three paragraphs are probably not appropriate for public disclosure because they involve matters of wealth. They certainly should be carefully thought through, however. Just how beneficial can a trading group be for the most-involved participants who trade for a living?

If all group members make a concerted effort then I think portfolio considerations can be discussed to some extent. If the common goal is trading for a living then these details affect everyone. One problem is that despite being the “elephant in the room,” in many instances portfolio considerations are not even acknowledged. Part of this is probably due to a second problem: discussion of trading strategies is much sexier than discussion of portfolio management.

I don’t know why. It just is.

Portfolio Considerations of a Trading Strategy (Part 5)

Recent discussion has labeled investment newsletters, trader education firms, and even informal conversation with other traders as different venues where portfolio considerations are overlooked. Today I begin to illustrate exactly where these portfolio considerations might apply when evaluating a trading strategy.

Suppose we participate in a weekly trading group and today is my turn to present. I show a 10-contract weekly iron condor position with a margin requirement of $8,000. My profit target is 10% or $800. I detail the trading strategy with position setup and risk management [adjustment] guidelines. I show last month’s successful trade and everyone is all smiles. Right?

Because one trade never makes a trading system, I need to zoom out to determine whether this trading strategy is for me.

Suppose I show three years of backtesting results and the worst year-to-date drawdown is $8,000. Does this suggest I need $8,000 to implement this strategy?


First, I would likely bankrupt the account or come pretty close. People generally become concerned once drawdown exceeds 10%. In 2008-2009, the stock market fell 50-60% and people were completely devastated from that. I can hardly imagine a drawdown approaching 100%

Second, some trading guru once said “your worst drawdown is ahead of you.” In general, the longer the time interval the greater the variety of market environments available to test a strategy. Three years is a very limited backtest. In some future year, this trading strategy is very likely to post a drawdown [much?] greater than $8,000. I will arbitrarily deem $20,000 (2.5 times) as necessary to implement this trade: $8,000 for the iron condor and $12,000 as supplemental cash in the account.

If I am being entirely honest when discussing this trade then I should also realize my weekly profit target is now 4% rather than 10%. The margin requirement of the trade might be $8,000 but I have now set $20,000 aside for the trade.

Further calculations will be more about gross dollars. I will continue with these details in the next post.

Portfolio Considerations of a Trading Strategy (Part 4)

In my last post, public discussion among traders was identified as another venue where portfolio considerations are overlooked. Such discussion carries the guise of being helpful but since live trading without portfolio consideration amounts to gambling, this really is not helpful at all (think optionScam.com).

Put a different way, managing a “small” position makes it easy for me to act brave because [by definition] a negligible percentage of the portfolio is at risk. Adjusting a position often increases the margin requirement somewhat but with a small position I can adjust repeatedly while continuing to maintain negligible loss potential. I can basically adjust as many times as necessary for it to work out profitably in the end.

As discussed in the recent mini-series on Martingale betting systems, for all intents and purposes “small positions” are but a fiction. Most Blackjack tables in Vegas do have maximum betting limits, after all. Furthermore, how many people can tolerate aiming to make $5 while being down many orders of magnitude more? This is a losing business plan because eventually I will encounter a losing streak extreme enough to bankrupt my entire account.

Full disclosure of position size includes percentage of total net worth, which is not something Western culture sees fit to share with others. This statistic is a vital piece of information, however, because it may be the key determinant of whether an individual trader chooses to maintain a position or to bail with catastrophic loss in the midst of severe drawdown.

Not having these discussions with other traders leaves us to make the “should I stay or should I go” decision without any outside assistance. And why is it repeated that 70-90% of all traders fail within the first 1-3 years? The first time we encounter this harrowing decision might be the last.

My next post will offer a complete illustration of where portfolio considerations may enter the fray.

Portfolio Considerations of a Trading Strategy (Part 3)

In the last post I argued that commercial interests do not care about our portfolios as a whole. What they offer is not suitable for live trading despite their misrepresentation to the contrary.

That’s optionScam.com.

In a similar vein, traders rarely talk openly about position size when associating with each other. I have participated in or watched hundreds of trading group webinars over the last several years. Traders repeatedly present under the guise of “small positions.” It goes without saying that position sizes and account values [if] shown are arbitrary and uncorrelated with actual risk and total net worth, respectively, of the individual presenting.

Western culture is probably not alone in classifying the disclosure of wealth details as inappropriate for public discussion. This holds true for degrees of association ranging from stranger to all but the closest of family.

The problem arises when the sole arbiter of whether a trading system will work depends on the position size itself. I suspect this occurs much more than realized and has everything to do with individual differences in risk tolerance. I have touched upon this concept repeatedly as the moment when drawdown becomes sufficiently large to cause sleepless nights or persistent mental anguish. From this perspective, any particular trading system may be acceptable for some and too risky for others.

Does it even make sense to share position details without sharing total net worth? Whether the position ends profitably often depends on the ratio between maximal margin requirement (i.e. risk) and total net worth. If this ratio becomes too large then the position is closed at a big loss. Not sharing this information is to discuss position management without portfolio considerations: an artificial exercise, at best, if the two are in fact inseparable.

Does this reek of commercial interests offering position recommendations without regard to total account value or trade size? Commercial interests are not viable as trading systems and are therefore optionScam.com.

I fear the sad truth may be that association with other traders can fare no better. Association with other traders may be yet another version of optionScam.com.

Portfolio Considerations of a Trading Strategy (Part 2)

In the last post I explained how portfolio considerations make a trading system out of a trading strategy. I argued that commercial interests (e.g. newsletter writers, trader education firms, and other subscription services) care little about our real money portfolios (i.e. overall success): they just want us to pay for their recommendations.

A strategy without portfolio considerations is not a viable trading system. Without guidelines for position sizing (including deleveraging), I have no idea how likely it is to fail. Without further study to determine position sizing guidelines, I can only consider myself lucky when I trade it and make money. I basically took a shot in the dark… a gamble.

As an aside, discretionary traders gamble in this manner on a semi-regular basis and one harmful consequence is an increased likelihood of further attempts. Since they made money last time, the next time they may gamble with a larger position size. Eventually their luck will run out and they will give back some of what they made or, in catastrophic circumstances, much more. This partially explains how the bull and bear market cycles perpetuate themselves.

Back to the main: since commercial interests only offer trades (A) and since trades without portfolio considerations are not viable as trading systems (B), commercial interests are not viable as trading systems (C). If A = B and B = C then A = C. This means commercial interests do not care about our success as traders. What’s left? The opportunity for them to profit on our monthly payments or tuition fees.

That’s optionScam.com.

I would claim that commercial services for retail traders are a giant scam. I challenge anyone out there to prove me wrong.

I do not attempt to make significant money with trading strategies until I do the further research to make trading systems out of them. As a “small” position to generate enough profit for dinner and a movie it might be fine. How about as a substantial position to generate enough profit for the mortgage every month?

I would never ever try. My risk of losing much more than expected is just too great.

Portfolio Considerations of a Trading Strategy (Part 1)

My last two posts have addressed some issues one must clarify before implementing dollar cost averaging (DCA) as a CC/CSP management protocol.  Deleveraging is necessary for DCA and this moves us from considerations about the trading strategy to considerations about the portfolio.

Deleveraging is the availability of spare cash on the sidelines. Typically we think of a position as consisting of stock, options, or futures. Cash is a position, too.

A trading system includes a trading strategy along with guidelines regarding the management of multiple simultaneous positions (i.e. a trading/investment portfolio).  Deleveraging creates multiple simultaneous positions because the cash position sits in the account next to at last one CC/CSP position. The necessary guidelines address sizing of CC/CSP and cash positions. Many good sounding strategies are not viable for live trading because they lack these key portfolio considerations.

Unfortunately, most newsletter writers, trader education firms, and subscription services (i.e. commercial interests) want nothing to do with your portfolio [think liability].  Instead they often say “position size in accordance with your risk tolerance.”  Most people either don’t know their risk tolerance [until the worst happens when they realize their position size was too large] or don’t understand the consequences of trading small.   They learn about these details the hard way when sometime down the road they either lose more than they could have ever imagined or they don’t profit as much as they might have hoped.

Said another way, many people think they have found the next great “Holy Grail” of trading only to later discover it doesn’t work well in reality.  They have learned a good strategy but a poor system.

Is this misrepresentation or false advertising by the commercial interests? Is this optionScam.com?

In the SysCW archives, Rich MacDuff shows us hundreds of individual CC/CSP positions that all work out. The key question for a viable trading system is not only whether they work out but whether they can work together.