Why Some Option Trades “Explode” In Your Face & What To Do About It

From OptionAlpha

Have you ever gotten the feeling that some of your trades just end up exploding in your face and turn into “massive” losing positions? They just never seem to go the way you thought it would and always demand or steal your attention right? Well, there’s likely a couple reasons why this happens and it gets back down to some of the most basic principles of options trading. In today’s podcast, I’ll walk through the psychology behind many of these “bad trades” and help offer a strategy to help manage them.

Key Points from Today’s Show:

  • Often traders get so wrapped up in these trades that are big losers or that are completely going against them. 
  • Their perspective is skewed, focusing on any trades that are moving into losing positions. 

Example:

When a young child is learning to use a regular cup, and they spill their cup of milk and it goes everywhere; all over themselves and all over the table. But in perspective, spilling the small cup of milk is not nearly as bad as spilling the entire gallon of milk! That would be a major catastrophe. However, for a young child, spilling a cup of milk is a big deal because they were in charge of this small cup of milk which is now spilled all over. What your child will see as a massive failure may not actually be that big of an issue to you as the adult.



  • In many cases, people behave very much like children when it comes to investing and trading. 
  • The psychology of many traders has not yet developed to the point of being a mature investor and trader in this market. 
  • People get stuck in the same childish psychological ways of focusing more of our attention on things that are losing.

The Middle Child Syndrome

  • Often times the middle child feels left out, and sometimes get unnecessary extra attention to compensate for their feeling “left out”. 
  • In trading, people often get middle child syndrome with a trade that goes bad.
  • When a trade starts to go bad, it’s like none of the other trades exist; it’s like they’re in a vacuum, 100% focused on the thing that’s going wrong. 
  • Markets are truly the ebb and flow of greed and fear.
  • When you have a position that goes against you, immediately your human instinct for fear kicks in. 
  • You start focusing just on that trade and it’s like nobody else exists.

1. Position Size

  • Position size becomes the number one issue
  • Position sizing is the number one thing you can do to be successful.
  • Try to his single, after single, after single; stop swinging for home runs. 
  • If the trade is a big loser, it means your position size is too big.

2. High Number of Trades

  • Often times, people are not trading enough. 
  • When you don’t have the confidence to continuously enter trades, you might run into a series of trades that are just bad trades; a sequence of returns that just don’t work out that well. 
  • When you increase the number of trades over time, you find that those bad trades start to average out. 
  • Having a lot of trades helps break the sequence of return risk

3. Don’t change the Swing of your $300 hitter.

  • Don’t change the core fundamentals of what you know to be successful.
  • Just because you had a losing trade, that shouldn’t change anything for you. 
  • Recognize and anticipate that at some point you will have losing trades.
  • Don’t adjust everything that you’ve done just because one or two trades “blew up in your face”

4. Adjust, Roll, or Close the Position. 

  • You can do a lot with a trade that is going against you.
  • Granted, you should be more patient rather than more anxious to adjust.
  • When you make adjustments later in the expiration cycle, that is generally better than making adjustments too early. 
  • If the trade is 30-60 days out, your default answer should be to simply do nothing. 
  • It is way too early in the expiration cycle to try to anticipate what’s going to happen. 
  • This takes a lot of patience and understanding that the markets are so dynamic and fluid, anything can happen in a 30-day time period. 
  • When you get 1-2 weeks from expiration, then you want to start making adjustments, start rolling positions, or just simply close the position and take the loss.

Conclusion:



  • When it comes down to this whole conversation around focusing too much on these losing positions, it’s really simple things that we can correct: Entry, frequency, the mechanics of trading, and not taking full losses whenever possible.
    Control what you can control, and forget the rest!
  • If you take all these precautions, there is no trade that can ever “explode in your face” to the point at which you have a mental breakdown about trades. 
  • You are going to have positions that go against you, you will have trades that end up being losers, that’s just part of the business.
  • Understand how to move away and remove your emotions from that environment and management the whole portfolio.
  • At the end of the day, if everything else is profitable, one losing trade really does not matter. 
  • Often times that losing trade adds balance to your portfolio to allow it to be profitable.

 

— The Option Specialist

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About the Author: The Option Specialist