Author: Clinton Lee.
Whoever told you
trading is "easy", is likely inexperienced and lazy; or has become
experienced but remains lazy, looking to dupe an even more inexperienced and
lazier person. You need more than
"Believe and Achieve" mantras.
Sustaining
profitable trading results requires cultivating daily trade discipline. Like any other demanding profession,
online options trading from home is no different. Choose one tenet to practise each month. There are 12, so
you have a year to build your skill progressively. There are 6 tenets below and the remaining will follow in
part 2.
1. Become a price puritan.
The ONLY reason for price to exist and change is because of Supply and
Demand. Where there are more
buyers with reasons to buy than sellers with reasons to sell, price must
rise. If there are more sellers
with reasons to sell than buyers have reasons to buy, price must fall. If buyers and sellers have equal
reasons or none to engage each other, price remains unchanged. Pure price trading techniques are true
to this inescapable economic law.
2. Dilute concentration risk.
S&P 500 accounts for slightly over 3/4 of the market capitalization
in the entire universe of mutual funds.
The top 100 stocks in the S&P500 (with minimal changes in
inclusion/exclusion) accounts for ~43% of what mutual funds use in constructing
their funds, i.e. the overwhelming majority of mutual funds gravitate to the
same stocks in their holdings. As the top 100 stocks are large–cap oriented,
two thirds of these funds are into large caps with only one third of these
funds choosing to include only small and/or mid caps exclusively. Large caps tend to have weaker relative
strength compared to small and mid caps.
You were sold “Sector Diversification” – printed on the marketing
prospectus. But you are actually
intensifying exposure to weaker relative strength, given the cap-weighted
concentration, even if the large caps you have holdings in, are distributed
across sectors.
3. Being “trendy” but missing the Trend –
the style junkie. Fund managers typically stay within
their style. An equity fund is not
going to become a fixed income fund.
Their company’s charter is pre–defined in the type of fund house they
operate as. A large growth fund
remains a large growth fund, even when large growth funds underperform, while
small and mid–cap funds are outperforming in relative terms. It’s not the fund manager’s fault, you
funded the fund with your money to manage. This also partly explains why the
high turnover of fund managers can affect the fund’s performance, as the fund
manager wants to change styles but is constrained. Diversify outside what the
news tells you is "Trendy".
Replace reliance on funds with the use of optionable Indexes/ETFs.
4. Limit the Fundamentals – the Paper
Poker Game. The psyche of
investors behind Supply and Demand is expressed in price, beyond fundamentals
alone. Investors sold off
fundamentally sound stocks, after the unfortunate 9-11 incident and it was
repeated with the financial pandemic of 2008, going into 2009. Benjamin F. King: Market and Industry
Factors; Journal of Business, January 1966: “ Of a stock’s move ... 20% is peculiar to the one
stock.” A Fundamental Analyst
fusses with paper (Balance Sheet, Income Statement & Cash Flow Statement),
only to explain 20% of price behaviour.
As valid as all the FA work is, would you gamble against the house armed
with only 20% of the odds with paperwork done by Analysts?
5. Divorce the underlying. You may think you are intimate (be it
"love" or "lust") with the traded product. So, you go looking for patterns,
setups, indicators that simply do not exist. Love is indeed blind.
It’s more sensible to understand the cyclical/seasonal behavior of the
asset class the underlying is in; and, how the underlying behaves near
support/resistance levels with changes in supply/demand. You really do not know the
underlying. Marrying one
underlying imposes opportunity costs of not trading other more valid candidates. The stock isn’t going to “love” you
back.
6. Define losses first, before profits.
Manage risk ABOVE and BEFORE profits AND as finite. However well planned
a trade is, it may never reach its profit target. Some choose to use a 1% absolute loss rule of the original
trading capital, to define the absolute risk per trade. E.g. if your trading
capital is USD $50’000, 1% is equal to USD $500 maximum loss per trade to
incur; versus, accepting a 50% loss on the P/L of that specific position.
In
adopting these practices as part of the daily trade discipline for online
options trading, what can I expect to achieve? View Consistent Results to see a model retail option trader’s portfolio that exercises the discipline
of the tenets.
As you exercise
stricter daily trade discipline, you should see these characteristics of a more
stable portfolio performance:
❑ Profits should step up gradually,
depending on the size of your account.
If it’s in the tens of thousands, the profits should step up
consistently like a ladder from the low hundreds, to the higher hundreds; then,
move up from the higher hundreds into the thousands. If your account is above $100K, profits should step up from
the high hundreds into the thousands.