“But it was all going so well!”

Last week hammered home an essential lesson for me: I have the knowledge I need to be a great trader. My technical analysis is sound. My options toolkit is bursting at the seams. But those are not the things that will take my trading to the next level. To truly “level up,” I need to improve my plan, my discipline, and my judgment.

I won’t get into the specifics of last week’s trades because that isn’t the point. The lesson here is mental, not technical.

Last week, I was managing spreads in two different stocks that expired that Friday. Both spreads were fully hedged–one to zero cost, one to a profit of about $350. The positions had also built additional open profits over $1,000 and still had big potential upsides. Both positions were flat-ish delta and positive theta. All they had to do was maintain their short-term trends for a few days and they would be “home runs.” I was feeling good.

But then situation began to break down. The market got volatile, and both my stocks broke their short-term trends. Had I cut and run, I would have made about $900. “But the longer-term trends are in tact,” I told myself. “There’s other technical support nearby. I’m theta positive; I can afford to wait. These are high-beta stocks; as soon as the market finds its footing, they’ll snap back. The ‘gamma ladder’ confirms my expected move.” Yadda yadda.

You know where this is going. Over the rest of the week, I watched these two stocks–stocks that had performed to perfection the week before–now stubbornly refuse to do what they were supposed to. Each day, they’d throw a head-fake in my direction, then drift off. As time passed, gamma steepened, my flat deltas kept growing, and my theta safety blanket slipped away. I played this game all the way to expiration. And I lost. I ended up closing the trades for the minimum hedged value–about $350.

For many traders, this would have been a win. After all, I made several hundred dollars on one spread and lost nothing but commissions on the other. But really, I lost big. I let 3x my winnings slip through my fingers. And while I was wasting mental capital playing “will-they-or-won’t-they” with these two positions, I was missing good new setups. Worse, the few new setups I did try were rushed, and they each stopped out. So at the end of the week, I’d lost $1000 of open profit, piddled away $350 of “locked in” profit on other bad trades, and burned a lot of mental capital. @#$%!

I was right about everything, by the way. The Monday after my positions expired, one of my two stocks bounced off that long-term support I’d identified and landed right into my max profit zone. Two days later, the other stock did basically the same thing. I don’t say that to brag; I say it to confirm exactly where I went wrong and where I need to improve. My technical analysis was good. My choice of options structures was correct. I got the kite off the ground. But once flying, my judgment let me down.

Don’t worry, I’m fine. My account is okay. Life goes on. I’m writing this dramatic story not because I like dramatic writing (well, not just because I like dramatic writing) but because I need to etch these lessons in my brain and writing them out helps me to do that.

Some takeaways:

1. For every position in every underlying, identify whether that position is short-term, medium-term, or long-term. Know know exactly what timeframe got you into the trade and what the trend is on that timeframe. Be able to articulate (a) what you expect the underlying to do and (b) how you expect it to do it. Once you’ve defined your expectation, demand that the underlying perform accordingly. If, at any time, the underlying doesn’t perform as you expected–whether you’re in profit or loss–cut the trade. This clarity of thought is especially important if you have multiple positions of very different durations in the same underlying. If you can’t keep track of all of that in your head (I can’t), write it down.
2. If you feel like you can’t take your eyes off your trade, you almost certainly shouldn’t be in that trade. You entered without a plan. Or your entry was bad. Or your stop is unsound. Or your size is too big. Something is wrong. And odds are, “monitoring” the trade is just creating an opportunity for you to “improvise”–i.e., break your plan. (I know that there are exceptions to this rule, trade structures that inherently must be managed by hand, but they’re the exception. You don’t need to use those structures. And maybe you shouldn’t.)
3. Don’t get lulled to sleep by delta-neutral or theta-positive positions. If the underlying breaks the trend that got you into the trade, get out. This is particularly important with high-beta stocks and positions nearing expiration.
4. As a position approaches expiration, treat it like a new, unhedged traded. Don’t negotiate with it. If it stops behaving exactly as you want–even if you think it will recover–take the profit and run!
5. Unless you are a very adept and disciplined scalper, always buy a bit more time than you think you need.
6. Remember that open profit is risk. Losing open profit counts as a loss just as surely as losing initial risk capital.

Let me know if this sort of post is helpful. Coming soon, Zen and the Art of Trading and The IRA Experiment.