An Approach to Options

In my trading process, it's never about one trade, it's about the system. The paradox is that ~90% of profits come ~5% of trades, so it's imperative to create an environment that can catch big moves, while keeping losses contained. I have no way of knowing where the next big trade is, so my basic philosophy is to de-emphasize any one particular trade. This is done through placing small ~equal amounts of risk as a % of my portfolio per trade.

Below is a note I took in Evernote on a recent trade I entered. I intentionally excluded the name of the asset traded, because I want to highlight my thought process on how I'm trading, not what I'm trading.

5/22/16: "XXXX 145 SEP PUTS look like a good bet. The risk I'd have to take for one contract is where I want to be relative to assets under management, and the potential reward is high relative to risk. The cost is about $370 per contract. XXXX can realistically touch back down to its 52-week low of $130; this would make my Put contract in-the-money by $15, or $1500 per contract--nearly a 4-1 risk/reward scenario.

I'm using the aggregate of the all-time high price of $213, the 52-week low of $130, the price retracement up to $190, and the continuation of the downtrend as the price headed down to $168, as anchors to determine a high risk/reward opportunity. The opportunity is only viable because the Put contract is aligned with my conservative risk management.

The price of XXXX peaked at $213 on FEB 2015 and hasn't reached those levels since. This trade is a good place to bet on the downside. It will no longer be viable when XXXX goes back to $190 per share."

The Importance of Committing to a Routine

Within the intentional confines of a routine exists boundless opportunities.

The nuances learned each day, compounded over months, years, and decades, creates meaningful progress.

One of the best writers in the world, Seth Godin, writes a blog entry every single day. The action of daily writing for 30 years is what has molded Seth Godin into a world-class writer.    

I go through the same process every day in my trading. I know if I commit to doing the difficult little things every day for the rest of my life, I will carve out a distinct advantage for myself and my investors.     

My daily process allows me to navigate the constantly changing markets. My risk management systems keeps me in the game so I can get a shot at being around for decades.

Quotes from Kovner

In trading highly liquid markets, it couldn’t hurt to learn from someone like Bruce Kovner. He has been trading since the 1970s and has amassed himself a net worth of about $5.3B. The following three quotes are from Bruce Kovner’s interview in Jack Schwager’s Market Wizards.  

“Tight congestions in which a breakout occurs for reasons that nobody understands are usually good risk/reward trades”

“The more a price pattern is observed by speculators, the more prone you are to have false signals. The more a market is the product of non speculative activity, the greater the significance of technical breakouts.”  

“Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on the trade is determined by the stop, and the stop is determined on a technical basis. For example, if the market is in the midst of a trading range, it makes no sense to put your stop within that range, since you are likely to be taken out. I always place my stops beyond some technical barrier.”

Market Thoughts

You can never succeed in market trading without a belief. A market belief is a strategic frame placed atop the “noise” of a market’s continuous price fluctuation.

I believe that a market’s sole function is price discovery. A market produces a price based on some sort of buying and selling equilibrium.

I believe that in the long term a market will flow toward the path of least resistance.

To think about: betting on a market's upside has infinite return potential. Betting on a downward price move can only reward you until price=0. This doesn't mean that betting on a market drop is a poor strategy; it's a terrific diversifier, but it will not create the same return profile as an upside bet.

Another idea to consider: if you want to see the interconnectivity of markets, follow the price of the US Dollar and notice how other markets move relative to a rise or fall in the $USD. The dollar is trending downward--there’s almost no arguing this. I find it interesting to see what other trends could emerge if the $USD downtrend persists.

$USD chart

A Trading Edge

I believe that trading in markets should be simple in its philosophy, simple in its execution, but extremely difficult for the majority of market participants to stick with in the long term.  

This is a quote from AQR Capital Management’s white paper titled, “A Century of Evidence on Trend-Following Investing”:

“Trends appear to be a pervasive characteristic of speculative financial markets over the long term. Trend-following strategies perform well only if prices trend more often than not. A large body of research has shown that price trends exist in part due to long-standing behavioral biases exhibited by investors, such as anchoring and herding, as well as the trading activity of non-profit seeking participants, such as central banks and corporate hedging programs. For instance, when central banks intervene to reduce currency and interest-rate volatility, they slow down the rate at which information is incorporated into prices, thus creating trends. The fact that trend-following strategies have performed well historically indicates that these behavioral biases and non-profit seeking market participants have likely existed for a long time.”

Price movement is due to human buying and selling decisions by both investors and non-profit seeking actors. Humans are inherently biased, humans make up the markets and humans haven't changed since the inception of markets. History doesn't necessarily repeat itself, but it definitely rhymes.

Gregg Popovic and His Basketball Philosophy

Gregg Popovic began his NBA coaching career in 1996, all 1,574 games with the Spurs. In his first season as the Spurs coach they missed the playoffs. Over the following 19 seasons, they qualified for the playoffs every single year, winning 5 rings along the way.

In the NBA, where head coach turnover is extremely high, Pop has grinded it out for two decades. There is a reason he’s been around so long; he is a flat-out winner. And it never hurts to learn from a winner of this magnitude.

It seems that most of his beliefs about life and basketball are so intertwined, it's hard to separate the two.

If you have any interest in great basketball or success in general, this video is for you.

Hope you enjoy: https://www.youtube.com/watch?v=XBZTPtENQCY

The Essential Tools I Use to Run My System

Finviz.com: Idea generation based on price trends

Barchart.com: Determine and track initial stops/trailing stops.  

Apple’s Stock Application: Stock ticker 

Evernote: Trade planning

GoogleSheets: Spreadsheet 1: Monitor individual trade open risk and aggregate maximum drawdown. Spreadsheet 2: Track system performance on completed trades(individual trade results, aggregate results).

Scottrade: Broker

The tools are useless without a trading philosophy. Ultimately, I buy strength, sell weakness, let my winners run, and cut my losers short.

The tools are a means of staying organized and disciplined.