Market Review
The market was choppy the past 10 days, and traded sideways (with potential downtrend). Market was higher the day I started on 11 March, than when I ended on 25 March.
I am glad I am not a typical investor who monitor the market daily (an oxymoron) - it would be an emotional roller-coaster experience.
Highly Active Short Term Trading
Below show the results for the experimental system only, not all of my trading systems. The experimental system is a highly active. It is a short term trading system which utilizes OTM options, which I do not recommend anyone blindly following for these reasons:
- vast majority of active traders lose money.
- vast majority of short term trading loses money.
- vast majority of Options trader loses money.
- vast majority of OTM (Out-The-Money) expires worthless and loses money.
When you combine these 4 attributes - odds are very good that you will lose money.
To make money, your Edges must be greater than these, so that it is large enough to offset all of these disadvantages.
Definition of a "Trade"
Overall, 64 "trades" over 10 trading days. 63 out of 64 are Options on underlying stocks. I actually traded options on 37 unique underlying stocks, but for some stocks, I traded more than 1 option instrument. There are 64 unique instruments (63 options + 1 JCP stock) altogether. In more detail, some instruments has one Buy and one Sell activity. Other instruments have several Buy or several Sell activities. For analysis, I have defined a "trade" as the profit/loss result by unique instruments, and not activities (since some instrument may have 2 buy activities but 4 sell activities, or some other combination).
Individual Trade Results
Two sets of results, sorted by $ Profit/Loss, and sorted by R-multiples.
Analyzing Losses First
1. Biggest $ loss is $993, for MMM Apr $165 Call where I lost 22% of the Option Premium.
2. Biggest R-multiple or % loss is -101%, for AMZN Apr $387.5 Call as I short sell this and the loss is 101% of the Option premiums I receive.
3. 31 out of 64 trades are losses.
4. Total losses =$9,445.
Analyzing Winners
1. Largest $ winner is $2,539, for MRK Apr $57.5 Call.
2. Largest R-multiple or % winner is 109%, for IBM Apr $160 Call.
3. 33 out of 64 trades are winners.
4. Total winners = $14,552.
Analyzing Net Result
1. Net Result = $14,552 - $9,445 = $5,107. By nature, Net Result is always smaller than total absolute winners and losers.
2. Max Loss = $9,445 / $5,107 = 1.85 times. This means that to earn $5k, I must be willing to suffer a maximum losing streak of $10k first.
3. Max Profit = $14,552 / $5,107 = 2.85 times. This means that to earn $5k, I must be willing to let a maximum winning streak of $15k turn into $5k.
Analyzing Trade Results using Van Tharp Principles
If you have been following Van Tharp, you may understand the terminologies below. If not, buy his books - they are highly recommended for the very experienced trader seeking to improve his trading results.
Analysis by R-multiples (RHS column)
1. The SQN100 score = 1.44. A normal interpretation is that this is a "Below Average" trading system. It is not even a Fair trading system for professional traders.
2. The main reason why my R-multiple result is poor is because I misread the Big Picture. I held on to most of my trades for too long, that a Big Down day on 25 March took out most of my worst case scenario stops. In fact, over the same 10 trading day period, the market was negative. And some, I had to manually scramble to get out on 25 March morning, as my mental stops were hit. The carnage on 25 March was quite bad. At the peak, I had over $15k profit during that week, but manage to scramble out with $5k profit.
3. The error is what Mark McDowell from Van Tharp Institute captures very accurately here - The S&P500 charts were already screaming "sideways" market since end 2014. Adam was already expecting 2015 to be a sideways consolidation market, as 2013 and 2014 was excellent years. I was long from Buy the Dip in nearly all my positions (except for say less than 10%), and missed this sideways picture, and held on too long and did not profit take much earlier. It is clear that the market will be moving sideways with upward bias, so, my trading strategy should reflect that perhaps selling 80% on strength, and only keeping 20% on trailing stops - had I done that to reflect the Big Picture, then, my SQN would have easily been 3 or more (a good system), instead of 1.44-1.46 (Below Average). I had a very good system, but a single episode of mis-reading the Big Picture had turned a Good System into a Below Average System. Trading Edges are small and very fine - one small mistake is enough to make massive differences.
4. Could I have avoided this mistake? Today, I have started to Buy the Dip again (but small % capital). My belief is that the Bull Market is still intact, but we could experience a more severe correction (retesting 200-day MA like in October 2014), or go into sideways consolidation mode over the next 2-8 weeks. Either way, the possibility of making a higher high in SPY appears in the minority - if I have to put in 3 possible outcomes over the next 2-8 weeks:
- 20% chance we make a new high
- 50% chance we stay in a sideways consolidation/trading range.
- 30% chance we retest the 200-day Moving Average.
If my Big Picture remains the same, then, the right selling strategy for my style must be to sell at least 80% or more on strength, since I feel there is only 20% chance of making a new high over my trading timeframe (less than 1 month).
This is what Mark McDowell says in that article - your Trading System must reflect your Big Picture of where the market has been and likely to do over the next 2-8 weeks (for my trading system).
Other Things That Went Right
1. This experiment benefited from "Hard Stop" in some instances.
An example is IWM on 25 March where I was stopped out entirely from the extended IWM move at the Open, protecting either my large positions or profits. Prior to this experiment, my tendency was to use Mental Stops than Hard Stops, and mental stops would most likely be worse. As the trade moves more in our way, we should be happy to be "unnecessarily" stopped out as short term traders. We never want to over-stay. The short term Trader's goal is to sell most/all at Resistance (except if it shoots up, which doesn't look likely here).
Unfortunately, I only applied this to some positions, not all.
2. This experiment benefited from hardcoding entries and exits based on rules for 1 contract.
- I would have missed many entries if I didn't hardcode the conditions to trigger the entry using 1 contract.
- I would have missed many exits, if I didn't hardcode the conditions to trigger the exits using 1 contract.
3. Pyramiding reduces loss.
- E.g. LL trade - it was a loser from the start. I risked nearly $400 and didn't add anymore. The loss is 83%, but in $ terms, it was only $317, which is typical of Average Loss Size of $300. When a catastrophe happens and we just lose Average Loss, it is an extremely good result.
4. Pyramiding cannot completely avoid larger loss.
- E.g. MMM trade losing over $900. This happened because the trade was a winner initially and I pyramid up. And suddenly turned into a loser. This is unavoidable, but still acceptable as it is only $900+ loss and not several thousands.
5. Pyramiding enable outsize winners.
- E.g. MRK - this position had 4 bullets, buying at $0.55 ($0.4k), $0.95 ($0.8k), $1.11 ($1.3k) and $1.21. ($0.2k) The exits are $1.50, $1.56, $1.68, $2.09, $2.14. It generated $2.5k profits, the largest profit. I am extremely lucky to catch this move, which I could not predict in advance when I first entered at $0.55. This trade took 2 weeks, with the first bullet entry on 11 March, and the last exit was 25 March. However, the bulk of my buys were in the 3rd bullet at $1.11, which was more than twice my first bullet of $0.55.
6. More stable Position Sizing.
- In the past, I didn't have a consistent strategy for position size, fluctuating from very small to very large positions. In these 64 trades, I kept my position size close to my Positing Sizing rules.
- My rule is quite basic. The rules for this experiment (which I plan to fine-tune) is as follows:
a. No more than $3k-$4k purchase per Instrument.
b. If catch bottom at Strong Support, limit the size of the first buy to no more than $300-$600 (10%-20%).
c. Only add as the move goes my way. Last resort is EMA20>EMA40 at various time-frames.
d. Pyramid up can be bigger if Daily Trend is rising. If Daily trend is falling, limit the buys to half.
7. Possible Improvements to Position Sizing.
- If the Daily Trend is rising (and nearest strong Resistance is still quite far away), then, can add up to 4 times. If Daily Trend is still falling (and nearest Resistance is quite near), reduce the number of pyramid up. It is okay to have a smaller position when Resistance is nearer. Better is not to enter if the RRR is less than 1.5 times. My overall RRR of 1.5 times is also because of late entries - e.g. the last bullet in MRK at $1.21 does not have an RRR of at least 1.5 times, but just 0.5 times perhaps ...
6. Appreciating more RRR > 2 at Entry and balancing against Pyramiding.
- Van Tharp and Adam stressed the importance of making sure that initial entry should have RRR of at least 3 or at least 2 times.
- It gets very difficult to pyramid up to 4 times, and still have RRR of at least 1.5 times.
- Perhaps the solution is to limit it to 3 times, with 30%/40%/30% or 30%/50%/20%, with RRR of at least 1.5 times at the last bullet.
7. Short cut to quickly assess Risks.
- In trading OTM Options, on 11 March, I thought the entire premium is a quick and easy way to approximate risks, since it is my maximum loss scenario.
- The Average loss of $300 vs a full position of $3000 showed that it is very conservative.
- I did not compare against trades where I got stopped out before the trade went right, because I knew my bullet was small and so, I try not to micromanage, but looked out for other trades that went right. Basically, I just ignored my quick losers, as they had built-in stops, as I wanted to keep finding winners to add. I also wanted to pay attention to trades that showed extreme profit or extreme loss sizes, to better manage these.
- It seems, there is room to increase the risks on the Average Trade Size, given I planned to risk $3,000 per trade on average. I may embark on this later once I get more trade results.
8. Be more careful to FAST rise or big volatility days.
- Exit larger percentages to reduce volatility. Tighten stops on most percentages. Set 1 contract alerts if necessary. Keep it simple as you have many instruments.
9. Be ready to roll down the Strikes if the Stock doesn't look like it will rise, or even better, Buy the Bull Call Spread instead.
- If too far out of the money, the Time-Value can fall extremely fast when the stock does nothing. Examples are the PEP trades where I had to cut loss, as my Strikes are too far OTM and losing money rapidly when PEP didn't move - I rolled down the $100 and $97.5 Strikes down to $95 to avoid further damage, and the $95 strike made money as the $100 strike keep losing money. A Bull Call Spread to buy the $95 strike and Sell the $100 strike would have been the perfect strategy for Range Trading, instead of Buying the $100 strike. Chalk the $370 and $248 losses as "Tuition Fees".
10. With $1/contract commission, each contract costs $0.01. Hence, try to avoid contracts priced less than $0.20 as commissions is 5% or more, unless it is a "sure thing" (which occurs very rarely).
11. Choose Time to Expiry carefully on Option selection. First priority is careful assessment on the underlying, what you think it will do and how long it would take. In general, naked contracts should have at least 1-2 month to expiry, if the move will take around 1-3 weeks. If the time to expiry is less than a month, trade Spreads to minimize Theta Decay, or go to a longer contract if still "responsive" and "liquid" enough. Sometimes, better to avoid trading if market doesn't give you the right feel.
12. Choose the Strikes carefully on Option selection. Sometimes, you just have to pick the nearest OTM strikes to be safer at the start, since majority of the moves tend to be small and only extremely few reach targets. Sometimes, you trade spreads where the first leg may be ITM so have balanced / minimal Theta Decay. Sometimes, Theta Decay can be minimized by a combination of naked calls, Bull Call spread and selling Puts to have higher Delta and Gamma compared to a pure Bull Call spread. The choice must be inflexibly flexible depending on the circumstance, and you need to continue experimenting and journal the results. Also, you must be inflexibly flexible to quickly roll up or roll down the expiries. Hence, avoid anything less than 50 cents as the costs of rolling up and down can quickly add up. Ideally, you want to avoid doing anything like this.
13. Portfolio Heat - do not exceed 5% normally, max is 10%-15% capital.
Steve Burns is conservative - he rarely exceed 5% capital. Alexander Elder states that if you lose 6% capital in a month, you should stop trading for the month. Adam on the other hand has up to 10 open trades, each risking 2%, suggesting that he could have portfolio heats of up to 20% capital. LWP limit is 20%. Adam's forex friend makes 10% capital risk trades, and don't mind losing 50% capital. I think, be happy with 5% limit, and be extremely careful to exceed 5%. Sometimes we think the day is bottomed, and we have full 5% at risk. But subsequent days showed new clear bottoms. We should be careful and plan accordingly since we are already wrong. But on the new bottom days, there are legitimate buys and we may increase to 7.5% or 10% capital. But the absolute limit must be 15% capital at risk. Actual loss are likely to be much less as we can still exercise stop loss. In the best case scenario, 5% at risk could turn to 10% gain if markets does what you think, and 10% gain in a month exceeds your monthly targets, so, we never want to be too greedy, but aim for consistent results, month after month.
14. Never forget the Big Picture.
The Big Picture drives the Strategy, whether Bull Market, Range Trading or the start of the Bear Market. It impacts directly Profit Taking and Exits. In a Bull Market, we try to minimize Profit Take to perhaps only 20% to buy insurance and the rest on trail stops as the odds are higher than it'll make higher lows. In Range Trading, we switch to 80% profit take, as the odds of Resistance is very strong. In the transition to bear markets, we exit 100% on strength for long positions and look for Shorts. Blindly forcing the same exits on different market types does NOT make sense. This is what Mark McDowell says in his article above. Similarly to exits above, all entry and all position size/pyramiding strategies must be flexible and be consistent with your Big Picture assessment first.
15. Take Profits when Returns > 100% is viable, as it is still more than 3-to-1
I need to find my own middle ground - in the past, I'd taken it too soon, I then swing to the other way and not take them, I then swing back and I think I'm getting a better feel - the key is the Big Picture, and be inflexibly flexible to be consistent with the Big Picture. In short term trading, another Big Picture is that the stock don't zoom up or down in a straight line. Hence, tilt more towards big profit taking when you have the chance for big profits. If get more than 100% returns, take most of it. The odds of having 50% loss from above is small - only 3 out of 31 losses are more than 50% loss. The average loss size is only 30% for the 31 losses, so, taking 80% profits at 100% gains is more than 3 to 1 already.
16. Consider setting a limit like $1,000 to take more profits
Many of the winners had more than $1k unrealized gains, some nearly $2k before they fell back below $1k. GOOGL, IWM, QQQ, MSFT, and a few others. 25 March took away much of it.
As your position size is not constant, you are not able to define the absolute $ limit - in short term trading, you must know and be ready. It is not always going to be $1k, as it depends on the position size, which you are changing. Know your numbers constantly.
17. Beware in all your analysis, that the results above are only in respect of 10 trading days when the market did what you showed above. If the Big Picture market performance is different, it is possible to get a very different set of results.
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