Posted by Mark on April 29, 2014 at 07:11 | Last modified: March 25, 2014 11:28
Over the last few posts, I’ve been making the point that portfolio considerations, or “money management,” is an integral component of trading system development. Without these details, a viable business plan cannot properly exist. I’ve suggested these details to be frequently overlooked because discussion of one’s personal wealth is very limited in Western culture.
Discussion of wealth is not suitable for strangers, friends, or even the closest of family (if that) in many cases. This leaves only one’s financial advisor or personal attorney as potential confidants.
Whenever discussion is taken out of the public domain and packed into isolation between a select few (or less), the medium suddenly becomes ripe for coercion and chicanery to proliferate.
Understanding this is why I encourage traders or anyone associated with Finance to watch the CNBC television series American Greed. Innocent people are repeatedly usurped by sketchy characters posing as investment advisors or lawyers who offer a cut of “special opportunities.” So often, the directive becomes something like:
“…but don’t tell anyone else. I’m making this special deal
available to only a select few. Give me your money and I’ll
invest it. You will receive monthly statements and be able to
track its growth. Just keep this between us.”
Because I hope to make loads of money, I heed your demands. If you can swear me to secrecy then you don’t have to worry about the authorities knocking down your door. You are free to steal my money and to find more victims.
Catastrophic loss in the stock market has a similar feel. The discussion is just between me and the market through my stock broker or brokerage. Things might be going fine for months to years as I receive monthly statements showing a steadily increasing account value. Suddenly a bear market hits and I’m stripped of much wealth.
I don’t even know what hit me. I am decimated.
Without meaning to be insensitive, I would argue the feeling to be comparable whether raped by the financial markets or by the neighborhood con-artist.
Categories: optionScam.com | | Permalink
Posted by Mark on April 24, 2014 at 07:34 | Last modified: March 19, 2014 03:53
I concluded the last post by claiming portfolio considerations are often overlooked because discussion of trading strategies is much “sexier.”
To evaluate this claim, I should first address whether it is even true. Ryan Jones writes in The Trading Game (1999):
> Money management is thought by many to rival only accounting in its boredom.
At least I am not the only one who perceives traders to preferentially enjoy discussion of other topics like trading strategy. Jones continues on to say money management is misunderstood. Money management is truly exciting.
In most contexts, “money management” can be substituted for what I have been calling “portfolio considerations.” Some believe that strategy (e.g. position setups, adjustment guidelines, and stop-losses) and money management (e.g. position sizing, portfolio risk management) are two different components of trading.
This traditional, almost intuitive division between trading strategy and money management enables commercial interests and fellow traders to focus on the former while overlooking the latter. While they may be separate, a successful business plan cannot exist without both!
Jones argues that $1,000,000 in profit may be generated using a conservative money management approach by earning $100,000 trading a single unit, contract, or option. This can be done in five years by:
–Making $20,000 profit per year
–Making $1,667 profit/month
–Making $384 profit/week
–Making $75 profit/day
What would it take to make seventy five bucks per day?
–Three ticks in the S&P 500
–Less than three ticks in bonds
–Seventy five cents on 100 shares
–Six pips in a currency market
None of these seem to be altogether too much, do they?
Ryan Jones has presented an example where “money management” is responsible for $900,000 of $1,000,000 total profit.
What is dull and boring about that?
Could the true power of money management just be misunderstood and/or unknown?
Categories: Money Management | | Permalink
Posted by Mark on April 21, 2014 at 07:07 | Last modified: March 12, 2014 11:23
In the last post I left off by planning for the cash position ($12,000) along with the iron condor position ($8,000). This makes for multiple simultaneous positions. I can imagine a trading group discussing this. However, other portfolio considerations must be made to evaluate this trading strategy that probably are not appropriate for public discussion.
For example, I may not feel comfortable discussing the need to pay a $1,500 mortgage every month on top of $5,000 in living expenses. Suppose the backtest showed this position to average $150 profit per week, which is $7,800 per year. Am I comfortable increasing this position 10-fold to potentially make $78,000 per year? I would need $200,000 in the account for this purpose. This is a portfolio consideration.
Rather than scale up this particular position, perhaps I seek other trading strategies for diversification or hedging. How much can I expect to make from those strategies? How much cash do I need on the sidelines for those strategies? Am I able to fund all of them? These are portfolio considerations.
Zooming out even further, how much of my total net worth do I feel comfortable having in my trading account? Perhaps I only feel comfortable allocating 70% of my net worth to trading and the other 30% to bonds, real estate, etc. I should also probably have a small checking account readily liquid in case of emergency.
All the portfolio considerations described in the last three paragraphs are probably not appropriate for public disclosure because they involve matters of wealth. They certainly should be carefully thought through, however. Just how beneficial can a trading group be for the most-involved participants who trade for a living?
If all group members make a concerted effort then I think portfolio considerations can be discussed to some extent. If the common goal is trading for a living then these details affect everyone. One problem is that despite being the “elephant in the room,” in many instances portfolio considerations are not even acknowledged. Part of this is probably due to a second problem: discussion of trading strategies is much sexier than discussion of portfolio management.
I don’t know why. It just is.
Categories: Money Management, Option Trading | | Permalink
Posted by Mark on April 17, 2014 at 07:30 | Last modified: March 12, 2014 10:23
Recent discussion has labeled investment newsletters, trader education firms, and even informal conversation with other traders as different venues where portfolio considerations are overlooked. Today I begin to illustrate exactly where these portfolio considerations might apply when evaluating a trading strategy.
Suppose we participate in a weekly trading group and today is my turn to present. I show a 10-contract weekly iron condor position with a margin requirement of $8,000. My profit target is 10% or $800. I detail the trading strategy with position setup and risk management [adjustment] guidelines. I show last month’s successful trade and everyone is all smiles. Right?
Because one trade never makes a trading system, I need to zoom out to determine whether this trading strategy is for me.
Suppose I show three years of backtesting results and the worst year-to-date drawdown is $8,000. Does this suggest I need $8,000 to implement this strategy?
No!
First, I would likely bankrupt the account or come pretty close. People generally become concerned once drawdown exceeds 10%. In 2008-2009, the stock market fell 50-60% and people were completely devastated from that. I can hardly imagine a drawdown approaching 100%
Second, some trading guru once said “your worst drawdown is ahead of you.” In general, the longer the time interval the greater the variety of market environments available to test a strategy. Three years is a very limited backtest. In some future year, this trading strategy is very likely to post a drawdown [much?] greater than $8,000. I will arbitrarily deem $20,000 (2.5 times) as necessary to implement this trade: $8,000 for the iron condor and $12,000 as supplemental cash in the account.
If I am being entirely honest when discussing this trade then I should also realize my weekly profit target is now 4% rather than 10%. The margin requirement of the trade might be $8,000 but I have now set $20,000 aside for the trade.
Further calculations will be more about gross dollars. I will continue with these details in the next post.
Categories: Money Management, Option Trading | | Permalink
Posted by Mark on April 15, 2014 at 02:56 | Last modified: March 12, 2014 10:55
In my last post, public discussion among traders was identified as another venue where portfolio considerations are overlooked. Such discussion carries the guise of being helpful but since live trading without portfolio consideration amounts to gambling, this really is not helpful at all (think optionScam.com).
Put a different way, managing a “small” position makes it easy for me to act brave because [by definition] a negligible percentage of the portfolio is at risk. Adjusting a position often increases the margin requirement somewhat but with a small position I can adjust repeatedly while continuing to maintain negligible loss potential. I can basically adjust as many times as necessary for it to work out profitably in the end.
As discussed in the recent mini-series on Martingale betting systems, for all intents and purposes “small positions” are but a fiction. Most Blackjack tables in Vegas do have maximum betting limits, after all. Furthermore, how many people can tolerate aiming to make $5 while being down many orders of magnitude more? This is a losing business plan because eventually I will encounter a losing streak extreme enough to bankrupt my entire account.
Full disclosure of position size includes percentage of total net worth, which is not something Western culture sees fit to share with others. This statistic is a vital piece of information, however, because it may be the key determinant of whether an individual trader chooses to maintain a position or to bail with catastrophic loss in the midst of severe drawdown.
Not having these discussions with other traders leaves us to make the “should I stay or should I go” decision without any outside assistance. And why is it repeated that 70-90% of all traders fail within the first 1-3 years? The first time we encounter this harrowing decision might be the last.
My next post will offer a complete illustration of where portfolio considerations may enter the fray.
Categories: Money Management, optionScam.com | | Permalink
Posted by Mark on April 10, 2014 at 07:33 | Last modified: March 11, 2014 11:02
In the last post I argued that commercial interests do not care about our portfolios as a whole. What they offer is not suitable for live trading despite their misrepresentation to the contrary.
That’s optionScam.com.
In a similar vein, traders rarely talk openly about position size when associating with each other. I have participated in or watched hundreds of trading group webinars over the last several years. Traders repeatedly present under the guise of “small positions.” It goes without saying that position sizes and account values [if] shown are arbitrary and uncorrelated with actual risk and total net worth, respectively, of the individual presenting.
Western culture is probably not alone in classifying the disclosure of wealth details as inappropriate for public discussion. This holds true for degrees of association ranging from stranger to all but the closest of family.
The problem arises when the sole arbiter of whether a trading system will work depends on the position size itself. I suspect this occurs much more than realized and has everything to do with individual differences in risk tolerance. I have touched upon this concept repeatedly as the moment when drawdown becomes sufficiently large to cause sleepless nights or persistent mental anguish. From this perspective, any particular trading system may be acceptable for some and too risky for others.
Does it even make sense to share position details without sharing total net worth? Whether the position ends profitably often depends on the ratio between maximal margin requirement (i.e. risk) and total net worth. If this ratio becomes too large then the position is closed at a big loss. Not sharing this information is to discuss position management without portfolio considerations: an artificial exercise, at best, if the two are in fact inseparable.
Does this reek of commercial interests offering position recommendations without regard to total account value or trade size? Commercial interests are not viable as trading systems and are therefore optionScam.com.
I fear the sad truth may be that association with other traders can fare no better. Association with other traders may be yet another version of optionScam.com.
Categories: Money Management, optionScam.com | | Permalink
Posted by Mark on April 7, 2014 at 06:47 | Last modified: March 10, 2014 01:53
In the last post I explained how portfolio considerations make a trading system out of a trading strategy. I argued that commercial interests (e.g. newsletter writers, trader education firms, and other subscription services) care little about our real money portfolios (i.e. overall success): they just want us to pay for their recommendations.
A strategy without portfolio considerations is not a viable trading system. Without guidelines for position sizing (including deleveraging), I have no idea how likely it is to fail. Without further study to determine position sizing guidelines, I can only consider myself lucky when I trade it and make money. I basically took a shot in the dark… a gamble.
As an aside, discretionary traders gamble in this manner on a semi-regular basis and one harmful consequence is an increased likelihood of further attempts. Since they made money last time, the next time they may gamble with a larger position size. Eventually their luck will run out and they will give back some of what they made or, in catastrophic circumstances, much more. This partially explains how the bull and bear market cycles perpetuate themselves.
Back to the main: since commercial interests only offer trades (A) and since trades without portfolio considerations are not viable as trading systems (B), commercial interests are not viable as trading systems (C). If A = B and B = C then A = C. This means commercial interests do not care about our success as traders. What’s left? The opportunity for them to profit on our monthly payments or tuition fees.
That’s optionScam.com.
I would claim that commercial services for retail traders are a giant scam. I challenge anyone out there to prove me wrong.
I do not attempt to make significant money with trading strategies until I do the further research to make trading systems out of them. As a “small” position to generate enough profit for dinner and a movie it might be fine. How about as a substantial position to generate enough profit for the mortgage every month?
I would never ever try. My risk of losing much more than expected is just too great.
Categories: Money Management, Option Trading, optionScam.com | | Permalink
Posted by Mark on April 4, 2014 at 05:20 | Last modified: March 7, 2014 08:53
My last two posts have addressed some issues one must clarify before implementing dollar cost averaging (DCA) as a CC/CSP management protocol. Deleveraging is necessary for DCA and this moves us from considerations about the trading strategy to considerations about the portfolio.
Deleveraging is the availability of spare cash on the sidelines. Typically we think of a position as consisting of stock, options, or futures. Cash is a position, too.
A trading system includes a trading strategy along with guidelines regarding the management of multiple simultaneous positions (i.e. a trading/investment portfolio). Deleveraging creates multiple simultaneous positions because the cash position sits in the account next to at last one CC/CSP position. The necessary guidelines address sizing of CC/CSP and cash positions. Many good sounding strategies are not viable for live trading because they lack these key portfolio considerations.
Unfortunately, most newsletter writers, trader education firms, and subscription services (i.e. commercial interests) want nothing to do with your portfolio [think liability]. Instead they often say “position size in accordance with your risk tolerance.” Most people either don’t know their risk tolerance [until the worst happens when they realize their position size was too large] or don’t understand the consequences of trading small. They learn about these details the hard way when sometime down the road they either lose more than they could have ever imagined or they don’t profit as much as they might have hoped.
Said another way, many people think they have found the next great “Holy Grail” of trading only to later discover it doesn’t work well in reality. They have learned a good strategy but a poor system.
Is this misrepresentation or false advertising by the commercial interests? Is this optionScam.com?
In the SysCW archives, Rich MacDuff shows us hundreds of individual CC/CSP positions that all work out. The key question for a viable trading system is not only whether they work out but whether they can work together.
Categories: Money Management, Option Trading, optionScam.com | | Permalink
Posted by Mark on April 1, 2014 at 06:56 | Last modified: March 6, 2014 06:59
My last post identified when to dollar cost average (DCA) as an issue to clarify for those who plan on doing it. Today I will cover two other DCA issues that should be clarified prior to trading live.
How much additional capital to commit is a second issue requiring attention. Doubling the position size is not the same as doubling the capital allocation. A stock that has fallen 50% will only require half as much capital to DCA. If I actually double the capital then I will more than double the position size. The latter will benefit me if the stock reverses higher because my position breakeven will be even lower. If the stock continues lower, however, then I will lose money at a faster rate.
What I wrote in the last post also applies here:
> Perhaps you will do some backtesting and see what best
> fits your sample. I don’t have an answer to this question
> and I don’t think a correct answer exists.
In other words, no specific approach will work for all situations.
Besides how to DCA, a third issue to define is size of the cash position. Capital on the sidelines will dilute overall returns. Without this spare buying power, DCA cannot be implemented. In a worst-case scenario, DCA’ing all positions might require 50% of my capital on the sidelines ready for deployment. Although individual positions are selected by the Math Exercise to achieve 15-18% annualized returns, this only represents 7.5-9% annualized if half my capital is on the sidelines.
If this decreased return is not enough for me then I have some decisions to make. Do I incorporate an alternative exit strategy if the market moves against me? Do I leave position size constant? How will either approach affect returns?
Of utmost importance is a need to completely define the trading plan and to understand what I can likely expect before going live. This will minimize the probability of becoming disenchanted when capital hangs in the balance. As always, the worst possible ending is a forced psychological exit when things get ugly that leaves me licking the wounds of a catastrophic loss.
Categories: Money Management, Option Trading | | Permalink