I hope last weeks blog resonated with you. I find that as I age I begin to see things very differently than I did when I was a young man. As a young boy growing up in rural Ontario, Canada, I always felt that I could figure out things for myself and achieve success with hard work and perseverance. Hard work and perseverance are extremely important and even vital in my opinion but what the hard work and perseverance can’t give you is the experience and the direction that can really bring the success we are so often looking for. That is where my mentors and all good mentors have great value. I wish as a young man that I would have learned this lesson as I believe this could have vaulted a young man with determination into levels of success that were not previously experienced. These are my thoughts and maybe you feel the same way.

This week we are again changing gears once again. This week’s blog is brought to you by the letter “P”. “P” as in pain! It is always the painful experiences that tend to teach us the most or in this case, remind us about things that we sometimes let slip by.

This week I made a rookie mistake and I am going to try my best to explain what I did and why it happens to the best of us. Also, I am going to hopefully give you the tools to prevent this from happening to you or at the very least keeping this missteps to a minimum. So here goes….

I use a particular trading strategy that involves doing very short term credit spreads with defined risk and defined reward and over the years of trading this system, I have refined the metrics that are used to get an edge in the markets. This system like any other is not foolproof but it does have a positive expectancy over time which is really all one can hope for from any real trading system. In case this is the first time you have heard this, we don’t win on every trade! I know, shocking, right? LOL In this particular trading system there are checks and balances that usually keep it from being too painful. There are really two parts to any system, there is the offensive part and the defensive part. Think of a collar trade and this will become clear. A collar trade involves buying a stock and selling a call for income from the equity. This is the offensive part of that strategy. The defensive part of that same strategy is when we add a protective put to the trade to minimize the downside loss that could occur. So with this in mind a credit spread system would also have the two parts. The offensive strategy is placing the spread and receiving the credit and the defensive part could be placing a stop at a pre-determined level or perhaps some other form of adjusting the trade if it goes against you. There are many ways to do this but that is beyond the scope of this blog.

For the example I am referring to I will need to talk about the metrics of a credit spread system so that one can understand which one I let slip and why it brought the pain. The metrics I am referring to, are time and strike prices. Regardless of how you do your credit spreads, whether they are out of the money, in the money or at the money you need to understand the risk/reward and the probabilities that go along with this type of trading. You also need to understand the time that you are going to give up in exchange for the credit received. Typically, if your new you’ve probably been taught to use OTM credit spreads that are 30 days out and around a .20 or .30 delta. This is a good strategy but requires a tap-out point or stop loss at some point well before the long strike is reached. You will find out quickly that if you do not have this point already worked out before you get into the trade that the pain will be huge if you let it run to expiration.

In this system, I had my rules and followed the time rules and delta rules to the letter and yet the pain still came, why?  The reason the pain came this time is that even though I followed the specific rules of this strategy I let the general rules of trading slip by me.  I could rationalize a million reasons why I forgot the most basic of general trading rules but the reality is that I didn’t go through my trade systematically as I normally do due to time constraints.  That is an excuse and not really an acceptable one but it does happen to all of us from time to time.  It is like the picture in this weeks blog, it is a snake that can be ready to strike when we let our guard down.  The general rule I let slip by me is the rule of liquidity.  This week I went through an old watchlist and saw a great little trading setup and I neglected to check the liquidity of the options.  I was able to easily get into the credit spread but when it started to go against me and I put in a hedge trade I could not get the price I needed for the hedge trade and BOOM the pain comes!  

The good news is that even though I missed one general trading rule, I remembered the most important general trading rule and that is position sizing.  I made sure that the pain doesn’t take me out of the game for good.

So this weeks lesson is that even if you make a rookie mistake that as long as you observe and follow the major trading tenents of position sizing and defined risk/reward that you can live to trade again.

Trade well all,

Coach Holmes