Ever watch any home remodeling shows on TV? Isn’t it just amazing when the before and after pictures are displayed side by side and you can see the transformation? I especially love the ladies reaction when they see their master bedroom closet. It’s like closet heaven when they see how organized it is. The shoes are neatly placed on the shoe rack and clothes hung by the occasion. Work clothes, casual everyday wear, maxi dresses, jeans, sweaters, and the little black dress for those special occasions all within reach and easily accessible once a final decision has been made on what to wear. I often wonder what that closet would look like in a few months after the cameras have stopped rolling. I’d be curious to find out what percentage still maintain and keep their closet organized and how many loose control and the closet looks just as it did prior to the makeover or worse. Another thing I’d want to know is of the ones that found themselves in closet mayhem, how many would have kept things in order if they checked in with the designer from time to time when they saw that their closets were getting a bit messy? As a trader, the same is true when it comes to your portfolio. No matter the capital in your portfolio, it’s crucial that you design and manage your portfolio to avoid drawdowns and minimize losses.
Regardless of whether the market is bullish, bearish or sideways/neutral, your portfolio needs to be able to withstand unexpected movements in the markets. For a beginner, a portfolio mostly will consist of stocks and options. Later they graduate to trading futures and forex/currencies for hedging and speculation trades. Envision with me if you will that you have that newly redesigned closet where everything is in order except this time we’re designing your trading closet. Like most closets, we’ll find that we have too much of something and we are forced to throw or donate some of it. Once we have a pile of what to keep, donate or trash it’s easy to now focus on how to arrange the closet. When I sat with my mentor I had already begun the disposing of equities that were not optionable. Thinking that was it, he quickly pointed out that I was way too directional (bullish) and I needed to have more cash flow strategies and less directional trades. My personally being that of a risk taker, I was crushed to hear that. Although there was some resistance on my part, just like there would be if I was asked to get rid of my favorite shoes, I had more trust in the process than in my ability to determine if a stock would go up or down. So we went to work spend a few days redesigning my trading closet with no emotional attachment once I good understanding of Theta, time decay vs Delta. Not to completely tie my or your fingers from ever trading directionally again, a percentage of your portfolio should be allocated for directional trades just not the entire portfolio.
Think of it this way, we all have certain clothes and shoes, belts, scarves, hats we like to wear all the time. They are comfortable and they fit well and you can just relax when you wear these outfits. We wash them and we fold them and put them away and repeat this cycle weekly or monthly. Eventually, these clothes get worn out and we might have to let them go at some point. Let’s put a percentage and say that’s 80% of the closet. Theta (Cash flow) strategies such as Iron Condors (my favorite), Covered calls, Naked puts, bull put and bear call spreads should be your primary trades on a constant rotation every month with a rinse and repeat cycle. If it works every month do it until it doesn’t. Find another stock/ETF/index and start the cycle again. The secondary is your Delta trades. Long call, long put, bear put and bull call spreads. These trades really pay off when you are right but if you happen to be wrong and over positioned you’ll be wishing you had some Theta trades. Think of these as your Sunday best type outfits. You look great, might even turn a few heads but don’t necessarily what to be in them all day. These are the outfits you wear out but the moment you get home you are undressing at the front door rushing to get into your comfy clothes. Lastly, we have that one small section in the closet where we have THE DRESS! Commonly known as the Little Black Dress (LBD). My mentor likes to call them the bag of tricks strategies. Short strangles butterfly, inverted butterfly, debit condor and ratio calendar spreads to name a few. Not to be worn every day but every now and then on those very very special occasions.
Over time, your portfolio might consist of stocks, options, futures, forex, physical commodities such as gold and silver, real estate etc.. and you will adjust your position sizing and strategies as your portfolio increases. When your closet starts to look a bit messy clean it up as you go along. Do not let it get out of control. We have a great community of traders and coaches to help you along the way.