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Winning the Loser’s Game

  
  Education
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In the book, Investment Policy: How to Win the Loser’s Game, author Charles D. Ellis discusses the interesting conclusions of Dr. Simon Ramo on playing strategy. Extraordinary Tennis for the Ordinary Tennis Player (New York: Crown Publishes, 1977) identified the difference between a winner’s game and a loser’s game.  Over a period of many years Dr. Ramo observed that tennis was not one game, but two: one played by professionals and a very few gifted amateurs; the other played by all the rest of us. After extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points; amateurs lose points.
In expert tennis, the ultimate outcome is determined by the actions of the winner. Professional tennis players stroke the ball with strong, well-aimed shots, though long and often exciting rallies, until one player is able to force an error by his opponent or to drive the ball just out of reach. These splendid players seldom make mistakes.
Amateur tennis, Dr. Ramo found, is almost entirely different. Brilliant shots, long and exciting rallies and seemingly miraculous recoveries are few and far between. The amateur player seldom beats his opponent; rather he beats himself all the time. The ball is fairly often hit into the net or out of bounds and double faults at service are not uncommon. The victor in this game of tennis eventually gets a higher score because his opponent is losing more points.
As a scientist and statistician, Dr. Ramo gathered data to test his hypothesis in a clever way. Instead of keeping conventional game scores—love, 15 all, 30-15, and so forth—he simply counted points won versus points lost. He found that in expert tennis about 80 percent of the points are won, but in amateur tennis about 80 percent of the points are lost through errors. (more…)

10 Options Trading Pitfalls To Avoid

  
  Education
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  1. The first question to ask in any option trade is how much of my capital could I lose in the worst case scenario not how much can I make. You can lose a high percentage of the capital you have in an option trade so keep it small in comparison to your total account size. I suggest never risking more than 1% of your trading capital on any one option trade.
  2. Long options are tools that can be used to create asymmetric trades with a built in downside and unlimited upside. The leverage is already there, if you position size correctly based on the normal amount of shares you trade you will stay out of a lot of trouble with losing a lot of money.
  3. Options should only be sold short when the probabilities are deeply in your favor that they will expire worthless, also a small hedge can pay for itself in the long run creating a credit spread instead of a naked option with unlimited risk exposure.
  4. Understand that in long options you have to overcome the time priced into the premium to be profitable even if you are right on the direction of the move.
  5. Long weekly deep-in-the-money options can be used like stock with much less out lay of capital to capture intrinsic appreciation in the underlying stock.
  6. The reason that deeper in the money options have so little time and volatility priced in is because you are insuring someone’s profits in that stock. That is where the risk is: the loss of intrinsic value, and that risk is on the buyer of the option contract.
  7. When you buy out-of-the-money options understand that you must be right about direction, time period of move, and amount of move to make money. Also understand this is already priced in.
  8. When trading a high volatility event that potential price move will be priced into the option, after the event the option price will remove that volatility value and the option value will collapse. You can only make money through those events with options if the increase in intrinsic value increases enough to replace the Vega value that comes out. This is why it is so hard to make money when holding options through earnings, the move is already priced in and that extra value is gone the next morning the options open for trading.
  9. Only trade in options with high volume so you do not lose a large amount percentage of money on the bid/ask spread when entering and exiting trades. You have to find those few option chains that have the liquidity to trade with spreads measured in cents not dollars. A $1 price difference in the bid/ask spread will cost your $100 to get in and out of a trade on top of commissions. Also be aware that the best liquidity is in the front month at-the-money options and option chains get more illiquid as they go deeper in-the-money or out-of-the-money this has to be considered in a winning trade because you might have to roll the option to a more liquid contract. Most options chains can’t be traded due to the fact that they are just not liquid enough.
  10. When used correctly options can be tools for managing risk by limiting capital at risk exposure and capturing huge trends, used incorrectly they can blow up your account.

Mistakes Were Made (But Not By Me)-Book Review

  
  Education
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MISTAKES-WERE MADEOne of the best things I came across this  past week was this terrific review by  Morgan Housel where he shared insights  from the book “Mistakes Were Made (But  Bot By Me)” by Elliot Aronson and Carol  Tavris. Several members have  recommended this book to me so I was  very interested to read his review.
According to Mr. Housel, this are the six  most important things all of us should  learn from this book, many of which are  very important to investors and traders alike:

1. Everyone wants to be right and hates admitting the  possibility of being wrong.As fallible human beings, all of us share the impulse to justify  ourselves and avoid taking responsibility for any actions that turn
out to be harmful, immoral, or stupid. Most of us will never be in a  position to make decisions affecting the lives and deaths of  millions of people, but whether the consequences of our mistakes  are trivial or tragic, on a small scale or a national canvas, most of  us find it difficult, if not impossible, to say, “I was wrong; I made a  terrible mistake.”
The higher the stakes — emotional, financial, moral — the greater the difficulty. It goes further than that: Most people, when directly  confronted by evidence that they are wrong, do not change their  point of view or course of action but justify it even more tenaciously. Even irrefutable evidence is rarely enough to pierce  the mental armor of self-justification.

2. You brain is designed to shut out conflicting information.In a study of people who were being monitored by magnetic  resonance imaging (MRI) while they were trying to process  dissonant or consonant information about George Bush or John Kerry, Drew Westen and his colleagues found that the reasoning  areas of the brain virtually shut down when participants were  confronted with dissonant information, and the emotion circuits of
the brain lit up happily when consonance was restored. These mechanisms provide a neurological basis for the observation that  once our minds are made up, it is hard to change them. (more…)

Dont Take Too Much Risk

  
  Education
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Dont Take Too Much RiskOne of the most devastating mistakes any trader can make is risking too much of  their capital on a single trade. One thing is certain in trading and that is if you lose all your capital you are out of the game. Why risk so much you could be prevented from continuing? There is a saying in poker than going all-in (risking all your chips) works every time but once. This is true of trading.

If you risk all your account on every trade it only takes one loser to wipe you out (and no trading method is 100% accurate), so you will be out of the game at some point it is only a question of time.

In general, we only risk 1-3% of the available capital allocated to a system on any individual trade. This is calculated using the size and, the difference between our entry price and our maximum stop price, and the amount of capital allocated to the system. With the win probability and ratio of size of winning trades to losing trades we are almost certain never to lose all of our trading capital. In fact, the chance of us hitting our maximum drawdown for the year is tiny. (more…)

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