Author: Chris Hood
Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.
The long call you bought isn’t doing anything.
With your technicals all flashing buy, you placed the trade hoping for a nice break out to the upside, but nothing happened.
You spent a couple of hours the previous day analyzing the charts, doing your research, and this ticker was your top pick. You’re not worried. It’s just going to take a few days for the price action to prove you right.
Three days later, the stock starts going against your bullish position. Dropping slowly and steadily.
You’re only down 15% on the call.
No worries. It’ll turn around.
Only it doesn’t, and now you’re down 25%.
What’s happening? You KNOW this is going to work out; the setup was absolutely perfect. And anyway, you still have 100 days before the expiration, so you decide to hold out.
Overnight gap down.
When you finally give up in confusion and disgust, you close the trade at an 80% loss.
It’s a story that’s all too familiar to options traders. And it’s a situation that I’ve faced many times in my career – holding on to losing trades far too long and taking completely unnecessary losses.
No matter the rationale for entering a trade, there are two primary reasons you might hold onto a position gone wrong.
Let’s examine both and how to fix them.
First, you didn’t have an exit plan for cutting your losses.
Though you may have had a profit-taking level for the upside, not every trade is going to win. You need objective criteria to let you know when to call it quits.
Let me say this loud and clear.
Always trade with rules and follow a plan. If not, you’re flying blind and will eventually crash and burn.
Consider these questions when building your exit rules.
How long will you give the trade to start moving towards profitability?
For options buyers, this is especially important because time decay erodes their value every day.
Will I exit on a percentage value drop?
Some traders exit when the option value drops by 50-60%. A perfectly valid exit plan but one that might sometimes knock you out of a potential winner due to volatility swings.
Will I get out only when the stock breaches a particular price point?
A close below the 8 EMA might be optimal for a short-duration trade, while the 21 or 34 EMAs might be more suited to longer-term trends. It’s a standard method because it’s straightforward and quantifiable.
The second major challenge is to actually follow your plan.
I consider exiting losers the most challenging part of trading. Not just for my students and clients, but among all the professional traders I know.
Sure, you have the rules, but wishful thinking and ‘hopium’ often win out.
You ignore the rules, so you don’t have to admit defeat.
It’s a blow to the ego to have put in all the time to plan the trade then have it misbehave. Unfortunately, however, this happens all the time.
NO ONE likes to be proven wrong.
However, we don’t trade for validation of our opinions; we trade for profit. It’s much better to be profitable than correct.
Trading is about making money, not having your ego stroked by the market.
Forget about win rates. Consider the more important metric of profit/loss ratio.
Always work to increase this ratio through bigger wins and smaller losses.
Your trading success depends on it.