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November 13, 2019
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Destruction of a Trader
by Don Wellenreiter

Millionaire Secrets Over Trading

This is one of the most dangerous things a new or a veteran trader can do. Whether driven by the excitement to be in too many markets at once, or trading in a market that is just too big for you to be in, over trading will quickly knock a trader out. Probably one of the worst things to happen to the retail option investor was the advent of SPAN margin. SPAN margin calculates the margin requirement for options that are sold. The original idea behind SPAN was that it was unfair to option sellers who sold options that were far-out-of-the-money and had little time left until the expiration to be charged the full margin of the underlying contract.

In other words, if on January 3rd the March S&P was trading at 950.00 and the trader sold the January 1000 call, in the past he would be charged the full futures margin of $15,000 (or whatever the margin was at the time). Traders argued that since there was little time remaining on the options contract and that the option was so far away from the underlying futures contract, they should not have to pay the full margin.

While this is a reasonable request, it opened the door for abuse. Now, instead of having a margin requirement of $15,000 the trader would have an initial requirement of much less, perhaps only $5,000 (based on a formula devised by the CME), and herein is where the trouble begins. You see, as the market approaches its strike price the margin requirements move up accordingly. So now an investor with $20,000 in his account believes that he can put on four short calls, where before he would only be allowed to place one into his account without generating a margin call. He may escape with doing this for several months until he finally gets nailed and suffers a large loss. The risk of ruin is just too great selling naked options. If commissions are the only thing preventing you from trading credit spreads, find a new broker.

Knowing More Than the Market

This is a sin we are all guilty of at some point in our trading careers. Before a trade is entered, much research is done by way of reading the technical tea leaves, mounds of fundamental reading, or both. It is due to all of this work that the trade begins to take a more personal twist. This trade has become part of us; we know everything about it. This is why it becomes so difficult to let go of it when it moves against us. We have done all of the required work, we were patient before entering the trade. It has to go up! No, it must go up!

Sorry, the market doesn't have to do anything. In fact, you can almost guarantee yourself that if you have to have the market go your way, it won't. Don't believe me? Ask your broker about how many times an error has worked in his or his clients' favor. Occasionally it will, but an unscientific guess would be that 90% of the time the market will go in the opposite direction you need it to go.

Bury your pride when you start to trade. This is not a game of pride and ego; it is a game of perseverance. The quicker you get out of a bad situation, the longer you will be around to trade, increasing your chances for making money. Admit you're wrong and move on.

Playing for a Crash

The biggest mistake that I see by retail index option buyers is that they play for a crash every time the market makes a run up – and sometimes even when it doesn't. Investors act like a crash will happen every other month. Don't get caught up in this crash mentality, because it will cost you a lot of money and grief. In a bull market, if you want to be bearish, just play the quick moves down but don't "let 'em ride." And in a bear market, don't buy calls thinking you have picked the bottom. I discussed this problem with a friend of mine who also trades, and it seems that the overriding problem comes when the market moves in the traders' favor and he begins to wonder if "this is the big one." Don't play that game. Taking many small profits will keep you in the game longer than rolling the dice for the big one.

Money Management

There is nothing more important in trading than managing your money. You must stick with your original plan to limit your losses. Keep your stops at reasonable levels; not so tight that you would get stopped out by any minor movement, but not so wide that you would lose more than 10% on any one trade.

As an example, if you are short a Mini S&P futures contract at 965.50 and your stop is placed at 966.00 you will most likely be stopped out as soon as you are filled on your original order, especially with any increase in volatility. One way of determining your stop would be to risk $1000, you would place your mental stop (physical stops are not allowed with electronic trading) at 985.50. If you are doing multiple contracts, your total amount of risk still must be limited to 10%. Another common way of placing your stop is to take the high of the last three trading days if you are short, or the low of the last 3 days if you are long. Again, the total risk should only be 10% per trade.

 
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