The following is an excerpt from Managing Expectations by Tony Saliba
The Making of a Successful Trader
Until you’ve traded, managed a position, or risked your own money, it’s hard to understand the importance of discipline, mental awareness, along with handling the various emotional facets that will – no doubt – come your way. The discipline to have a pre-determined and iron- clad risk management plan in place ahead of time, possessing the willingness to allow your winners to run, and most importantly – acquiring the humility to lose money without making situations worse – are all part and parcel of what makes a good trader.
Decades of experience have taught me that a pre-trade risk management plan has helped to remove me from the situation – perhaps keeping me from making less than optimal trading decisions. A good trader simply cannot be afraid to lose money – for it happens to everyone. The chief problem with losing money in a trade is not merely the money – it’s the enticement to make irrational decisions – no doubt making things exponentially more risky.
We are trained to equate losing with shame. We are prone to avoid it at all costs. Sometimes losing stimulates a reaction to fight back. But for most of us, we permit losing trades to cause us to deny responsibility, avoid situations, and think irrationally. The result may well be a foolish decision to remove a stop in an options trade. Making blunders and losing trades no doubt have varying effects on individuals.
But if you can value and appreciate that traders will lose money, and sometimes lose money on a consistent basis, you will be well on the road to successful trade management. Guaranteed.
How to Deal with Market Outliers
The hardest part about successfully trading options is being willing to put in the days and weeks and months and years of discipline required. Many trade options attempting to chase the dream of “quick riches” and for some that does happen. However, for the most part, good traders spend most of their waking hours dreaming of the big payday yet knowing the realities of what could happen if they don’t do the hard mental work of remaining disciplined.
Baseball has a saying that, “the ball will always find you.” It’s uncanny but it seems the minute a player is out of position or not physically 100%, the ball seems to be hit to him! This parallel can and does apply to options trading as well. The biggest – sometimes catastrophic – losses occur when the trader lets his guard down with regards to position and trading discipline. You may get away with being overly “short options units” for months – perhaps years. However, one day you will experience a market event that could very well wipe away all the meager gains you achieved with your undisciplined approach.
Think back on some of the bigger market events we’ve had in the last three decades:
- The U.S. stock market collapse in October 1987
- 1994 U.S. bond market crash
- Asian Financial crisis in 1997
- Russian debt default and LTCM in 1998
- Tech bubble of 2000
- Great Recession of 2008
I was personally able to make large sums of money as the result of these major events. I didn’t make money due to luck nor due to skill. I was profitable because of my daily position, trade, and risk management routine. That self-scrutiny kept my options risk well defined. Additionally, my thorough, in-depth knowledge of options strategy and more importantly, how they perform during crisis, allowed me to make markets aggressively when everyone else was hiding.
Market outliers are sometimes very daunting to live through. Yet, I challenge you to always remember the following:
• Always know what strategies will do during extreme periods. Example: during very high periods of volatility, wingspreads will naturally become very cheap.
• Always know exactly what happens to your current position during both a “melt-down” or “melt-up”.
• Be aware of skew shifts and shadow deltas when hedging your position.
• Economic events seem to come in episodic waves and the next one is sure to be different from the last one.
• Volatility is typically persistent and it seems to persistently overshoot and undershoot what conventional wisdom otherwise believes.
• The vast percentage of your profitability is made in very small slices of time. Opportunity knocks very briefly.