k1 Project - Virtual Portfolio Management

"You can play whatever you want in any kind of market, as long as you have a plan, good money management, and a good exit strategy." – Optrader

"Please do not play with money that you can’t afford to lose." – Optrader

Optrader’s got a million of these, Phil’s got a million and one. Don’t make me go the archives for them, you know I will. – k1

This section provides a wealth of information for protecting your wealth from yourself. The plan and exit parts of Optrader’s quote we’ll handle elsewhere. But your money management strategy is the way you restrict your losses as you learn to trade effectively, and the way you reduce your overall risk once you attain that effectiveness.

There’s no getting around the reading assignment on this one. You may think that the $1M virtual portfolio setup doesn’t apply to you and therefore you have nothing to learn from Sage’s writing, but you would be wrong.

Reading List

Scaling In

I know you’ve already read this, the first line of the Strategy page: "I do not generally enter a position when it is moving the wrong direction or if the market/sector is moving the wrong direction. I rarely take a full position right away." While the Strategy does not explicitly mention the concept of Scaling In to a position, the concept is one of a couple of key factors, because it allows you to test your theory that an option is a good play without risking a lot. If you’re exactly right and the position moves your way immediately, you’re going to make bank on your small initial position. If the trade goes against you right away, you’re going to have a chance to cut your losses without losing much of a small initial position. If the trade holds steady for a while, you’re going to slowly accumulate into the position, preparing yourself to be in the right place when the right time comes around.

First reference is a link to an article Phil wrote (Strategery) about starting a $1M challenge virtual portfolio for a contest, and documented the overall plan for the virtual portfolio, as well as which entries he took in the initial stages. My favorite quote: "It’s very painful to build a new virtual portfolio and they don’t pay off right away so we must learn patience." It’s worth paying special attention to the details of how much money is allocated to which kinds of plays, which plays he entered at first (the ones that presented themselves) and how much of the total he allocated.

Next is a very detailed comment talking about not only how to allocate a 50k virtual portfolio, but how to manage the process of scaling in. It’s too long to pull in here, but you’ll have to scroll into the middle of the comment to get to the salient part. It begins: Portioning is key

Entry strategy for BA, details scaling trades based on possible stock movements:

BA – as a simple strategy I would go for the Jan ‘09 $95s at $14. If I were going to buy 20 ($28K) I would buy 5 to start and another 5 if it hits $15 (at which point I would sell against at least half). If it keeps going down, I would buy 5 more at $12 (now half in at $13) and then spend $2.50 to roll down to the $90s if it heads lower at which point I would cover with the $90s (paying for my roll). Then I would wait and either buy the $95s on the way up as a pre-roll or wait until I can buy more $90s for $12 or less so I can DD to DCA at $14 (including cost of roll) and then I would spend another $5 to roll down to the $80s for a total cost (not including caller credits) of $19 per positon to be in BA ‘09 $80s which currently cost $23. Between here and ‘09 I’d be pretty comfortable with that position.

10kP/25kP Entry Approach (begins "Welcome Jimmyo!"). Notice that above, Phil mentions that he tries to begin scaling in just before the stock bottoms, which means trades often begin with a painful "collapse" stage. New Members who enter on the DD steps for the smaller virtual portfolios benefit from missing that first bit of pain:

We make several new $10KP and $25KP picks a week so don’t feel like you have to “catch up.” I always say to new members though that the best plays to make are the ones we got wrong and are still either rolling or doubling down on. That way you get to skip the collapse part of our ownership and go straight (hopefully) to the recovery. OXPS is one we just did a DD on at .35 on the Nov $30s as our original entry was .70 back on the 12th.

Entry strategy:

The most important thing about entering any trade is to scale in. I have discussed this in great detail somewhere and I’ll try to dig it up for the weekend but the short story is I consider 5% of my virtual portfolio (and I break my virtual portfolio up into subs to manage in more detail) is a “Full” position but I rarely go more than 2.5% in and I generally enter in .5% rounds. This does not, of course work, if you only have $25K but with $100K or more it’s a good rule of thumb.

No matter how little money you have, you should never make an entry that you are not willing to double down on if it drops 30%, which will bring you to 2x at a 15% loss at which point you would need to stop out before the whole position gets to a 25% loss, which would be a 40% loss of your original bet. I am not saying you always should double down but, if there’s a quick move against you (like the FXI’s today) and your premise remains intact, then you should be able to take advantage of the great entry point, not stand there like some stunned accident victim watching everyone else enter your position for 30-40% less than you got it, allowing them to exit with a nice profit before you can get even.

Detailed entry trades looking for the turn:

It helps to be ahead of the curve a bit so it’s good to scale in so if I want 40 $350 puts for $7 or less and I’m willing to lose $1.50 I buy 10 at $8, 10 at $7 and 20 at $6 for a $6.75 basis (and the stock is at $6 by then) with a stop at $5.25. Obviously, once the mo play goes my way I stop buying. If I make 20% on just 10 contracts, I’m thrilled. The trick is to get used to guessing the turn and buy just before. I don’t do this robotically, if it really breaks up on me I may stop out but stopping out of 10 with a $3 loss is way better than stopping out of 40 with a $1.50 loss!

Final thoughts: the strategy for Scaling In needs to be a key factor of your Entry plan for the LTP. While Phil notes that smaller virtual portfolios cannot scale in to the extent he does with 100K or more, you will still benefit from "testing the waters" to see if your timing is right.