“To be conscious that you are ignorant is a great step to knowledge” – Benjamin Disraeli
For many traders, novices and experienced alike, surprising news events can derail a virtual portfolio and many months of gains. In the past week I have had the opportunity to chat with a number of traders who made fantastic gains last year (>100%). And yet a good number of them have seen those hard-earned gains nearly decimated in the first month of the year. As I delved deeper into their strategies, I realized that many had been lulled into bullish complacency and had turned a blind eye to managing risk. A standard approach to managing risk is to maintain a degree of hedging at all times by employing index long put options against bullish virtual portfolio positions. But what happens when week after week and month after month the stock market rises and those long puts lose value as happened throughout much of last year?
Understandably, most traders hate taking losses and it becomes so frustrating to see gains from bullish positions diminished somewhat due to long put losses. As a result, many choose to abandon the protection afforded altogether. Indeed, a great majority of the traders I chatted with who suffered declines this month stated that they had decided not to buy put options because they considered them “expensive”. One trader in particular saw his account drop over half a million dollars because he refused to buy ‘expensive’ put options to protect bullish positions.
One of the biggest advancements in any trading career is learning to accept losses. More specifically, a huge leap forward for any trader is to recognize that the goal is for the overall account value to increase and that it is perfectly fine for some positions in the account to lose value. In short, successful options trading demands hedging positions and it is the combination of those positions that should be profitable. Most traders focus on single positions within a virtual portfolio at the expense of prudent risk management. If you want to take your trading to the next level, focus on profiting from the combination of hedged positions.
This is so important because any number of surprises can derail a virtual portfolio at any time and it can be challenging to stay on top of all the possible factors at every given moment. For example, this week alone I have highlighted earnings announcements and economic events that could move the market. As a trader, you need to be aware of each of these economic events and their potential impact on the market. You also need to be aware if any of your stocks are reporting earnings. You may not necessarily hold any of the stocks listed this week, but what if you held one of their competitors? Or what if you owned Google and forgot that Yahoo was reporting a few days earlier? What if Yahoo came out and said Search projections were much worse than expected? Or what if economic numbers are reported that diverge strongly from consensus estimates listed? Do you know with 100% certainty that some event will not derail your virtual portfolio?
Monday
SanDisk (SNDK), Halliburton (HAL), American Express (AXP), McDonald’s (MCD), Sysco (SYY), Black & Decker (BDK)
Tuesday
EMC Corporation (EMC), Pepsi Bottling Group (PBG), Centex Corporation (CTX), Occidental Petroleum Corporation (OXY), The Travelers Companies (TRV), Yahoo (YHOO)
Wednesday
Amazon (AMZN), Altria Group (MO), Eastman Kodak Company (EK), Starbucks (SBUX), Kraft Foods (KFT), Dominion Resources (D)
Thursday
Bristol-Myers Squibb (BMY), Wyeth (WYE), Procter & Gamble Company (PG), Altera Corporation (ALTR), Electronic Arts (ERTS), Raytheon (RTN), Google (GOOG)
Friday
Exxon Mobil (XOM), Gannett (GCI), Chevron (CVX), Cummins (CMI), MeadWestvaco (MWV)
Economic Events
Monday
New Home Sales (Consensus: 645K)
Tuesday
Durable Orders (Consensus: 2.00%), Consumer Confidence (Consensus: 87)
Wednesday
GDP (Consensus: 1.2%), FOMC Policy Statement
Thursday
Employment Cost Index (Consensus: 0.8%), Personal Income (Consensus: 0.4%), Personal Spending (Consensus: 0.1%), Core PCE Inflation (Consensus: 0.2%), Initial Claims (Consensus: 315K), Chicago PMI (Consensus: 53), Crude Inventories
Friday
Auto Sales (Consensus: 5.2M), Truck Sales (Consensus: 7.2M), Nonfarm Payrolls (Consensus: 55K), Unemployment Rate (Consensus: 5.00%), Hourly Earnings (Consensus: 0.3%), Average Workweek (Consensus: 33.8), Construction Spending (Consensus: -0.5%), ISM Index (Consensus: 47.5), Michigan Sentiment (Consensus: 79)
Every year I have been trading, I have found that at least one event arrives that completely surprises me. During those times, little saves the existing position. However, what saves the account is risk management and balanced hedging. If all you do this week is spend time evaluating your positions and identifying whether a combination of them results in a balanced virtual portfolio with risk acceptable to your level then you have made a huge leap forward in your trading career.
