After closing out a losing trading, the natural tendency is to want to jump back in and wrest a profit out of the market. You've just lost one battle in a long war, and you're anxious to regain the advantage.

Wrong attitude. This isn't a war: it's a business. While I sometimes anthropomorphize the markets in my articles with statements such as "the RUT likes to overrun boundaries," the markets are not entities endowed with the will to overcome us. When I get into that "make it back" frame of mind, I remind myself of one time when I complained to my husband about how my stop orders were being picked off deliberately before the markets were allowed to reverse. My trades often would have been profitable if the stops orders weren't picked off before the reversal. Then, sheepishly, I remembered that those were simulated orders no one was actually seeing. The simulated trades had just plain been stopped out by adverse market action.

Stick to your planned trade entries for your major trades. If you enter new trades 45 days before expiration, wait until that 45 DTE time period rolls around for your next entry. Instead of trying to make back the money right away, I find it's helpful to spend the down time before my next regular trade entry by testing new trades or backtesting new permutations on my preferred trade.

Lately, I've been spending spare time on strangles, testing them first in a simulated trade or two and recently moving into a few live trades in small lots. The small size ensures that there's little emotion attached to the trade. The money at stake is far less than my usual margin or debit for a trade. I know that trade is not going to "make up for" the losing trade, so I'm pushed out of that wreaking vengeance mode that would be so dangerous. I can find out how the strangle might act differently in live trading than in simulated trading and learn something about an alternative trade, feeling as if I'm accomplishing something while I'm waiting for my next planned entry in my bigger trade. It keeps me out of trouble.

After I had closed out my March RUT butterfly trade for a loss, I waited for my normal entry time (about 35-45 days before expiration) for my April entry. However, I found no meeting of the minds between what I thought I ought to be paying for my new April position and what the powers that be thought they ought to be paid to match up my demand with their supply. Market behavior had become volatile. While I have tested my trade through enough market conditions to feel comfortable entering even in such conditions, I certainly wasn't going to do so at a disadvantage from the beginning by buying at an unfavorable price.

As a result, on March 19, I went to the free CBOE trade analyzer and input parameters for a possible position if I thought that the IWM might climb to just about 122.25 by March 28. I was far from convinced that the IWM was going to climb to 122.25 by March 28. My actual view was that the IWM was getting ready to move big and might either climb to 122.25 by the end of March or drop to about 113, but one drawback to that free tool is that it doesn't allow me to input two possible end prices. The CBOE returned six choices to me, and they were obviously all going to be bullish trades since I'd been able to input only one of those two possible targets. Below are two of the returned trade choices, set up as simulated trades that day.

CBOE Suggestion of a Long Condor:

As we can see, this trade is more bullish than bearish because of where the call and put strikes are positioned with respect to the then-current price. The trade's delta tells us the same thing. For the size of the trade, the delta is strongly positive at +32.28. We see that if the IWM sits near its current price too long, time-related decay will start sinking that profit/loss (PnL) line down into the valley of death. However, with theta--the Greek that relates to time decay--at only -3.64, the loss would not be too great at first unless the implied volatilities start dropping precipitously. This trade is a positive-vega trade which means that its immediate PnL is helped by a rise in implied volatilities and hurt by a drop in those volatilities. The shape of the current PnL line suggests that if price retreats to the downside right away, the trade will at first lose money due to the price-related move before it starts moving into the profit zone. Expiration breakevens are 114.34 and 121.65. This OptionNet Explorer site calculates in the costs of my two-way commissions when it calculates those expiration breakevens.

Another CBOE suggestion was a strangle, but it, too, was bullish in construction because I could input only one price target into the trade analyzer. I input the potential upside target.

CBOE-Suggested Strangle:

We see that this is also a bullish setup. If the IWM heads up right away and if implied volatilities don't drop a lot, this trade will begin making money right away. This trade doesn't cost as much as the other--the cost is visible at the bottom of the valley of death--but the downside breakeven is 109.07. If the IWM heads lower instead of higher, there's a long distance to go before the PnL turns profitable unless implied volatilities climb a lot as they could do with a sharp downturn.

I'd followed a similar simulated setup for the MAR expiration with the simulated trade set up in February, and that simulated trade had performed beautifully. However, I wasn't really bullish in the middle of March when I was looking at the setup for April's expiration. I thought a big move could be coming, but I thought it could as easily be a move down as a move higher. What could I do?

I liked the lower initial outlay on the strangle. I decided to try a neutral strangle, with the calls and puts still the same distance away from each other but with price centered between the two. I opened it on 8:47 am on 3/19, but for some reason, the charting program is not showing it until the next morning.

My Actual Live Trade, to Test the Performance:

We can see right away that this was a more neutral trade with respect to the price action. Price is fairly well centered between the expiration breakevens. Delta was negative, at -15.21, but the absolute value of delta was lower than in the previous two cases, so price action wasn't going to help or hurt the PnL too much over a short distance.

This trade was going to be hit by time-related decay more quickly than either of the two, but the biggest immediate impact would be on changes in implied volatility. If prices just sat for a long while, that PnL line was going to rapidly sink into the sea of death just beneath it. The vega was 46.03. Vega relates to the impact of implied volatility, and a positive vega means that the trade's PnL benefits from a rise in implied volatility and is hurt by a drop in implied volatility. The PnL was going to be hurt rapidly if prices just sat and implied volatilities dropped. Of course, that's what happened for a few days before prices finally dropped and implied volatilities rose.

However, by March 27, prices had dropped near to, if not quite all the way to, my original price target. How did my chosen live speculative trade perform?

Neutral Strangle, Results on March 27:

This chart was not snapped at the low of the day, when profit would have been higher, unfortunately. Let's also look at the performance of the other two trades, the more bullish ones.

CBOE-Chosen Long Condor:

CBOE-Chosen Bullish Strangle:

Each of these performed worse than the neutral strategy. Did I decide during this testing time that it's always better to enter a neutral trade?

No. Although I generally prefer trades that are not purely directional these days, it's appropriate to have a market view, especially on small trades that fit into the speculative part of one's portfolio. That's what I was testing while I was using the down time between my regular trades.

What would be wrong for me or any trader, however, is not having an appropriate exit strategy for the trade if one's original trade outlook is proven wrong. For me, it feels appropriate to have a hedge in case that market scenario is wrong and one cannot act soon enough to prevent a too-large loss. All of these trades provide that kind of hedge, in a way. First, there's a known maximum risk that's small in relationship to my usual trades. For speculative trades, that's one way of controlling possible loss. Some traders might prefer to structure a pure directional trade and limit the expenditure on that trade to the total amount they're willing to lose, for example. If that's going to be your only method of controlling risk, however, you'll need to have a strong ratio of profitable trades to losing trades. Controlling risk is doubly important when one is testing a new trade, and nasty surprises could result. Having adjustment pre-planned or stop losses preset is a good idea.

I closed this trade when it closely approached one of my two original targets. The profit was not as much as I would have hoped--certainly not as much as it would have been if the sharp drop had been immediate rather than occurring after some price decay during consolidation. I have not discussed potential adjustments to this trade, one of which I employed before I closed the trade.

This article is already too long to delve deeply into adjustments, but that's the point of these tests during downtime, too, to learn if planned adjustments work as expected. In my case, my adjustment was to vertical roll the puts higher when IWM headed up more than two points away from entry or vertical roll calls down when price headed down more than two points away from entry. I would have been better off not to do that this month, but maybe next month that would have been a great idea. I'm still testing in a small way, in my down time between my main trades. This month, the point was not only to continue testing this speculative trade but also to avoid jumping into my bigger trade to try to wrest my profit back after a loss.

That's one way to avoid that temptation to wreak vengeance on the markets. SOH (sitting on hands) is another. Whatever it takes, make sure you're entering a trade because it's an appropriate tactic, not because you're trying to win back what you just lost.

Linda Piazza