I've made a lot of comparisons to trading and my previous life as a fiction writer. Many parallels exist, believe it or not. Just as few traders excel from the beginning, few writers succeed in placing their first books, for example. Typically, writers propose many books to editors or agents before one is accepted. Only gradually does a writer learn how to successfully query an editor or agent. The first successes, those first sales, are typically to low-paying publications. Few authors write blockbusters, with many more crafting careers in which they're steadily able to place their work and, hopefully, support themselves through their efforts.
All but those blockbuster writers deal with rejection throughout their careers, however, just as all traders deal with losses. Occasionally, through no fault of their own, even writers of blockbusters find that mergers or divestitures in their publishing houses result in a rejection of future writing projects. Such authors may find that they've been working for free after they spent months preparing for the next project that they thought was a done deal. That's akin to a trader finding that the hard work of placing and managing a trade is rewarded with a loss and not a profit.
How did I recover from a rejection back then? It took time. First, I ran all the requisite "you'll never succeed tapes" through my head for a day or two. I might even run those tapes through my head a week or two, depending on how far a book project had progressed through the rings of first reader, junior editor to head of acquisitions. Just as my disappointment in my trading skills right now is commensurate with the size of the losses I've just sustained, my disappointment back then was related to how high my hopes had risen.
However, fairly soon, I found myself typing up another query letter to another editor or agent, tailoring that letter to that editor or agent's specific needs. And that's what I'll do now after experiencing a loss that knocked several months' worth of prior profits off the account balances in my trading accounts. I'll run those "you'll never succeed" tapes for a while. Then I'll dispel them and get back to work.
In fact, I've already gotten back to work. What does that entail? It better entail asking some hard questions. Was the trading plan flawed? If so, how can that trading plan be modified? Was the trading plan fine but did I fail to follow that plan? In either instance, do changes need to be made?
My trading plan was definitely flawed, although it was a plan that seemed conservative at the time it was written and has served me well since that time. A storm of unusual circumstances tested that plan in a way that it had never previously been tested. A house might seem to be well built until a Category 5 hurricane roars through your area, when its flaws are revealed.
As I detailed a couple of weeks ago, a storm tested my plan and found it lacking. As mentioned in that previous article, my primary problem was in having too many different trades in too many vehicles. The almost 50 percent cash cushion I'd left for possible adjustments, even after placing two months' worth of trades, had seemed conservative, and it would have been if only two or three of my trades had been threatened. However, rolling the number of contracts I had into 1.5 times the original number when all were threatened at once would have required putting about $210,000 at risk in what had already proven to be a dangerous storm of a market. That would have been akin to taking all my money out of the bank and holding it in my hands inside that said house being assaulted by that Category 5 storm. One of the tapes I've been playing inside my head concerns how dumb I was this last month, but I wasn't that dumb.
So, the plan will be altered so that I will no longer put on a full allotment of back-month trades if I still have a full allotment of current-month trades. My plan might previously have said I've left enough money to do that, and my plan might previously have said that I'll put on new iron condors 45-60 days away from expiration, but that plan will have to be altered.
Hear this: if your plan for adjusting iron condors is to roll into 1.5-2.00 times the original number of contracts to make up all or part of the debit you lost closing out the threatened spread, then you need to consider how you would feel if every single iron condor trade you had on went wrong all at once, and you were suddenly looking at the fact that would have 1.5 to 2.0 times the total number of iron condors that you typically have. What is your comfort level with the number of contracts you can trade without going into can't-sleep-at-night, can't-make-sound-decisions mode? Mine is about 120 contracts. I had already slightly exceeded that when every one of my bear call spreads were threatened the first week of March.
How often does that happen? My experience with years of trading iron condors had taught me that it didn't happen often. Does that mean it can't happen? My experience in March showed me in the worst possible way that it can, however unlikely it might have seemed.
So, in addition to altering my overall plan to ensure that I don't have too many contracts on at once, my method of adjustment needs reconsideration. Prior to the last couple of years, I adjusted by delta hedging--buying a back-month call or put position to even out the deltas--and then stepping out of my in-trouble spreads in thirds as the deltas of the sold strikes started moving through my adjustment range. I did roll back then, but less frequently. That method had kept my losses within an acceptable range, about equal to the gains I made most months. Since my experience back then had been that I took losses about two months out of twelve, the losses would never wipe out of my gains.
However, trading conditions changed, with markets zooming straight up or straight down, hitting the adjustment points more frequently. This meant that if I just stepped out, locking in the loss, I was going to be taking losses a lot more frequently than in the past. A high probability iron condor theoretically has about an 80 percent probability of achieving full profit, at least at the deltas at which I set them. However, that assumes a normal bell-curve type distribution of prices in the stock market, and many feel that the market's bell curve has "fat tails." Prices tend to spend more time in the tails than in a normal bell curve distribution. That's what seemed to be happening. Prices have to move out into those tails to exceed the sold strikes in high-probability iron condors.
Under those conditions, I gravitated toward a more decisive adjustment. I gravitated toward just getting the spreads out of the way by rolling them up or down. I'll be re-examining and doing some back testing of the two methods. I've already begun, back trading through a couple of years using adjustment methods that I've variously called "pin the ears on the mouse," "just peel off the shorts," and "nifty fifty" adjustment methods. Each is aimed at making sure that the unrealized losses in my trade never exceeds some preset level, typically 11 percent of the margin held for the iron condor. So far, I'm getting limited success with a method that harks back to my old method of hedging with back-month longs when the price risk gets too high, temporarily holding that loss below the preset level while I wait for markets to finish gyrating around or to prove that I need to roll. The rolls I'm testing employ only 5 contracts more than the original trade, rather than 1.5-2.0 times the original number.
I mentioned "limited success" for a reason. This test is not without its cons. I'm whipsawed out of those back-month longs so often that commissions are huge. For example, in about 18 months in which I started out with 25 contracts, I theoretically would have paid $5,377.25 in commissions on SPX iron condors and an even larger $8,372.76 in commissions on RUT iron condors. Theoretically, the SPX iron condors would have yielded a realized profit of $25,207.80 but the herky-jerky RUT, only $6,382.56, less than the commissions my online broker would have earned.
It's not a hands-off strategy, either, sometimes requiring putting hedges on and taking them off more than once during the same trading day if it's a big-range day. The above-named "nifty fifty" strategy is one I haven't yet fully tested. It will begin an adjustment when the delta of a 25-contract iron condor is 50 or -50, or, alternatively, when the unrealized loss mounts to 5.50 percent, but I haven't set all the rules yet for that test.
Back trading through several years is not a failsafe way of testing a trading strategy, and I certainly don't expect to replicate great results if I find a new strategy through this testing. If my guidelines for testing say that I'll start delta hedging when the unrealized loss reaches 5.5 percent or the absolute value of the delta of a sold strike reaches 16, that's what I'll do on the back trading. But what would I do in real life if the day ended with the unrealized loss at 5.4 percent, the absolute value of the delta of a sold strike at 15.6, and with the day's range a 2.3 standard-deviation move to the downside? Would I adhere to my guidelines then or would I move early to delta hedge by buying some extra back-month long puts? What I do in real life could change the whole outcome. However, if I can't count on some theoretically great results to be replicated identically in real-life trading, I can at least weed out the strategies that are doomed to fail, such as that "pin the ears on the mouse" strategy that was abandoned as unworkable.
I'll let you know if I find the holy grail of adjustments but don't hold your breath. There's no one right way to adjust. Each tactic will have pros and cons. The "pin the ears on the mouse" adjustment, for example, kept me from experiencing a large loss but it resulted in a win/loss rate of about 50 percent on the RUT, a totally unacceptable rate for the high-probability iron condor. I abandoned that test after a test of about a year's worth of trades because I know that, even if the test proved the adjustment to be a workable one over a longer term period, my confidence in myself as a trader could not sustain that many losses in such a short period of time.
We're likely always going to be balancing something: more safety against a greater number of months when we are stopped; more commissions and smaller, or more frequent losses in trades in which we adjust against less frequent but bigger losses if we don't adjust and wait until an expiration breakeven is hit to exit the trade. That's the way trading is. That's the way life is. If I ride my mountain bike and kayak, chances are I'm going to get hurt eventually. In fact, I've already had one surgery when I didn't realize I'd badly fractured my nose in a biking accident until it began healing. A month later, my nose looked like the California shoreline might look if the tectonic plates in the ocean started shifting beneath the skin of earth. But if I stay inside and opt for safety, I'll probably age more quickly and I won't have nearly as much fun.
When that storm of market events conspired to prove that my plan was flawed, I fumbled. I'd managed sharp market downturns with aplomb, but I fumbled this time. I had already been questioning whether I was a trader more comfortable in one or two large trades than four or five medium-sized ones. I had already been coming to the conclusion that one or two big trades was better for me. I'll be gravitating that direction.
So, what are your takeaways if you suffered a rough March expiration? Was your trading plan at fault? Was the loss a manageable one so that you just have to chalk it up to one of those things we traders must expect? Did you mismanage the trade and do you have to retrench? Was the mismanagement due to the timing of your entry or exit or the way you exited? Is it possible that you're blaming yourself for mismanagement when what happened was simply a case of slippage, of market action suddenly barreling through a decision point before or as you're placing a trade?
Ask some tough questions. Make the appropriate changes. Then cut off those "you'll never succeed" tapes and replace them with something more helpful. However, just as an "I'll show that editor" attitude wasn't helpful as I prepared to query a new editor about my book, neither is an "I'll get my money back" attitude toward the markets. Weed out that attitude before you return to trading.