From Our August 2015 E-mail Archives: One of our traders sent a multi-question email about his recent trading. Our Head Trader, Robb, answered with a 1,500-word reply. No one can ever say that Robb is a man of few words! So, we broke up the original email into four parts. Today, we present the reply to Question #4 of 4.*
-----Original Message-----
From: Thomas G.
Subject: Trades
Robb,
Hope all finds you well. I have a few questions from my recent trading.
- Diagonals – In my Trading Plan, it says that if I'm down on the diagonal option spread at expiration, then I either take the trade off the table or use lower lows to exit the trade. If I bought September and sold August and I'm down, then is there a way to sell against it again since I'm down overall in the trade?
- Verticals – In my Trading Plan, it says keep vertical option spreads until expiration to increase my R/R (Reward/Risk). So, when do you scalp these or take them early, if ever? I placed a trade on CAT this week: a 77.50 / 75 vertical. I'm up a little on the trade and I do believe it will get to 75. However, I'm not as confident in CAT staying below 75 until August expiration with it being this extended to the downside. Maybe I just picked the wrong strategy or time frame; however, if it were to bounce, then I can't just see holding it to a max loss...but I also don't want to cut my winners.
- On lower lows, is it a closing low or just a lower low during the day?
- When I trade my account, I often have over 20% of my portfolio at risk. If I had less than 20% and I was trading at 2% per position, then I would have 6-8 trades on at a time. Are 6-8 trades of $3k-$4K invested at a time enough trades at a time? I'm over trading currently (I'm trying to work on that!), but I don't want to under trade either. Editor's Note: We will show the answer to this final question this week.
Tom
-----Reply Message-----
Hi Tom,
Thanks for your questions. I’ll try to answer them as best as possible:
Editor's Note: Answer to Question #4 below. This completes the 4-part series.
“How many positions and portfolio at risk?” I wish this was a question that had a black and white answer; however, there are just too many variables. We don’t have a rule on how many positions a trader can take since the number of positions isn’t as relevant as the amount at risk is.
The ideal number of positions really comes down to you as a trader. That is, you have to decide for yourself how many positions you can carry at once and manage all of them well based on your trading plan. Personally, I top out at around 20 positions. Any more than that and I find myself making mistakes or forgetting to make exits/adjustments. With that said, we have traders who can effectively manage more than 20 positions.
On the other end, we do think that there is such a thing as not enough positions. At Maverick, we look at trading as an overall numbers game and not about the individual trades you may have on at any one time.
If you are only trading 2 or 3 positions, then you are much more likely to be overly focused and concerned with your trades. Traders tend to make these trades too big in relation to position sizing rules. With so few trades, you have the risk of getting an unlucky piece of news that comes out and blows up a trade or two. If you only had 2 trades (especially with too big of position sizes/risk), it will lead to a big monthly drawdown. This is when traders make mistakes and don’t take small losses; rather, they tend to dig a deeper hole.
In contrast, if you have 15 small trades, then you are putting yourself in a position where your monthly returns will be determined not by a stroke of good or bad luck, but by correctly charting and managing the basket of trades. Even if 1 or 2 of the 15 trades are hit by bad news, you should have plenty of others that work your way – especially if you have a fairly balanced number of bullish, sideways and bearish trades.
In our opinion, 6-8 trades per month are about the minimum. You will have to test yourself to understand what your personal maximum number of trades is. Just cut down the average position size to carry more trades and you should see smoother results (i.e., less account volatility).
As far as your question of risk goes, it’s not about how much capital you have invested, but how much of that capital is at risk. One of the reasons that we believe in always carrying both bullish and bearish positions is to allow us to use more of our account sizes in trades without carrying huge risk in case the market spikes/plunges.
One of the best trading tools that our traders have access to is the Risk Management tool in their Interactive Brokers account. It basically takes a trader’s basket of trades (bulls, bears & sideways) and draws a risk graph of what would likely happen if the markets spike +5% or drop -5%. This allows our traders to see how much of their account is at risk from an unexpected move in the markets. It gives them a worst case scenario where – if everything went wrong – they could see the impact on their account. Then, a trader can make an educated decision to, for instance, never carry more than a 30% worst case scenario.
Hope this helps.
Robb
* NOTE: Some original wording has been modified for legibility.