Mistakes Were Made ... But It's OK

SPY has completely ripped my face off today, up about 4.25 points as of writing. What a rally.

I made a (quite large) error in my earlier post about rolling. I grossly overestimated the amount of risk that would be reduced, and that's because I did the math wrong, and also partly because I failed to recall exactly what happened last September. But I figured it out, explained in this picture:

Maximum risk has been reduced, yeah, but not by NEARLY as much as I had thought. So, here's the game plan now:

We can only lose ~0.45 for it to become a full loser, or another $150. If SPY remains between 194 and 198 for a two week period, then we'll cut the loss as it would be equal to about $100 (the spread would be worth ~0.33 less than what it is worth currently). If SPY continues to rally, which it certainly may given today's strength, we will roll up the puts again and collect more credit, or potentially roll out to another expiration if it can be done for a credit or a small debit (>0.05).

In the above picture, that little "@ 0.84" ... we want to get that as close to "@ 2.00" as possible by taking in more credit. I don't mind paying more commissions if it brings the maximum risk down on the position more than what those commissions cost. This position is a loser and must be treated as such.

God, what a headache. It's a good thing that I've had years of training with virtual money to prepare myself for the plunge, because these kinds of things can and will happen. This is why we ALWAYS ALWAYS ALWAYS analyze what our maximum risk is whenever we place a trade and assume that the worst will happen from the get-go. Always look at any trade by how much you can lose, not by how much you can make!!!!!!!

There are 5 outcomes to any trade:

1. make a lot of money
2. make a little money
3. make / lose no money
4. lose a little money
5. lose a lot of money

 As long as you can cross out 5, you will be a successful trader. This is what we're aiming to do.

This also highlights the importance of capital contributions, which help:

• reduce the psychological effect of losses by replenishing capital
• reduce the actual effect of losses by replenishing capital
• helps maintain a stable and/or growing risk pool

The first two are straightforward. What's a risk pool? Your account size. It's a pool of money that you can take risk with. You should always size your positions in relation to how much of the total pool is at risk in percentage terms. For example, if your account size is $10,000, and you risk a maximum of 5% per position, then you have a max risk of $500 per position. If you have a big loss, and now your account is worth $9,700, following the same rule your max risk per position is $485. By stashing more cash into the account, you help keep the risk pool more stable than it otherwise would be.

Now let's say 6 months have passed, you've had mostly profitable trades, and the account is up 10%, now worth $11,000. Your max risk per position becomes $550. However, if you added $100 per month to your account, it would be worth $11,600, and max risk would be $580.

Remember, adding max risk (in dollar terms, not percentage) also means you're adding more max profit, and if you're a successful trader, that means more $$$ in returns.

I was hoping that I wouldn't have to deal with a loser like this so soon, but I guess it gives the opportunity to educate. Hopefully the rest of the week isn't as painful.......