Gain Consistency in Options Trading

okay good afternoon and welcome back everyone to our options education webinar series my name is tony zhang i'm the chief strategist here at options play and what today we i want to cover a topic that is a continuation of what we spoke about last week which is how to grow a small options account we talked about the strategies in terms of option strategies that you could deploy to help you grow a trading account and the reason that we stick we're looking at strategies like vertical spreads with the credit spread is that it's very easy to define how much potential risk you have and how much potential reward you have it's easy to plan around that so today it's going to be part two where we take that to the second step or we talk about how do you take a strategy like that and gain more consistency in your options trading and more gain consistency in the profits and losses that you have in your portfolio this is arguably in my opinion the most important lesson that investors need to learn whether you're a stock trader or an options trader whether you'd like to sell credit spreads or buy calls or trade iron condors it doesn't matter the rules that we're going to talk about here today the shift in psychology that i'm hoping to be able to instill in today's lesson is going to be applicable and is going to be our i think probably the most valuable tool in your toolbox in order to succeed in trading so let's go ahead and get started but before we do what we're going to discuss here today is purely for education and demonstration purposes it is not a solicitation or recommendation to buy or sell any specific securities so during today's session what we're going to do is actually before we jump in i just want to do a bit of housekeeping in terms of upcoming events so we're covering gaining consistency and trading today tomorrow morning we're doing our next thematic investment series this is where we're going to be talking about the future of work we're going to talk about cloud competing we're going to talk about the different different companies that are going to benefit from our shift in working from home the different types of cloud companies we're going to do a deeper dive into many of the companies that power our ability to work from home next thursday i'm doing a special event with michael cohen the co-host of options action we're going to be talking about trading oil futures a lot of interest in crude oil so we want to talk a little bit about that so we'll we'll get a we'll talk about trading small oil features with michael co uh and then the following thursday i'm doing a session that i that i had to cancel in uh may i'm doing it in july here for i'm sorry in early june i canceled it we're going to do it again in july which is understanding liquidity and how market making works because i get this question almost every single week an investor asking me why i trade something with low open interest and volume and what it speaks to is a lack of understanding as to how liquidity works and how market making works a lot of investors get the sense that if something has low volume or low liquidity that you're going to get stuck in the contract you're not going to be able to get in and out of that contract that is about as far away from the truth as possible so i want to demystify that and actually spend some time making sure you guys understand how the other side of a trade works to help you better understand how you can find liquidity in the markets for your trading and then when we come back we're going to talk about a rapid fire session uh where we do a technical and fundamental analysis on the broader markets uh gary um the tuesday morning market outlooks are always there this is this is in regards to uh kind of more special events or more educational events we always do the tuesday morning market outlook sessions uh but the primary question uh whoops but so as far as what we're going to cover here today first and foremost what i want to help establish is an understanding of the difference between strategy and psychology because a lot of investors get mixed up between the two with respect to what is what is driving the success or what is driving the lack of success in your trading is it your strategy or is it your psychology so we want to really make sure that we understand the difference between the two then we're going to dive a little bit into this concept of trading psychology so that you understand whether or not you know how to go about thinking it from the right way there is in my opinion a right way and a wrong way to think about the winners and losers in your portfolio and the way you sh you approach it is going to have a significant impact on the long-term success of trading um you know and and it's it's an it's a area i think of trading that many educators and many traders don't spend enough time thinking because we spend all our time thinking about strategy we think all of our time about technical analysis fundamental analysis we consume ourselves with the news that's out there but we don't spend enough time thinking about how much psychology affects our ability to handle wins and losses because at the end of the day we are human beings we are emotional beings and it does affect how we um how we trade and ultimately it has a huge effect on our bottom line so that's why i want to spend quite a bit of time here discussing that then once we have a better understanding as to how psychology affects our trading i want to talk about the golden rule of trading how we can trick our brains if you will to some degree to allow to to shift our way of thinking and move it in our in our favor by applying this golden rule of trading and some of you that have been with me for a while you've learned this golden rule of trading many of you tell me that you already applied this golden rule of trading i'm glad that you do but for those of you that are new you're you're this is going to change the way you think about your portfolio and the way you think about risk and even for those of you that have seen this session here before i've changed the format a little bit to give you a different perspective hopefully to help help you understand the shift between you know what i sh what i believe are successful traders and how they stand apart from basically everyone else and in order to understand that we have to talk we have to talk a little bit about the difference between linear versus exponential functions and talk a little bit about how consecutive losses compound uh losses and the difference between a consecutive losses versus a huge loss with respect to blowing up your portfolio because we have all seen uh portfolio blow-ups it's not pretty and the question is how do you prevent it and then we'll open this up for q a here at the very end but like i said the primary question that i want to help investors answer from today's session is what can i do to gain better consistency in my profits and losses in my trading so before we get started here let's do a quick uh please bring up your chat window at the bottom of your screen i'm curious how many of you find you find it difficult to gain consistency in your trading please type yes if you find it difficult to gain consistency in your trading if and type no if you feel that you've already got this you know down in terms of figuring out a more consistent approach to trading okay so overwhelming number of yes is quite a quite a few no's as well i'm hoping the ones that have answered no uh you answered you're answering no because you've already applied some of these things that we're talking about and you know someone's saying average loss is bigger than average winners um so you know we're going to talk about all of those things and how that ultimately affects your bottom line um and again psychology has a lot to do with it so when you understand the psychology that's when you have the opportunity to shift your views and and all and i want to start off by saying the what i'm going to teach you today is actually really really simple it's not complicated it's just it's so simple that sometimes it's sometimes the simplest things are the things that we have our hardest time wrapping our arms around and and and um i would say um embracing if you will uh because it is counter counter to our human nature but it's actually quite simple what i'm gonna teach you today so hopefully you're gonna be able to walk away from today learning something new and hopefully uh with a plan as to how you can help how we can help you gain more consistency in your training so my name is tony zhang i'm the chief strategist here at options play and what i'm going to teach you here is a result of 15 years of of being a market strategist and working with thousands of retail and institutional clients over that period of time and what i've learned and what i've seen and the strategies and and accounts that i've watched uh rise in value decline in value and the and and the patterns that i've seen that that um that lead to inconsistent results versus the the small number of accounts that do have very consistent trading in their accounts what the difference between uh those two and many times a lot of investors feel the difference is you know the guys that are more consistent have a great strategy and it's just a matter of finding that great strategy and i can't and i cannot stress enough that the difference between a successful trader and everyone else has really nothing to do with strategy yes those guys are are better at using many times are have spent a lot of time honing their strategy but it's not the strategy that differentiates successful traders from everyone else it's psychology it's how you manage winners and losers how you think about winners and losers that define whether you're successful or not so i'm going to bring up one chart here that i think define a lot of investors that say that they struggle with consistency with trading so you have two charts you have a bar chart showing you every single trade many times many traders have these types of wins and losses you have small winners small losers uh and you're kind of figuring out your way you're you're trying to learn your strategy you're trying to apply it and then all of a sudden you have these one this huge loss in your portfolio and there's a number of reasons that we have these huge losses in our portfolio but and then once we have this huge loss we get very gun shy from trading again and what we do is we try to build our way back up from that huge loss after huge losses but it's usually this huge loss in our portfolio that that blows a very large hole in our portfolio and really keeps us from continuing to progress forward and trading if you can relate to this please type one into the chat window if you can relate to having a series of small wins small losses feeling like you're making progress feeling like you're getting a little bit more comfortable with trading and all of a sudden you have these huge losses in your portfolio okay i see a lot of ones okay now the because uh this is what i'm seeing with investors with uh with these huge losses in their portfolio this is how i know it has nothing to do with your strategy because if if it was truly your strategy that was wrong if it truly was the indicators that you're using you're just using them in the wrong way um or you know you're following you know someone who's just really bad at trading you wouldn't have huge losses in your portfolio what you would have is a series of consecutive losses and and you would just have losses all the time and what in this chart here would not look like this the chart would look more like this right so you know that it's very important to understand the difference between these two charts right one is a bad strategy that's a strategy that's just constantly losing money losing you money in the long run but when you have losses that look like this it has nothing to do with your strategy it has to do with how you're managing your risk and how you're managing your losses okay so and you know and i'll just bring up an example of what i have seen over and over again from clients as to what leads to those big losses and it's usually something along the lines of our trade that where we get emotionally attached to a trade and this is perfectly normal as human beings because as human beings we want to be right we want to win right there's and there's nothing wrong with that but it's actually this desire to win this pursuit of winning that ultimately caused us unfortunately to have some of our largest losses in our portfolio so you know here's just an example here of a stock that gapped lower here and finally managed to fill this gap and break out higher i think this is a pretty bullish pattern that many investors could get caught into and will say okay it filled that gap it broke out above it i think it's going to now resume back up to that eight dollar level here or so but instead after you buy the stock whether you buy a call option or if you buy the stock or you trade some credit spreads the trade goes against you what do you do um so this is really where this decision the next decision you make is what differentiates in my opinion successful traders from everyone else who struggles to gain consistency because i'm not saying you do it i'm not saying you do it all the time but all you have to do is just once and that's what causes these blow-ups in your portfolio which is okay this trade didn't work out i don't want to lose i don't want to be wrong what can i do to fix this right this is a common question that i get is how do i repair losing trade um and people will say okay i sold one credit spread it didn't work out let me sell another one because i think that it might bounce back next month right or the next week wherever it is so you sell another credit spread and guess what instead of bouncing back higher to that gap fill it continues to move lower here and what you do is you keep doing this over and over again many times sometimes you know i've seen this unfortunately where people lose their entire life savings chasing these types of trades now that might be an extreme example but this is something that a lot of investors do because and it has nothing to do with your strategy at this point it all has to do with your emotional attachment to wanting to be right and wanting to win and not lose and i will say that i also find that some investors feel that as if they can correct the losers back into winners that's how they're going to be more profitable in the long run and that couldn't be further from the truth because it's traits like this where you find alternative reasons to now buy a stock or go long a stock that had nothing to do with your original reason to buy the stock to begin with just to not lose that's when you start making really bad decisions so you know and in this particular case maybe you you you buy some here you buy some more here and the stop bounces higher here and some of you are lucky enough to get out of a trade like this maybe at flat or maybe at a small loss and you think to yourself oh i've really you know i'm really this is a great way to repair a bad trade um but not everyone's lucky enough to get out sometimes you get a little greedy and you're saying okay i want to wait for it to get all the way back up here so i can make a profit only to have the stock gap further lower now you've bought the stock once here one's here once here and the stock is down here again at this point this is really where i see people making really desperate trades if you will to try to get themselves to brat back to break even they start finding new reasons like oh there's a prior support here let me buy some more only for the stock to decline further then you start to see some negative divergence and you say okay that's definitely the bottom on the stock let me buy some more only to have the stock continue moving lower and again this is a bit of an extreme example right but i have seen this over and over and over again and the thing is that you don't have to do it all the time you just have to do it once and that's what's going to drive you to have this type of loss in your portfolio and this is the hard part about trading is because you cannot make this mistake even once if you make that mistake even once game's over and that's what we're trying to help you avoid here is how do you shift your thinking and how do you shift your psychology to avoid this type of of trading and the reason that i go back to you know making sure that you understand the difference between strategy and psychology comes down to the fact that a lot of investors when they have this huge loss in their portfolio what they don't do is look at what did i do wrong from a risk management perspective most investors will say what have i done wrong with my strategy i'll have investors tell me my strategy is terrible i need to find a new strategy i'll have investors tell me uh you know i've had such a large loss in my portfolio i'm going to stop options trading and you know what that means is that you're not addressing the core of the problem the problem is not the asset class you're trading the core of the problems not the strategy you're trading it's not the way that you're trading it has to do with how you decided to manage risk on a trade so which is why we really have to spend some time looking at how do you manage risk and the reason i know psychology is at the core of the problem is because this is the type of question that i receive on pretty much a daily basis i get questions from investors saying i have a losing trade how do i repair that trade this tells me that they're not worried they're not thinking about risk management they're thinking about how do i not lose um another question that i get very confident often is how do i make my money back on a losing trade or sometimes i get emails saying that hey you've had four losing trades in a row on options play your service sucks i'm gonna cancel it and this tells me that again you know not thinking about strategy not thinking about you know worried about the long-term um you know worried about the wrong thing if you will and the question that i always ask investors is are you asking the right question to begin with and this is really where i have to introduce a concept called finite versus infinite gains and this is really at the core of how do you shift your psychology from options from trading in general to what i consider is the right mindset of trading um so james p cars is a is a is a uh nyu professor in the 80s that wrote a book called finite versus infinite games and james p harris is not a businessman he's not a finance professional he was actually a religious philosopher and he wrote this book called finite versus infinite games and he theorized that there's two types of games there are finite games which are games that we all are familiar with uh rule games that have a fake set of rules games that end at a certain point and at the end based on those rules you are declared either a winner or a loser and when you play a finite game your only goal is to win that's you do everything to win at all costs an example of a finite game are games that we're all familiar with basketball football chess rules sets of rules and your goal is to win and then he theorized on the other side that there are set of games called infinite games in an infinite game he he says that there are no agreed upon rules there's no rules to an infinite game and it also never ends so what does that mean right if there's no rules and it never ends what is an infinite game an infinite game is something where there are players in the game and there are dropouts meaning there you either have the resources to continue playing or you've lost the resources to continue playing and you've dropped out and i think a prime example of an infinite game is running a business there's no rules to starting a business there's no rules to there's no end goal in sight right you can't win at winning at running a business but you can either be in business or out of business and if you think about it trading is very similar to that right there's no rules to trading right as long as you you can buy and sell anything you want there's no uh there's nothing that there's no rules to it and you either have enough capital to trade or you've blown up your account and you no longer have the resources to continue trading so what you realize is that trading is not a finite game but most investors still think of trading as a finite game they think of them as wins and losses and many times what we do is what the the struggles that we have with trading and the reason that we are inconsistent in our trading is because we're trying to apply the rules of a finite game to an infinite game and that's really where you have this frustration that comes in because you keep trying to win and you keep trying to win at something that you can't possibly win so what you realize is that when you're trading uh when you're playing an infinite game your goal is not to win your goal is to stay in the game your goal is to make sure that you don't drop out of you don't you don't run you don't um go out of business if you will and that in the game of trading is making sure you don't blow up your account you don't blow those huge holes in your portfolio and and and i know that that sounds easy to do and the reality of it is that it actually is uh but i understand that you know the question from many investors is how do i go about doing that and that's why we're going to show you the golden rule of trading the golden rule of trading is really simple it's trying to to effectively trick your brain and trick your account into making sure you don't have any account blow-ups so this is what we call the golden rule of risk management which is very simple you never risk more than one to two percent of your total portfolio on any single trade we're going to go through some examples of this using some credit spreads using some debit spreads but the goal is to make sure that any trade that you make will never exceed more than two percent of your total account value so even if the trade goes completely in the opposite direction that you expect it to you're wiping out roughly two percent of your total portfolio value and that means you still have 98 of your total account value intact ready to play so you know whenever i i hear uh whenever i get an email from investors and i and i get this unfortunately all the time people tell me you know a trade didn't go well and i've lost a lot of money and that is a that is a sentence that should never exist because no single trade no matter how bad it goes right you think a stock is going to go to 100 but it ends up going to zero that trade should only cost you two percent of your total account value and we're going to talk about why this is so important why one to two percent is that is the golden rule and risk management and we're going to talk we're going to discuss it very quickly but it's going to become very apparent why you need to stick to these rules but psychologically speaking one of the reasons that you want to stick to these one to two percent rule is because smaller losses are simply easier to accept and let go of whenever you have let's say a ten thousand dollar portfolio and you risk a thousand dollars on a single trade it's gonna be difficult emotionally to let go of that trade uh you become what poker poker players call pot committed you don't want to lose that money because it's such a large chunk of money and you'll do whatever you can to protect that loss you'll you'll even throw more money at it to try to protect yourself from losing that thousand dollars and unfortunately again in that pursuit of trying to prevent yourself from losing that thousand dollars you make mis you open yourself potentially of opening up uh risking even more money and occasionally some i'm sorry even maybe half the time you are able to to recover from that trade but the other half of the time when you're not able to recover from that trade and that trade goes out it only takes once just once for that to not work out and for you to blow up a huge hole in your portfolio and you end up in the scenario that i showed you on that very first screen so the golden rule of risk management is designed to prevent your account from blowing up in the first place because that's your only goal when you're playing an infinite game think about it the goal of trading is that over the long run you're going to make thousands of trades to focus your time and attention on a single winner or loser is just the wrong thing to focus on focus on the big picture thinking focus on the long term longevity of your portfolio not on single wins and losses does that make sense everyone please type 2 into the chat window if that makes sense to you i know i've spent a lot of time talking about this but i cannot express how important this is for the long-term longevity of your portfolio and i'm just going to show you some a few things to hopefully help make solidify this idea right so the one thing that you also have to consider whenever we're trading is the fact that every single trade is really two two parts probability of success and risk reward of that trade that you're making right every trade you make has a potential risk potential reward and a probability of making that risk and making that reward and the most important thing to remember whenever you're trading options is that or i'm sorry the most important thing to remember with any type of trading is that the higher the probability of success on a trade the lower the risk reward is going to be and vice versa a trade with very high risk reward is going to have very low probability this is just the law of life it has nothing to do with options or or trading it's just the law of life right think about on one extreme a lottery ticket uh something that costs a couple of bucks that can potentially make you millions very high risk reward it's gonna have very low probability of success vice versa if you bet on the shore bed on on the super bowl um you know the the team that's favored to win guess what if you do win you're gonna win less than what you put at risk right that's just a law of life you can't get around it um and it's very important for investors when you're trading options to focus on both or look at the balance between the two because i unfortunately see too many investors who will tell me how do i find really high probability of profit trades and what that tells me is that you're only focused on one thing and when you focus on one thing and you don't look at the other thing guess what you're missing half the picture and that's recipe for disaster if you only focus on one thing i see too many investors that have this belief that as long as you trade something with a high probability of profit you'll make money in the long run you forget that high probability of profit trades are risking substantially more than what you can potentially make so the more important equation that you want to look at is what we call expected return what you want to do is you want to weight the probability of success with the actual return of the strategy so i have here you know what is a model of what typically a credit spread looks like roughly right so we talk about when we when we sell credit spreads that we take losses at about 100 percent of our max gain and we take profits at about 50 percent of our max gain so our worst outcome is usually twice as bad as our best potential outcome and then when you weight this by the probability of each one happening so a good a a good credit spread usually should have 55 to 60 percent winners in this particular trade and only about 25 of the time you have a full loss and then and then you have a 20 chance of a small win and what you do is you multiply the probability of each return and you add the three together and what you get is an expected expected return as long as your expected return is positive in the long run you need to focus on the long run and as long as you can continue this this trade you can expect positive returns in the long run but what is the one thing that can that can do derail all of this it's when you make that when you make the decision of throwing good money after bad money and you have one large loss that completely wipes this equation turning it into a negative expected return the goal is to have a positive expected return in the long run and the steps to that is almost inconsequential because when you're trading thousands of trades having a few losers here a few winners there it's inconsequential so let go of your losers as long as you're focused on the positive expected return in the long run but again the one thing that derails all of this is when you have those large losses when you exceed your expected loss and instead of losing 100 you end up losing let's say 300 on just one trade because you insisted on trying to not be wrong and you want to roll a loser into another trade hoping to make your money back so does that make sense everyone please type three into the chat window if that makes sense to you perfect okay i see a lot of threes okay i'm throwing a lot of new concepts at you and if this is new that's okay these are recorded so that you can go back and watch this at another time so to go back to why this exp this two percent rule is so important we need to go back and understand a little bit about linear and exponential functions because exponential functions is really the one thing that really creeps up on us um and it really bites us in the s we don't get it right or if we don't figure it out correctly if it's not on the right side for us um and linear versus exponential functions not everyone truly grasped this i think before covid but i think as a as a result of covid people kind of started to better understand it basically when you have one case of covet and you say oh that's no big deal and then a week later you have two uh cases of coven you say that's nothing next week you have four and you think to yourself this is not really going to be a thing at all and all of a sudden next thing you know you have a hundred thousand two hundred thousand million cases right that's how exponential functions work is that at first it comes it's so small it really it seems like it's almost nothing until it's a little too late right um and this is how unfortunately sometimes you know the way your portfolio works and it has to do with a few exponential functions that are very critical to the success of long-term returns in your portfolio and someone said count compounding returns and that's exactly right well guess what compounding returns works in your favor when let's say you're talking about a savings account in your that you have for a long time but compounding returns also work against you with respect to losses because the amount that's required to break even on a trade uh grows at an exponential pace depending on how much you lose of your portfolio so when when we say you know losing 30 of your portfolio you still have 70 of your portfolio intact uh well guess what when you lose 30 percent of your portfolio you now need a 43 return just to get back to breakeven and i would say that this chart really doesn't do much justice in my opinion because this bar looks so large that these bars actually look fairly small but even a f but a 30 to 40 percent loss gets to the point where it's almost impossible to get yourself back to break even once you blow that big hole in your portfolio the chances of your of you getting yourself back to break even without depositing more capital is increasingly difficult and the larger you are down this line the more difficult it is to get yourself back to break even so you think to yourself oh i lose 10 not a big deal then you make another trade and you have another ten percent loss and that third trade that lost lose thirty percent if you have four losing trades that lost ten percent each your chances of getting back to break even are almost in are almost zero without depositing more money that's why whenever we're trading we we try to make sure that we stay on this side of the line we never ever at any point in our career have a total loss in our portfolio greater than 20 percent you know have you had extreme events that can cause a loss greater than 20 sure but that might be something that you experience once in a decade or once every 20 to 25 years the goal is to stay on this side of the line as much as possible because if you're able to do so guess what if you stay on this side of the line your game your chances of getting back to break even and continuing to your to grow your account is fairly high once you exceed this level your chances of getting back to break even are almost impossible once you lose 50 you have to gain 100 back just to get back to where you were and then you want to grow from there guess what that's going to be very difficult does that make sense please type 4 into the chat window if that makes sense to you perfect and then the trick here is that compounding this this exponential function also works in our favor with respect to how much of our percent uh how much of our portfolio we risk for every one percent less we risk in our portfolio for every one percent less we risk in our portfolio the number of trades that that that we need to blow up our account grows at an exponential function and guess what you want to be here on this end of the curve you want to make sure that only that it takes 50 to 100 trades so you literally have to have 50 to 100 consecutive losses imagine having 50 consecutive losing trades that's losing today tomorrow the next day for basically three months straight every single day before you've blown up your account that's what it would take to blow up your total account value if you if you risk 10 percent of your account per trade then it only takes 10 trades to blow up your total account it only takes three or four trades to get you into what i call the danger zone and if you have five or six losing trades it's nearly impossible to ever get back from those levels so the goal here is to try to use exponential functions in your favor so that it takes an astronomically large number of losing trades before your your um your portfolio blows up okay now if you can utilize this rule this is really where i see a lot of investors who again focus on the wrong thing get tripped up because even when you have a large number of losers so here is the same chart same portfolio that i had before but instead of taking that huge loss here what i have is i have 1 2 3 4 5 6 7 8 9 losing trades in a row right but the nine losing trades in a row that i took stayed within the two percent rule but having nine losing trades in a row guess what yes my portfolio took a hit right over that nine losses but i had most of my portfolio intact in order to continue trading that is the difference between sticking to the rule and not sticking to the rule and just to put that into context again look at the difference between these two trades a lot of investors think having nine losing trades in a row is a death sentence and i cannot express to you enough how much if you stick to these rules even if you have nine losing trades in a row you have most of your portfolio intact ready to trade again versus if you are just the type of trader who doesn't want to take a loss and you know half the time you keep doubling down and you make your money back but the other half of the time and again only takes one one trade that just because of bad luck right and you know whenever i showed this example of this right um of trades it's not necessarily because you're a bad trader you're you're bad at reading the charts you just can't get it right it's just bad luck that you happen to have bought at the top and then kept trying to buy it just odd times and the stock just keeps dropping it has nothing to do with your inner your ability to trade you just had bad luck and guess what bad luck blows up portfolios and what you need to make sure you do is that bad block doesn't blow up your portfolio that even a string of bad luck doesn't blow up your portfolio so a lot of investors that have you know and i can't express this enough how many times i've seen investors that have four or five losing trades and what they do is they give up on a strategy they say this is a terrible strategy i'm gonna move on to the next trade i gotta find a new service to subscribe to i gotta find a new indicator i gotta find a new option strategy don't do that because five six seven nine consecutive losses in your portfolio is not going to derail your whole portfolio what derails your portfolio is if you don't follow risk management am i clear on that please type five into the chat window if that makes sense to you um you know and anyone who says that hey i've lost this much on an entire trade what that means is that you're not sticking to the two percent rule because if you stuck to the two percent rule that loss would have been like this and you would have continued on with your trading but when you when you make that when you when we get stuck in not wanting to be wrong right and again i completely understand the human emotion of why we don't want to be wrong right because we we made this pig we personally picked this stock we thought it was going to go higher and it went against us it it screws with our ego it screws with our our um um perception of how we are able to read the charts or look at the fundamentals of a company and you don't want to admit that you're you're wrong but guess what when you think about you know and this chart here you know this is a small series this is only 40 trades over your lifetime you're gonna make hundreds thousands of trades each individual trade is so inconsequential that being that trying to be right or wrong is really it's not the dumb is not the right word but it's really um just don't spend the time trying to uh look at individual wins and losses because it's such a small factor in the grand scheme of this infinite game that you play that's irrelevant exactly thank you gene it's completely irrelevant to the long-term uh you know goal of playing an infinite game wins and losses do not mean anything at the end of the day it's how you grow your account over the long run that matters um now i understand that winning is still up because we're human right we want to win and that's part of why i suggest for many investors who are trying to figure out a way to gain consistency in your trading is to use credit spreads because credit spreads you will win at least about 55 to 60 percent of the time just by selling credit spreads right even if you're not very good at picking the direction on a stock you'll still win about 55 to 60 percent of the time so when you win more often than you lose you're going to be able to gain a little bit more confidence in your trading so it's the combination of using a higher probability of success strategy like a credit spread with the uh the the rules here of of risk management that's going to help you truly gain that consistency in your trading and what i'll do is i'll give you a quick view of how options play helps you stick to these rules okay um so regardless of how you arrive at a strategy that you want to trade the options play tool when you click on the options play score and you just click on the options play score when you click on it there's going to be a a line here called max risk right so remember let's go back to our spreadsh our spreadsheet here of how much you can risk per trade based on your account value so let's say i have a 50 000 or let's say i have a 50 000 account which means that i can risk somewhere between 500 to a thousand dollars on a single trade and this is really where you want to use the max risk aspect of this of this um platform to help you make sure that you stay within that 500 to 100 000 risk on every single trade and you don't want to just look at how much you're paying you want to look at the max risk right because if you're selling a credit spread let's say you're selling a credit spread and let's say i'm selling this particular credit spread you're collecting 346 dollars on that particular trade but you're risking 1054. so that's why it's important that you don't just look at the trade costs you also look at the max risk which is truly the number that you want to pay attention to so regardless of how you arrive at your trades you want to make sure you look at the max risk of a trade and make sure that that max risk does not exceed the limits for your account size so if let's say you have a fifty thousand dollar account your limit as a thousand dollars that means you know what whenever i hear someone's tell me your trade has lost a lot of money there that should not that should never be a statement that you have to say because no matter how bad a trade goes you should never lose more than two percent of your total account value and feel comfortable with the fact that you have 98 of your account still left to trade to make the next trade um is that clear please type six into the chat window if that makes sense to you okay so i'm gonna give you an example here right i'm gonna look at the credit spread file and i'm gonna show you some trades and i want to show you how you can apply this concept right so let's say i'm looking at bp there's this 2725 put spread this is a relatively low price stock so let's click on this bp put spread here and let's take a look at the max risk on this bp put spread here as you can see the max risk is only a hundred and twenty six dollars so for someone with a thousand dollar max risk i can afford to trade quite a few contracts here so let's look at our risk and investment calculator which is the third dot at the bottom of your screen and there's two options you can say i want to invest or i want to risk and what you want to choose is i want to risk and you want to type in the dollar amount that you can afford to risk that means for my thousand dollars in in max risk i can sell seven contracts of this august 27 25 put spread and that's going to put me at my max risk at 880 just underneath a thousand dollar limit that i have for my portfolio so the the options like platform does the work for you all you have to do is type in the number that you're willing to risk based on the two percent rule and that's going to be able to help you stick to that rule now i'm going to give you another example let's say you're looking at this report and you're interested in uh let's see um there was shopify on this shopify is a fourteen hundred dollar stock and i see this too often with investors right is that they kind of just get into whatever trade they think is best they don't really look at how much is the max risk and does it exceed my risk tolerances because this max risk as you can see is eleven thousand dollars okay now if my risk tolerance is a thousand dollars meaning the most i'm willing to risk is a thousand dollars what should i do with this trade you know sometimes you know and maybe maybe the question is not always this extreme right let me see if i can find a less extreme example which i think some investors may may find themselves more likely in let's look at franco nevada let's look at this put spread this put spread risks uh let's see this this is okay it's risk only 635 dollars that's within my risk tolerance so let's do this let's say let's say i have a smaller account let's say i have a 20 000 account so my limit is 400 that's the most i willing to risk on any single trade if i'm gonna stick to the two percent rule and i look at the credit spread file and i look at franco nevada and i see that this this contract risks 635 now i see a lot of investors well what they'll do is they'll say uh well you know what that's the minimum that i can trade so let me just go ahead and place one contract the best rule here is that if you if a trade if the max risk of a trade exceeds what you can risk the two percent rule for your portfolio you should not be placing this trade at all because if this trade goes south you're gonna lose more than two and two percent of your total account value yes there's some local room in that rule but when you have wiggle room in your rule that's when you start to deviate away from discipline right because ultimately in the long run in order to stay with the strategy in order to be have that positive expected return in the long run it's about discipline it's about understanding the rules that i've set in place with respect to credit spreads you know what are the rules we're getting in what are the rules for setting your stop losses and getting out and what are the rules around risk management the more flexibility you give yourself on those rules the more flexibility you're going to deviate from those rules the more likely you're going to have chances where you can blow up your account if you have these rules in place and you stick to them and they're black and white for you guess what you're never going to be in a position where you blow up an account because you follow these rules to a t so i cannot and i'm not i cannot express enough how important these things are for the long-term success for your portfolio so and and because i understand how difficult it is that's why we we made it so easy all you need to do is find your account value and make sure that you understand what is the range that you can risk in a total portfolio and if you ever come across a trade that risks more than that amount you know you cannot trade that amount you cannot trade that at all you got to trade something with lower risk that's how you're going to be able to gain consistency in your portfolio and as you slowly build your portfolio in value that's when you're gonna as you build your portfolio into a larger and larger portfolio not only from games but also depositing more money on a regular basis into your account let's say you deposit 500 in your account every single month and you have some gains to go along with it that's going to grow your account and eventually you're going to be able to trade that franco nevada trade where you're risking 635 but that's because you've grown your account not because you've bent the rules as far as how much you're willing to risk so that covers what i wanted to share with you here today and again i cannot express how important this is for your trading so just a quick summary of what we discussed here today remember you're playing an infinite game focus on the big picture not on the wins and losses get yourself out of the weeds i see so many investors focus on individual wins and losses they're somewhat inconsequential for the long run of your portfolio so stop focusing on individual wins and losses there there's rules around when you take profits when you take losses it's not something you need to have emotional um you know ties to a trade just stick to the rules it's either a trade that's out of take profit or a stop loss and guess what you know sometimes you just have consecutive losses will happen that's okay consecutive losses are not a death sentence i cannot tell you enough how many times someone has sent me an angry email telling me that three trades in a row that i've told them about has ended with a loss or they're cancelling their subscription well guess what if that's your view on trading that three consecutive losses is something that's gonna deter you from trading you're gonna run into that everywhere you go from what strategy you go to you're in the next strategy you go to at some point you're gonna have three consecutive losses you're gonna keep moving on and guess what you're never gonna be able to gain that consistency learn the strategy and stick to it even if you have to ride out through five six seven eight nine consecutive losses in a row you're all you're going to be able to ride that out if you stick to the one to two percent account value rule account blow-ups will basically end your trading career which is why uh you want to avoid it at all costs and like i said it just takes one slip up to blow up your account that's all it takes you know and and i cannot express to you enough how much um you know how how hard it is sometimes to avoid it but the rules in place are here so that help hopefully helps you from avoiding that and if you do want to manage roles you know a lot of people ask me about roles well roll your winners don't roll your losers cut your losers that's all you have to do when you have a winner you have a lot of options you can roll a winner into a bigger winner right those are that's when you want to apply your roles stop applying your roles to losers because that's when you can turn a small loser into a much bigger loser that's when you deviate from your trading plan that's how this all goes south so with that that covers what i wanted to share with you here today i hope that this was helpful in giving you a better understanding of how you can shift your thinking from trading because again it's not a finite game it's not about winners and losers it's about the finite game the infinite game where you have to trade thousands of trades in over the long run so individual winners and losers are completely inconsequential stop get your health get yourself out of those weeds and stop spending too much emotional time figuring out how do i turn my loser back into a winner because the decisions you make in that space is usually what causes you to make bad decisions and cause you to potentially blow up your account um so with that again like i said thank you so much for your time here today i hope that this was helpful in giving you a better understanding of trading psychology and how you can shift your thinking so with that i do have just only today about 10 minutes of time to answer some questions i unfortunately have to run but i do want to spend some time trying to answer as many questions i have time before i have to run so with that there's a q a window and a chat window at the bottom of your screen if you could please type into your q a window um we will i will try to answer as many questions i have time for during in the q a section uh so let's see uh okay uh with the 50 and 100 oco don't i don't i need to do better than 80 of the time uh no with the 50 and 100 oco you have to be right 67 of the time to break even um but you're not taking into account the fact that you're gonna hit your take profit far more often than the full max loss on a credit spread but no not 80 of the time if you're if you're 25 75 i'm sorry no not even that if you are a 20 80 then you have to be right 80 of the time uh samir thank you so much uh lori what about taking a higher risk trade but stopping out when it reaches your accounts max risk so lori this is a great question the question laurie is asking is why can't i uh risk four percent of my account per trade and then just stop myself out at half of that right so normally if i'm if i'm only willing to risk a thousand dollars why can't i risk two thousand dollars and then give myself that stop loss lori in theory you can but stop losses do not guarantee execution which means that the the stock can oh gap open the next day and you and when it closes one day you're down 700 the next day it opens you're down 1500 so at that point you've exceeded your max loss already so you can but there's a risk that you're going to exceed your max loss on the trade again people always want to find ways around these rules and try to find poke holes in these rules i cannot express you enough why do that why why try to cheat the system you know it doesn't quite work in the long run so who you're cheating is really yourself right you're trying to find ways to to maximize return but what you really do is you're maximizing or you're increasing your risk uh do you ever use rsi overbought to close a winning trade um frank rarely i you know usually i don't use indicators to be the sole reason that i get in and out of a trade there's usually more behind a trade than just a single indicator of being overbought or oversold does the max two percent rule apply to trade costs or total value of the account uh the two percent rule is the max risk of a trade relative to your total account value on managing winners rather than rolling a position would it be advisable to exit at 50 profit perhaps 60 to 70 profit so brian um you can uh you know many times you know 50 is when you start to take profits by the time you actually take profits you might be actually up 60 to 70 on time most of our winners will actually take at almost 60 to 70 of the time or 67 profit level um but yes you know you can do that but you but i'm saying that you can take 67 60 to 70 profit level and still roll your position into further profits is what i'm trying to say uh when should you close a debit spread the rule of thumb for a debit threat is cut your losses at fifty percent loss and take profits at about 75 percent gain uh rolling a trade is very simple rolling a trade is just closing an existing trade and opening a brand new one in a single trade that's it you're just placing all both trades at the same time will this be posted on the website for viewing again yes all of our videos are posted on youtube for replay uh so placing oco orders will take care of risk placing oco orders kind of take care of risk because again uh the market can blow through your stops and you can get stopped out worse than what you were expecting to get stopped out of so you really need to make sure that you understand the difference between those two is the cash secured put report available as a proper spreadsheet so i can sort the rows i'm graham that is something that we are actually just finished so we will be launching that very soon because the credit spreads you can now sort and filter uh we're going to be doing the same thing here how you can sort and filter on the credit spreads we're going to launch the same thing here for uh cover calls and short puts as well uh william thank you so much i have three separate portfolios do i risk one percent of one portfolio or the sum of three uh david i guess that depends on what which portfolios you speculate with i would say that you have to take what percentage of your portfolio do you do your speculation with right so if you have two of those portfolios there are long-term retirement accounts and you're not actively trading in them then those are excluded from you know the portfolio some if you will how hard is it to trade at the five thousand dollar account and keep it to the one one to two percent rule it's difficult because a five thousand dollar account means that you cannot risk more than a 100 i tend to find that at this extreme value many traders have to find themselves in that three to four percent rule now three to four percent rule is not it's not the end of the world it's it's more risk than i think most investors should trade but i understand that when you have a small account there's only so far a lower you can go so i do find that sometimes with a five thousand dollar account investors do have to step into the three to four percent range in order to even find trades to make can you explain how the unwinding of a large put position fuels share put price higher andrew um i'll try to address that in our market making class because that kind of has to do with how uh market makers hedge their airport how how they hedge their risk on the trade that's going to help us uh better understand that so i'm going to answer that under uh when we when we do the course on market making before cutting a losing spread why not sell the other spread other side of the trade to collect more premium to reduce the loss so again kenneth is suggesting a way to potentially gain a little bit of a slightly higher edge so kenneth what i'll say is that yes in that position you can potentially reduce the loss a little but you can also increase the risk on that as well so you know you're increasing your potential returns but at the same time you're increasing your risk and yes you can do that but in the long run that's not going to net you some big you know significant change to your strategy in my opinion um so with that that covers what i have time for you here today unfortunately i have to run but i want to thank everyone for taking the time out here this afternoon i hope that this was helpful and giving you a jump start into how you should think about your training and your psychology and hopefully this gives you some insights into how you can gain some more consistency in your trading uh with that thank you so much i'll see you guys tomorrow morning on our next thematic investment series have a great evening you

Channel: OptionsPlay

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Keywords: options trading, options education, OptionsPlay, Tony Zhang, technical analysis, trading, trading education, CNBC, options trading for beginners, options trading explained, options trading 101, consistency in options trading, options trading consistency, trading psychology, golden rule of trading, consecutive losses, strategy or psychology, stock market, financial education, investing, option trading strategies, linear vs. exponential, psychology of trading, smart trading

Id: 8RhyEzlvoHs

Length: 57min 54sec (3474 seconds)

Published: Thu Jun 24 2021