Stock Trader Confession

Stock traders like to talk about their winners, their successes. This makes the trader feel good and impresses others with their prowess. More important than winners are stock trading losers. Why? You can learn much more from your losers than your winners. Losing stock trades are expected. No stock trading system is perfect. Carefully analyzing losing trades, though painful, often reveals areas of improvement so you can be a better trader.

I have spent tens of thousands of dollars on stock trading courses, books and other educational material. Yet, I learned much more from my losing stock trades than from all those. Losing trades are the real tuition of a stock trader. So here is my confession and what I learned from it. Hopefully you can learn from it too.

By mid-February 2009 my stock portfolio was up almost 20%. I was feeling good, probably over confident. As part of my market neutral trading plan, I put on a large March Iron condor index option spread. Iron condors are profitable when the index stays within a range (between the short strikes). Soon after I put on the position, the index started rapidly dropping.

Recently I have been developing a way to hedge against such moves to offset the potential Iron condor losses (I put on Iron condors every month). In October 2008, hedging turned a 25% losing Iron condor into a 25% winner. So I felt like I knew what I was doing. I developed my hedging approach through training and experimentation. I had the rules in my head: a mental trading plan.

Following my mental trading plan, I started hedging my March Iron condor in early March. Soon after I hedged the market turned upward. I sold the hedge at a loss. Within a week the market had moved high enough to put the Iron condor at risk again, so I hedged again. The market reversed for two days and my hedge lost money again. By the time I closed the March Iron condor it had a 30% profit, even though it was threatening to be a big loser twice during the month! My hedge losses erased all the Iron condor gains and all my year-to-date profits.

Painful as this was, I objectively evaluated what went wrong (after a few days to get over the shock). I made several mistakes:

1. I did not have a written trading plan. It was all in my head. This caused my emotions to affect my trading. I always follow my written trading plans. But with a mental one, it was easy to second guess myself.
2. I started to hedge too soon. My rule is to hedge only if the Iron condor is threatened within two weeks of options expiration. Almost all of my Iron condors expire on the third Friday of the month. This one used quarterly options, which expire at the end of the quarter, much later than regular monthly options. I forgot about this in the heat of the moment and hedged this position as if it expired on the third Friday. This resulted in me hedging too soon. I would not have hedged the first time if I remembered this was a quarterly option. Not having my trading rules written down was a major factor in this mistake.
3. My rules to manage my hedge are vague, based somewhat on gut instincts. My instincts failed me that month. This is a trading system failure. I need to clearly determine how I will manage the hedge and write that in the trading plan.

Bottom line: I need to update my market neutral trading plan to include hedging with precise rules on how to manage the hedge. This was a very costly error that I still have not financially recovered from.

Tags: stock trading system, trader psychology, trading plans

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