Welcome everybody. I was actually talking there for a little bit and realized the on button wasn’t on yet. Okay, welcome everyone to what is literally going to be, literally going to be the greatest class you’ve ever been to. Okay, that’s not entirely true.
Let me just say this will literally be a class that you’ve gone to. I’m just kidding. Actually, this is something I have been wanting to go over for quite a while with the group. When we were in Las Vegas as a firm and for those of you who were able to come down, we had a great, great time. That was in late March.
We were able to get … It’s such a nice and to be able to do to get in person with our traders and really sit down and chat and talk. Not just have a good time and get to know each other, but really get a good feeling where people are and where they are in their trading and their knowledge and education.
This was something that after the Vegas summit, I thought, “This is really something we need to go over and discuss.” For those of you that weren’t in Vegas, all we did in Vegas was talk about position sizing and consistency.
We played a really neat game called the marble game. It was where we had a bag and in the bag were 20 marbles. 10 marbles were winning marbles, 10 marbles were losing marbles. What we did is we first had somebody come up and pick 10 trades.
Actually, you know what? We did 15 trades. We did 15 trades. They decided before they picked out a marble how much money they were going to risk on the trade. We didn’t give any guidelines. The first one I said, “Okay, I’ll risk $500 of my $10,000 account.”
If they lost that, on the second trade they’d typically cut back. Well, I’m only going to risk, “$200.” Then if they won that one, they would say, “Well now, I’m going to risk $1,000.” What happens is is that the emotional side of trading would get into it where they were using motions.
They were using what happened to them on the trade before to determine what they were going to do on the next trade. We talked about how that’s such a deadly thing in trading. I gave a couple of examples about myself how my mode of operation, my first couple of years was the more I won, the more I bet.
What happened was I eventually ended up taking that really big catastrophic loss and wiped out all my gains on my prior six or seven grade trades. There’s a lot of people in the group that could definitely identify with me.
We talked all about consistency, we talked about position sizing, but the next step I wanted to take was this class. Portfolio Management. About in your account, you’re going to have a basket of trades. I want everyone to start looking at their basket of trades or their account as one trade and that’s what I’m really going to be talking about is that when you total everything up in your account, you are going to be positive delta, negative delta.
You’re going to be positive Gamma, negative Gamma, you’re going to be positive Theta or negative Theta. You’re going to be positive Vega or negative Vega. This is really what I want you guys to look at is that when all said and done, you might make five or six individual trades, but when it’s all said and done, your entire portfolio will also have a Delta, a Vega and a Theta.
It’s really important to keep in mind what that is in your portfolio because that’s going to be very important when the market moves up or down, when the market goes sideways, how is that affecting not just each one individual trade, but how is that affecting your entire overall trading portfolio?
All right, this is something that people get stuck on all the time. You know that I’m a big picture guy. If you guys have been with us for any amount of time, I’m always talking big picture in the trading room and it’s … I know it’s so funny when people join up with us the first time, they go to the trading room.
We spend 45 minutes of the hour. 45 minutes of the entire hour on our current positions management, but then most of the time is spent on the overall market. I know when people come jump on their first trading room, they’re like, “Geez, when are these guys going to get to the trades? Come on, the trades are the important part. I’m not talking about the market. Let’s get to the set ups.”
Then we blow through six or seven set ups in about 10 or 15 minutes. Everybody were saying, “What? Wait a second, why did they blow through that?” They spent so much time on the overall market. Well, it’s because the big picture is such a huge, huge deal.
I feel like people all the time get tunnel vision. Now, I clipped out this picture here, Joe and I were laughing about this. This is a really nice pontoon boat. Take a look at it. It’s got two-stories, it’s got dual overhead cam engines with … Sorry, I have no idea what that even means, but anyway.
If you were just to look at this picture, you’d say, “Wow, you know what? That looks really, really great.” But you’re not looking at the big picture. All of a sudden, things don’t look so great anymore. I’m always, always telling our traders, “Look at the big picture. Look at the big picture.”
This is why we talk about the market so much is why we talk so much about our top down approach. People always look at one stock and they say, “Oh, this one stock is great. It’s fantastic.” But how does it fit in to everything?
Tim’s right. Here’s the funny thing. Joe and I were joking about this. The boat looks absolutely fine. This boat could easily go back out on the ocean. It looks fairly undamaged. The town is completely destroyed. This is where in our top down approach, we really preach this looking at the big picture.
Then we’re going to talk about today as portfolio management where people get so focused in on one of their trades or two of their trades or they get focused on one trade and they don’t understand how it relates to everything else in their portfolio.
I want to today have everyone take a step back and look at their overall portfolio. These are the things that’s from now on if you haven’t already been doing this, I want you to really think about your portfolio. Take a look at your long, short exposure.
Meaning, are you 100% long? We had a couple of traders that just up to about two or three weeks ago were 100% long in their portfolio which of course is fantastic when the market goes up. The problem is when the market goes against you, you get creamed, you get absolutely hammered. You get destroyed.
Then we have some people again let’s just take last week. Last week, I was pretty much all short. Last week wasn’t a great week. As far as the positions I had, I had pretty much at one point. I had four out of five and my trades were all losers.
It didn’t look great because I was net short and the market bounced. I want everyone to really keep in mind, “Okay, I’ve got three or four bullish trades on, do I really want to put on another bullish trade? Is that really what the market is telling me right now? Is that we are that bullish?
We are that bullish that I can just load up the boat on bullish trades? Or does that not reflect what I really think about the market?” Let’s say right now you think the market is mildly bearish. Well, if you have three bullish trades on one bearish, your portfolio is not reflecting your outlook on the market.
If you have 10 bearish trades on and no bullish trades on, your portfolio does not reflect your overall market outlook. What you really want to do is you really want to have your entire portfolio reflecting the overall market stance you want to take.
Next is what is your overall portfolio delta? Right now, a couple of months ago, Joe and I were playing around with a new trading platform. We ultimately decided not to go with it because it was … It didn’t have a lot of the features that we liked at [IB 00:10:30] and the order entry was pretty crummy, but it had one feature that was one of the coolest features I have ever seen.
It was exactly what number two is here. What is your overall portfolio delta? This software would tell you if you had 10 trades on, if you had some bull calls, some bear call, you had some diagonal, you had some long calls, you had some long stock, you had some short stock, it would actually tell you at all time what was your overall portfolio Greeks.
It was really, really I thought one of the neatest things I’ve ever seen. I’ve never seen it on any other software. Like I said, we ultimately decided not to go with it because it was terrible for everything else, but what I want you to start thinking about and maybe even going in and doing this by hand is I want you to start to think about what is your net exposure?
What is your net exposure on your portfolio? Right. Yeah, it’s not how I wanted it. All right, anyway, what is your position? Let’s take that first of all, you got into a … It’s called a 55, 60 I want to call it a bull call spread. All right.
Let’s say that is your position. Let’s say we look at the numbers and your delta on this trade is 0.35. Your theta on the trade is -0.02 and your Vega on the trade is going to be fairly hedged out. Let’s say it’s going to be +0.01.
On that one trade, we run all the numbers, we’ve run all the numbers, we run everything and we say, “Okay, this is where we’re sitting.” Max just asked a question, “Doesn’t the trade journal calculate your exposure?” It calculates your risk exposure.
It calculates your risk exposure, but what we’re really talking about is our delta exposure or our Greek exposure. If you haven’t really dived into advanced options yet, it’s not going to make a whole lot of sense, but every single options trade you put on, every single stock trade you put on too is going to give you a set of Greeks.
It’s going to give you what’s your delta, what’s your theta, what’s your Vega. What I’m going to do here is that we’re going to total up our net exposure. Our net exposure in this portfolio. Let’s say our next one is 110, 120 bear call.
That’s our next position we’re looking at. Now this one, the delta exposure on this is -0.20. We’ve got positive theta of 0.03 and we’ve got a Vega of let’s just call this Vega 0. All right. If we go through them and we list all of our positions, let’s say we’ve got a 65, 75 call ratio of backspread, on this one we might have delta exposure of … We might have positive 120 delta points, but on this one you might have -8 theta.
Of course, we’re going to have a very nice positive … Anyway, we’re going to have a positive … I don’t know why I’m putting this in decimals. It should just be a +5 or a +1. The point I’m trying to bring up is that at the end of it all, at the end of it all, you can calculate out your net Greek exposure.
Like I said, this is what the software we looked at did for you automatically. Do you need to go through and hand calculate this on a daily basis? No, you don’t. I think that is ridiculous. Now look, we have some traders. We have one that was right by us here that he would, he would go ahead and do this. He loves to do stuff like this.
I personally think you’re missing the big point. However, should you be conscious of your net exposure? Absolutely. Absolutely. For instance, right now I’ve got on three straight bearish trades. When I say straight, I mean straight puts.
One is calls, but it’s on the VIX. On those three trades, I know that, “Okay, I have tilted my portfolio pretty much all the way bearish.” I have theta against me pretty heavily. All of my trades are negative delta and negative theta.
What that is telling me is that every day the market goes sideways, I’m going to lose money in my portfolio. Every day the market goes up, I’m going to lose even more money on my portfolio because I’m going to lose on delta and I’m going to lose on theta.
All of a sudden, that’s going to really factor in to how I treat my positions. I know that, “Hey, the market’s got to fall, the market is going to fall soon or else it’s going to start costing me money.” I might be looking at my portfolio saying, “Does this reflect how the market is reacting right now? If it’s not, then I’m in the wrong basket of Greeks. I’m in the wrong basket of trades.”
The net Greek exposure, do you need to calculate it? No. Do you need to understand where you are? Absolutely. Now, this morning I had it on four bear call spreads. Now, those four bear call spreads, what did they come with? Will they come with more negative delta, but these come with positive theta.
What I’ve just done is I’ve just become more bearish to market now, but I’ve now got positive theta. Meaning if the market goes sideways, it’s no longer going to hurt my portfolio. I’m in a neutral to bearish position. Then of course I added on two longs because you know what? I didn’t want to be … Maybe I thought, “Hey, I’m a little bit too bearish.”
When we add on two longs, what that does that brings my net delta from being really negative back to being more moderately negative and it allows me to have a better set of Greek. The point I’m making here is if you add up all these numbers, let’s say someone had these three trades in their portfolio, they’re looking at being having 135 positive delta points.
They’re looking at being -7 theta points. They are looking to be positive Vega. They’re just how I talk about … +4. As you can see here is that this portfolio has an overall exposure to the markets. Now, I don’t need to know any of the actual trades.
Let’s say that someone came to me and didn’t even tell me what trades they were in. They didn’t tell me what stocks they were in, they didn’t tell me what strategies they were in, but they said, “Here is my net exposure in the markets.”
I can already tell you what this person needs. This person needs a bull market and they need it to move today. They need it to move soon. They are positive delta, but they’re negative theta. Every day, it takes for this move to happen. It’s going to cost them more money.
They are looking for bull market. Then, here’s a question. I could ask them, “So, it looks like you are pretty bullish over the short-term.” What if they tell me, “No, I actually don’t think this market is going to go anywhere in the next couple of weeks.”
Then they’re obviously, obviously in the wrong place. They’re totally in the wrong place. Looking at your net Greek exposure, very important. As I said, you don’t have to calculate it, but think about how many bull call spreads are you in.
Those bull call spreads they start out as positive delta, but negative theta. How many diagonal spreads are you in? Okay, a diagonal call spread. Well guess what? That’s positive delta and positive theta. Great, you’re in some condors and butterflies.
Okay, that’s hedged, that’s zero delta, but you’ve got positive theta. Positive theta and you’ve got positive Vega on those a little bit too. The point I’m bringing up is think about your overall risk exposure in your portfolio.
Last thing, worst case scenario. Worst case scenario. I have probably become way too paranoid in my life. Look, I’m not paranoid in the rest of my life, but in my trading life, I always think worst case scenario. It is one of the reasons why I’ve been able to do this for as many years as I have is that I’m always thinking worst case scenario.
I’m always thinking, “Okay, let’s say I’m 100% long in my portfolio.” What am I thinking about? I’m thinking about, “Okay, you know what? What if there’s another disaster? What if there’s another terrorist attack? I’m really tilted bullish here.”
Now, it’s okay to be tilted all the way bullish, but at least be thinking about the downside. Most amateur traders, they never think about the downside, they always think about the upside like, “Oh, look the market is running. I can’t wait to see how much money I’m going to make.”
Professional traders are always like, “Okay, let’s put our portfolio bullish, but let’s think worst case scenario.” All right, now again, those users then with us for a while, you are familiar with them. I’m always make fun of the pie chart. I’m always making fun of the pie chart.
Now, this is the infamous pie chart. This is the pie chart that people all over the world are paying 1% of their net worth every single year to get this on a piece of paper. Now, I always joke just if you go to a financial planner, they’re going to put you in an ampersand large cap, 15% small cap, 20% international and they’re going to put you in this pie chart.
If you’ve got a million dollar portfolio, you’re paying 10 grand a year for this pie chart. I’m telling you. I was going to say my 12 year old daughter could put you on this. Actually, she couldn’t, but I could teach someone in two days how to take anyone in off the street and put them in a pie chart.
Now, here’s the thing is that they always say, “This is customized to you.” Guess what? It’s customized to someone your age. That’s all it is. If you go to a full service broker and you’re age 50, the brokers has already told them what your allocation should be. All they need to do is follow it.
Now, let’s talk about why this actually is a good idea. He gives you diversification. Now, I’m not a huge fan of diversification. There’s a guy named Warren Buffet. Warren Buffet calls diversification the modern word for ignorance. I love that guy. Modern word for ignorance.
He says that blind diversification, meaning just putting your money and all sorts of different asset classes is only a good idea if you don’t know anything, but he says, “Hey Wall Street, why don’t you do your job and avoid the things that are bad and buy the things that are good? Why don’t you actually go in and do some research? Do some analysis, do some study, do some channel checks?”
Well, Wall Street just says blind diversification. Just spread it out. Here’s the irony here is that if you do have a pie chart and you know some of this pie chart, they think they’re diversified. They’re not diversified at all. They’re all in long stocks, your long equities.
That is not diversification at all. If this is someone’s portfolio, they are long … Well, all alright, they’ve got some fixed income. I’ve got 20% in bonds that are going to go up slightly in a down market, but in 2008, there’s some white people that were so-called diversified still lost 30 to 40% of their portfolios because they really didn’t have any diversification.
They would just spread out over a lot of long stock. Now, what this pie chart does, it does offer a measure of safety. It may fit to where anything under performs really awful that it’s not a huge part of your portfolio. Let’s say that small cap, non-US small cap, it does awful. It does terrible. It plunges.
It was only 4% of your portfolio. There might be some things that did well. Let’s say during that period of time, fixed income goes up. During that time, absolute return alternative investments go up. Let’s say real estate stayed sideways.
Let’s say all these went down. You’re going to see that even though you had a couple of bad investments in there, you had a couple of good investments as well. What happened is it evened out your loss. This is the idea of diversification.
Diversification does lower risk. However, diversification also lowers return. It’s a double-edged sword. Meaning, let’s say non-US small cap equities do great and guess what? It’s only 4% of your portfolio. The whole time, your fixed income portfolio is going lower and you don’t really get that huge bang for your buck because you had it in such a small area.
All right, now again, I wanted just to go through the idea of diversification, the idea of the pie chart because what I really want to talk to you about is looking at your portfolio as a pie chart. You’re going to have trades.
You’re going to have trades and they’re going to be part of your portfolio. You’re going to have multiple trades on at the time. How does it affect the entire portfolio? I wrote a little bit in here about hedge funds. Hedge funds were traded in the … I always thought early 50’s, but in 1949, Alfred Jones.
Alfred Jones he said that, “You know what? Asset price or prices of stocks.” He said, “Look, they are partly due to the underlying company itself.” But then a huge part of what a price does is attributed to the overall markets as a whole.
He said, “Look, I want to get paid based on my analysis.” I want to go in and say, “Look, I analyzed this company, I think it’s bad, I think it’s good.” I am sick and tired of the markets gyrating where I could go in and pick good companies, but the economy goes south and I take a loss on my portfolio that year and my clients aren’t happy.
He devised the first hedge fund. His idea was he balances portfolio by taking $1 short for every one dollar he held long. In this idea, he was always hedged. If he bought some, a million dollars worth of Ford, a million dollars worth of GM. At this point, he would be market neutral.
Now, what happens is a market neutral portfolio, the idea that if the market crashes, well guess what? This short, she performed very well. The long should underperform and lose money. However, it should be balanced and vice versa.
If you had a portfolio and the market went higher, but obviously your shorts would be no good and your longs would produce well. Now, if you were totally balanced and again, just to do something dumb, let’s say you went long 50% of your portfolio in the S&P 500 and you went short the other 50% of your portfolio in the S&P 500.
Obviously, you would never ever make or lose any money at all. You’d be 100% hedge. The hedge funds what they do is they say, “Look, we think that we can choose stocks better than a coin toss.” They go in there and they do their analysis and they do 50% long and 50% short.”
What that does, it creates a market neutral portfolio. A market neutral portfolio gives the point where the market itself shouldn’t affect the portfolio at all. What should affect the portfolio is how well you picked the underlying investments.
I got a question from Doris, “Okay, well it sounds like we should keep our portfolio fully hedged.” We do have some traders that pretty much keep a delta of zero in their portfolios just like we talked about with the hedge funds where they really have no delta exposure in their portfolio.
They have 50% of their trades are longs, 50% are shorts. If the market moves up or down, it shouldn’t affect their overall portfolio at all. However, there is always this balance between risk and reward. A delta neutral portfolio also is going to be a very slow-growing portfolio, but look, there’s nothing wrong with it.
We have some traders that say, “Look, I just need to make 20, 25% a year and I make a really good living.” A delta neutral portfolio is a fantastic way to do that. They take five longs, they take five shorts, they take five neutral trades.
Some are going to work, some are not, but overall they say, “Look, I’m going to put myself in the right place. Every time I’m going to be delta hedged, I should overtime make money.” However, it’s also a very slow way to grow your money.
What I wanted to talk about today is basically think about your portfolio as a pie chart. Think about how you’re allocating your capital. Now, this is just the same pie chart we saw. What I want you to think about is instead of doing individual areas, we could actually put in, “Okay, this trade is our VXX long September 22 calls.”
All right, that is that portion of my portfolio. Then in this other portion here, I have … I’m going to be long the VMware 100, 105 bull call spread. You guys get the idea. Basically, looking at your portfolio as a whole, you’re going to see, “Okay, where is my exposure? Where is my long exposure? Where is my short exposure?”
Now, this is my great pie chart because what we talked about in Vegas was consistency and position sizing. As you can see, some of these wedges are bigger than others. We said, “Look, to get the best results, you want to have every single one of these wedges be the same size.”
You want to have uniform position size. Now, if you do not have uniform position size, let me tell you what’s going to happen in your results. As you can see in this example here, our long VMware trade is a much bigger part of our portfolio than our long calls on the VXX.
Obviously, let’s say that we make money on one of these trades and we lose money on the other. One is a bullish trade and one is a bearish trade. Well guess what? You can’t just look at this. You can’t just look at this and say, “Okay, but look. I’ve got one long trade, I got one short trade on delta neutral.”
Well, you’re not. You are really heavily weighted towards a bull side because look, you are taking a much larger position. A much larger position on the bull call spread. People might say, “But look Rob, I’m one bullish, one bearish that’s not … That is true, but you are not in any way neutral in your portfolio. You are really, really heavily weighted to the bullish side.”
Realize that that’s why we always talk about uniform position sizing. Uniform position sizing is going to give us the ability to be able to manage our portfolio a little bit better. You could say, “You want to make sure all the pie wedges are the same, make sure they’re the same, make sure they’ve got the same amount of risk. That way, it’s easier to calculate.”
Now look, if you do want to take that extra step and you don’t want to do uniform position sizing, I really, really advise against it, but again, people say all the time, “Well geez Rob, I’ve got a good feeling on this one. I want to do twice as much.”
Well, just factor that in. Let’s say you’ve got one bullish trade that’s twice as big as your average trade. Factor that in to your overall portfolio. You may no longer be delta neutral. You may be tilted bullish and if you take a look at the market, you’re thinking, “What? That’s not the right place to be. The market is more bearish right now.”
You just look at everything and use it together. Some of you have heard this several times before. I’m going to do it again. This is such a huge, huge thing to understand and it’s a little bit embarrassing, but I think this took me about four or five years to really understand. That’s pretty dumb.
Four, five years to really get one topic here. I try to share this with our traders at least a couple times a year as we have some new traders coming in because it’s something that once I got this, once I understood this, it really liberated my trading and it made me a much better trader.
Before this, I would have told you I understood it, but I would have traded differently. I would have still screwed it up because I didn’t really get it. I called my 10 trades. 10 trade analogy. Let’s take a trader. Let’s say they make 10 trades. Now, what we just talked about is that you could be any combination of trades.
Let’s say a trader makes 10 trades. Let’s say one trader let’s say they make all 10 trades are bullish. Now, this is again, a heavily weighted portfolio to the bullish side. Now, I can already tell you about what’s going to happen to this trader.
Now, the 10 trade analogy is just the idea that you’re going to make a number of trades over a certain number of time. You might make two at a time, you might make five, you might make 10, but anyway, let’s just take the next 10 trades you make.
There is no way. There is absolutely no way that you’re going to be right on all 10. It’s like I know there’s someone out there saying, “You know what? It’s possible.” Of course it’s possible. It’s just very highly unlikely that you’re going to be right on all 10.
Also, there’s going to be people say, “Well boy, they’re going to be wrong on all 10.” You know what? Again, it’s possible, but it’s going to be highly, highly unlikely. Highly unlikely. They might be wrong on most of them, but to be wrong on all 10 is pretty unlikely.
However, how you put these trades together is going to make it more or less likely. Obviously, this is a long weighted portfolio. All 10 trades are bullish. What happens if we get a 5% move down on the market? I’m guessing this trader is going to be right on one out of 10, two out of 10, three out of 10.
They’re going to have pretty dismal results. However, let’s say the market goes up 5%. I bet this trader is right on eight out of 10. I bet this trader is right on nine out of 10. It might even happen. It might even happen 10 out of 10.
The point is there’s a position for that. This kind of a portfolio is going to take some wild swings. Some wild swings. If the market goes up during this period of time, they’re going to have a great month. If the market goes down, they’re going to get hurt.
They’re going to lose 20, 30, 40% of their portfolio. Obviously, what goes into the 10 trades is a big deal, but the whole point of the story of the 10 trades is that you’re not going to be right on all. Some of them are going to be bad.
Now, if you are doing the right things and again what we talked about is beat your trading with the markets, top down approach, you’re trading with the markets, you’re trading with the sectors, your long to strong sectors, your short to strong sectors.
Let’s say that this trader makes 10 trades and there are 10 trades, let’s say that they make five long in outperforming stocks and five short in underperforming. All right. Now, this is a delta neutral portfolio. As long as they’re in the same position sizing, this is a delta neutral portfolio.
What’s happened is they’ve taken the market out of the equation. What’s going to matter now is how well they picked their trades. Now remember, there’s no way they’re going to be right on all 10. There’s no way they’re going to be wrong in all 10. They’re going to be right in a percentage.
Now, I tell everybody that no matter how hard you try, no matter how much analysis you did, no matter how much praying you did and begging for guidance, I’m telling you that you can just expect three to four trades to be bad, just expect that.
Just totally expect. I know that going into a trade I’m going to be about 60 to 70% accurate. That’s where my win loss is fluctuated over the years. Now, this is where I always tell people that I didn’t quite get it yet. I didn’t understand that this is how the game is played.
People always said, “Rob, do you think you could be right on every single trade?” I would say, “Of course not, that’s ridiculous. No one can be right on every single trade.” Then they say, “Well geez, what about the one you’re in right now.” “Oh yeah, I am definitely going to be right on this one. I’ve got a good feeling about this one. This one is a guarantee.”
Do you see how ridiculous that is? It’s why I said I didn’t quite get it. Yes, I know you couldn’t make money on all of them, but the one I was in, I was really confident about. It’s ridiculous. It’s a ridiculous notion to have. You have no idea.
Yes, you’ve done your research, you’ve done your charting, you’ve done everything you can, but you have no idea. Out of these 10 trades, three or four if you did everything right are going to be terrible. That means that on it’s called three out of five, they’re going to be okay.
Now these are going to be trades that at one point during the trade were working for you. Maybe they were up and then they came back down and you got knocked out of breakeven or they were down a little bit, but then they ended working in the end to making you a couple of bucks.
Again, these are ones that just were so so. Then you’re going to have one to two that are great. You’re going to have one of … That’s it. That’s it. Isn’t that depressing? Isn’t that depressing that all that work you’ve done, all that research you did, all your looking at charts and plenty of risk reward and plenty at all these things.
Only one out of two are going to be great. Sorry. One or two out of 10 are going to be great. Sorry, one or two out of 10 are going to be great. That’s depressing isn’t it. That is really depressing. All that work to get 1 out of 10, the ones that really take off and go your way.
That is the game. That is the game folks. Now of course, a lot of factors go into this. The market is a huge factor. If the market went out 5%, you’re going to have more great ones on the long side. Do you realize that? If you did five long and five short, you might have two or three great long trades that go all the way up to your target more.
However, let’s say that the market went sideways. Well, in this portfolio, a sideways market you might get one great one. The rest of them are going to be probably okay or bad. This is the game. This is what you’re playing. It took me years to figure out that it wasn’t about one trade.
I always thought, “Oh okay, I’m going to make this great trade. It’s going to go up. I’m going to make a ton of money.” It was nothing about that. It was about making 10 trades, doing them all correctly, doing them all at the same way with the same position size and losing all five of them and making money on five and at the end of the month, counting up, “Oh yeah, look I made a couple grand.” That is the game.
This fits perfectly into our portfolio management. Position your portfolio the best way you can. Your overall match up of positions should reflect your overall view of the market. I’m just going to draw a couple of scenarios out just so everyone can understand.
Again, this is what everything we do at Maverick here is designed to put you in the right place. First thing I’m going to put in is let’s say that we are in a let’s do sideways. Let’s say we’re in a sideways market. Part of this market is let’s call it falling, volatility.
Falling volatility. If this is our outlook on the market, we don’t think there’s going to be any real price movement and we think the volatility is falling. Well, this is where we go get out our options strategy forms. Sorry, it’s going to take me a little time to get to this, but this is such an important thing here.
This is where you go and you pull out your strategy matrix. Again, go to the manuals and handouts. I’m going to go to advanced options. I’m going to go to session one, go to the manuals and handouts. I’m going to go to the advanced options strategy matrix.
All right, remember, my overall outlook at the market is that it’s going to be neutral with falling volatility. All right. What we want to find is we want to find neutral strategies. Here we have the bull put, the bull call.
We’ve got some of the credit spreads. The credit spreads are going to work and we also have the iron condor and the iron butterfly. All these are going to be working. If this was your overall strategy, this person might say, “Okay look, here is my strategy. I’m going to take 3% of risk …”
Sorry, I’m going to make my math really simple here. Let’s say it’s on our $10,000 account, small account. This means that they are going to risk $300 per trade. Max risk is $300. Okay. They have gone out and they said, “Okay look, I’m going to take 12 positions. I’m going to take 12 positions.”
This person says, “Okay, what I’m going to do is I’m going to find four bullish and I’m going to do four bull puts. I’m going to do four bear calls and I’m going to do four condors.” Each one of these I’m going to position size it to where my max loss is $300.
What this person has done is they have put themselves in a neutral to stagnant portfolio. Now, what’s going to happen is that if they are correct, let’s say that the market didn’t go anywhere, volatility fell, this is going to be a very good month because they should make money on probably two or three of their condors.
They should probably make money on two out of four of the credit spreads on each side. They might make a max gain on seven or eight trades out of 12. That’s going to be a really good return for the month. I also want to point out do you see how one trade doesn’t matter at all? It doesn’t matter at all. It was the combination of all being put together.
All right, let’s go next to let’s say your outlook is bearish with a rising volatility. All right. Bearish with a rising volatility. Let’s take the same parameters. Let’s take someone with a $10,000, 3% of risk. Let’s say that the side I am going to … I want to tilt my portfolio bearish rise in volatility.
This is where you could go do 12 bearish trades, but let’s talk about the worst case scenario. If this person went and they did 12 good options. They did 12 trades that they did all put options on. They may as well have just put it all on one.
They may have well just put it all on black, spun the wheel and see what happens. Now look, if their overall analysis was correct, they’re going to make a killing. They would make an absolute killing during this period. Out of those 12 trades, they’re probably right on the nine.
Probably nine out of 12 trades and since they were just in in direction of put options, it would be very, very profitable, but here’s the problem, worst-case scenario. What if it was a sideways market? What if it was a sideways market? All of a sudden you’ve got 12 trades with negative theta.
It’s going to just to sideways just because the market could follow a little bit, but not enough, you’re going to take a loss. If the market rallies unexpectedly, you’re going to get murdered. Realize that this is one of these where you’ve got to put your portfolio in the right place.
Very rarely do I put on everything bearish. We’ve got to balance things out. Let’s say this trader they would say, “You know what I want to do? I want to be bearish.” Rising volatility, okay. “What I’m going to do is I’m going to do six put option trades.” Actually, sorry, this is a little aggressive.
I want to do four put options. I’m going to do four bearish spreads. It’s called bear call spreads and then I’m going to do two condors and I’m going to do two bull call. Now, what that’s going to do is it’s put them in this bearish portfolio.
They have four put options, four bear call spreads, two condors, but they’ve got two bull calls. What the market does rally. If the market rallies in the wrong or the market goes sideways, guess what? They’re going to make money on a lot of these bear call spreads just from time decay.
They’re going to make money on these condors. I’m guessing they’re put options, they’re only going to make money one out of four. They’re going to be one out of four. They’re going to lose money over here. Let’s say they ended up losing money on the bull calls as well.
As you can see here, they still position themselves that if the market crashed, they were going to have a great month, but they also position themselves that if it didn’t exactly happen how they thought, it wasn’t awful. It still could be a profitable month.
All right, I’m not going to take the time to go through the bullish because I think we get the picture, but I want everyone to start thinking about positioning your portfolio for the current market. The other thing I wanted to talk about is adjusting. This is something that I have found to be really, really beneficial.
Let’s say that I was … Let’s say that I position myself for a bearish portfolio. Let’s say I got a little bit aggressive. Let’s say I got a little bit aggressive and I went all bearish. I went all bearish. I did four put options and four bear call spreads.
All of a sudden, the market started to have a bounce just like we had last week. We had a little bear rally bounce. Now, what I could do is I could freak out, I could take losses, I could unwind my positions and get out, but guess what? It might just be a bear rally. I don’t know yet.
I don’t know where this rally is going to go. I don’t know how big this rally is going to get. I’m still bearish, but how big is this rally going to get? I don’t want to throw in the towel on my bearish stuff because I don’t want to take a loss, but I definitely can’t leave my portfolio overexposed to the short side.
What can I do? I can add in some bullish and sideways trades. What this is going to do? This is going to pull my complete portfolio from heavily bearish, I’m going to pull it back to neutral to bearish. If I even have to change it more, I could even pull it to neutral to bullish if I need to.
I might say, “You know what? This market is really starting to run. I might need to add in three long call trades.” Now, at this point, let’s say the market continues to run. Let’s say that we were totally wrong in our analysis and this market continues to run.
I’m guessing that on the directional put options, they’re going to be zero out of four. I’m guessing that you’ll probably make money on one out of four of the bear call spreads. I’m guessing you’re probably going to make money on one out of two of the condors, but all of a sudden, you’re probably going to make money on all of the bull calls and all of the long calls or maybe two out of three on the long calls.
You see how what you’ve just done is you’ve taken a portfolio that was tilted bearish and really all of a sudden becoming a really awful portfolio, you add it in some bullish trades, you pull the whole delta of the portfolio back to neutral and actually a little bit bullish.
Look, you didn’t have a fantastic month. Let’s say in that month you ended up losing 500 bucks. When it’s all said and done over all your trades, you lost 500 bucks. Guess what? That’s pretty darn good for being 100% long when the market rallied 5% up.
That’s a win. That’s a win to be able to adjust your portfolio. Again, think about adjusting. Think about adjusting your portfolio. This is just what we talked about. Keep in mind your market exposure as a whole. Balance your portfolio if/when the market turns against you.
If you’ve been tilted one way and the market starts to turn against you instead of just panicking and selling your longs, if they haven’t broken down technically, just start to add in some stuff on the other side. Bring the overall portfolio back to a more reasonable place.
What this is going to allow you to do is stay in your trades longer giving them time to work for you. Now, you just have to ask this question. Over the past three months, the trades that you ended up taking losses on, raise your hand if you would have made money had you just stuck in them longer.
Go ahead and give me your little hand raise, but all right. A bunch of hands all going up, but you had to get out of them because it was getting so painful. Maybe they got your stop points, maybe they did this, but the point is that if you had something working on the other side, you may be able to stay in your trades for a little bit longer because again, if you look at the overall portfolio, “Hey, you know what? This trade is really going against me, but I’m not down at all my portfolio. I had the luxury to letting it work for me in the future.”
It’s the great thing, it allows you to stay in your trades longer, giving them time. Again, I’ve been trading for close to 15 years now and it’s one of those things where I want to give my trades as much time as possible. At some point when they really break technically, you know that, “Wow, I was wrong on this one. I was just flat out wrong.”
That’s when you need to take a loss, but sometimes where it’s just they’re short-term movements, they’re short-term volatility and it’s just like, “You know what? I can’t take the risk anymore, but I really still have faith in the trade.” This is a great way as long as you’ve positioned yourself correctly, position size yourself to where it’s not too ugly, it’s going to be really allow you to let your entire basket move around with the market.
Again, you can add on longs, add on shorts. Let’s say that at the bottom you start to see a bear rally. You short your portfolio, you start to add on a couple longs, the market has a bear rally, but guess what? At the top, if you want to go back to being bearish, sell off your gains on your long trades and go back to a net short portfolio.
During that bounce, you hedged everything out. It’s a very, very nice way to do it. All right, I have been on a little bit of a role here. I didn’t take any questions. Let’s go through the questions here. All right. Yeah, Bob has a question.
If you were short-term bearish and long-term bullish … Sorry, I had to laugh because that’s our running joke here at Maverick. Anytime you get any analyst on TV, “Hey Jim, what is your outlook on the market?” “Well, short-term, we’re cautious, but long-term, we’re bullish.” That’s our running joke here.
It doesn’t take a rocket scientist, but yeah, if you were short-term bearish and long-term bullish on an extent to pull back, absolutely you look for the strategy that’s going to benefit. All right, I think there’s going to be some short-term weakness, but I think long-term, I think it’s going higher.
Diagonal spreads, yeah they could work. The vertical spreads, you can sit through a lot of volatility on those. Yeah, put together the right portfolio for your outlook. Then ultimately, if the outlook is wrong, then you start to change your overall delta exposure.
All right. Dan has a question. Delta measures the direction you’re interested in, theta will indicate your timeframe. Right. Beautiful. That sounds very nicely here. Take a look at and I just looked at three of the deltas because those are the only two that really mattered.
Delta is direction, theta is time and Vega is volatility. Obviously, if you think that the markets aren’t going to go anywhere, then you want to have as much theta as possible and you don’t want to get a lot of delta because usually, to get a lot of delta, you have to give up theta.
Yeah, you’d position your portfolio base on your outlook. Let’s say there’s a lot of volatility, a lot of movement, you may say, “You know, I don’t really care much about theta. I want to get more delta. I want to get more delta.”
Or, “Hey, I don’t care about delta or theta, I want to get more volatility.” That’s where you could look at doing something like straddle or strangle. Say, “Look, I don’t know about delta, I don’t know about theta, but I do know about volatility. My outlook is that volatility is going to pick up dramatically.”
Yeah, you position yourself based on those Greeks. All right. Walter has a question about changing position size as a portfolio grows. For example, you go from 20 to 30 to 50. How often would you reconsider your uniform position size?
First thing is I hope that you are doing uniform position size based on percentage. Based on percentage. I want to say the answer to the question is very rarely if ever. Now, I was going to say never, then I just thought about my own personal experience.
When you have a smaller account, you really probably do need to risk a little bit more portrayed because what happens is commissions start to become a big deal. Sometimes it’s very difficult and I think I saw this question.
If you’ve got a $300 max risk that you’re willing to take, you might go look at an options position and you might not even be able to take one contract of that position. One contract won’t even fit within your risk parameter.
Frankly, you just need to go find a different trade. On a smaller portfolio, you typically see people risking a little bit more. As you get a larger portfolio, the percentage of risk usually goes down. I would do that on a semi-annual basis, take a look at your portfolio.
Obviously, here’s the way it works. I hope everyone sees this. The more percentage a risk you put on each trade, the wilder your swings are going to be on the up and the downside. However, if you are a trader that is profitable, let me draw another white board here.
Let’s say that you are a profitable trader. That means that your account goes up in value overtime. Here is somebody using 5% at risk. Portfolios are going up overtime, but they’re going to experience some volatility.
Here’s someone using 3%. You’re going to see of course a little bit more muted. Ultimately, not quite as profitable. If you look at someone using 1%, you’re going to see it really smooths out, but in the end, probably ends up returning a little less, but if you take a look at draw downs, you take a look at at times where it wasn’t so good, the 1% portfolio was a lot more steady.
Now, I want everybody to flip this upside down in their mind. If you are a losing trader over that period of time, the 5% is going to be devastating where the 1% is going to be … It’s going to hurt, but it’s going to be at least manageable.
We always tell people, “Look, until you’ve really built up a track record, you know what? A smaller percent is going to keep you in the game a lot longer until you can build that track record.” Once you’ve got a track record, of course you do want to build up your percentage, but let’s say you’re trading with a million bucks.
Do you really want to risk 50 grand on every trade? I don’t know. This is where you dial it back down to a reasonable amount, 1%. That’s a great question about the position sizing. All right, Jim brought up the question, yeah.
On a smaller account, if you risk one to 1/2% of your account and you tried and sometimes it’d difficult to squeeze each trade into that box. You’re exactly right. There are going to be some trades you cannot even make based on the contract size and the position size.
I would go and say, “You may not be able to make the exact trades you want to make. You may want to go just long calls, but it may not work for you.” You might have to change it to a vertical spread or maybe you wanted to do a $10 vertical spread and it just won’t fit in, there’s too much risk.
You might need to cut that down to $5 vertical spread. There is different ways to try to still keep the same trade and fit into the profile, but ultimately, you could just go find another trade, if it doesn’t work, go find another trade.
All right, Tim has a question. Would you also consider the beta weighting? All right. This is such a great question and it’s so cool. Let me ask the question Tim asked. He said, “Would you consider looking at the beta? The beta is the overall volatility of each stock.”
Then you could take a look at your overall beta of your portfolio. Would you also consider looking at small cap, large cap, would you look at short and long. The answer is yes, but realize that if we tried to look at everything, can you imagine if you actually had to look at your sector exposure, you had to look at your beta, you had to take a look at your Greeks, you had to take a look at your net delta?
Can you imagine doing all that stuff on all your trades? It would be very, very, very difficult. Not all that, but doing your technical analysis, doing everything you need to do. We’re looking at a serious, serious job. What we’ve always done at Maverick and what in some of our classes, we explained this.
We do a class on Fibonacci. We love Fibonacci. We think Fibonacci is awesome. There’s a lot of technical analysis stuff out there that’s pretty junky, but Fibonacci is really pretty cool. However, it can get really, really technical and really, really detailed and we find out that when you get to that level, if you get what I called tunnel vision, you miss the big picture.
Tim just asked a question. “Okay, would you consider beta, small cap, large cap? Would you consider long and short? Would you consider all that?” Yes. We actually do that. That’s the point we make at a the Fibonacci classes that all of our set ups, the high base, the pull backs, the triangles, they’re all Fibonacci-based set ups, but we don’t really get into Fibonacci in any real great detail because you don’t need to get that exact, you don’t need to get to the 0.007%.
As long as you’re doing the right steps, you’re going to be in the right place. If you take a look at what we do here is we take a look at overall market. Again, our top down approach. What do we do? We focus on overall market. Now overall market, that’s going to give us our percentage of long versus short trades.
We do this. We do take a look at the overall market and we take a look at long versus short trades. Then we get into sector analysis. Sector analysis. All right, this is going to give us … Okay, do we want to be in what sector did we want to be in?
Do we want to be in a fast moving sector? Slow moving sector? I’m also going to put in large cap versus mid cap. We don’t really at least … I know, I’m sure I’m speaking for me and a lot of the traders. We don’t really trade any small cap because we are options traders.
Small cap stocks typically have really terrible options or no options at all. Realize that we’re mostly trading large cap and mid cap stocks. As far as small cap, large cap, we don’t really dive into that because that’s not part of our game, but again, we get to play weak versus strong sectors.
In our sector analysis, we’re going to be, “Okay, overall market, how much percentage long and short?” Sector analysis, okay great. We’re going to be in the right places, we’re going to be looking at our longs here, our shorts here.
Beta. Beta weighting. Yeah, beta is taken care of in your … You know what? I’ve got to say … I think your beta is a non-issue in spreads. That’s a little bit too strong of a statement, but realize that beta is calculated into the options.
If you want to go along a low beta stock, your very low volatile stock, the option will be very cheap relative to any others. If you are in spreads, the beta is hedged out. The volatility is hedged out. Meaning, if it’s super volatile and you do a spread, you’re going long and short a spread, you’ve hedged out the volatility.
If the volatility is low, you do a spread, you hedge out the volatility. We are going straight longer calls and long puts. Yeah, volatility is always an issue. I’ve always used the term scaling. If I see a stock that’s at 42 that I think can run to 43, I’m not interested in it. Not interested at all.
I’m interested in things that are going to be a little bit bigger movers. That’s why on all of our set up sheets, when we look at doing options, we always want to do options on stocks over about 40 bucks. Anything below that they get … The percentage moves aren’t big enough to just by the option.
That’s why we love trading stuff like the Google’s, the intuitive surgical because $5 move in those percentage wise is very small, but on an option, it’s a lot easier to justify making an options trade than a stock trade. Again, everything we do really takes into account Tim what you’re asking like, “Okay, what do we do in large cap, mid cap? How do we position ourselves long or short? How do we handle beta? How do we do this?”
Everything we do in all of our set ups and all of our analysis is to lead us to that exact point without spending all day long doing this. All right. I think that just about brings us to a close. Again, this is something I’ve wanted to do for a while.
It’s something that … It’s so weird. When I got into trading, I read so many books, I looked at everything I get my hands on. Half of it was through my detriment and half of it was to my success. I can’t tell you how many books I’ve read that’s caused me to lose thousands of dollars as I was trying out this or that and realized that, “Wow, this doesn’t work or at least doesn’t work for me and what I’m trying to accomplish.”
But the biggest thing, again, it just took me so long time to learn was the 10 trade analogy. The 10 trades. Whatever strategy you do, whatever analysis you do, you’re going to make 10 trades and you know what? Some are going to be right, some are going to be wrong.
How you handle those and again, how you did your analysis is going to make the difference, but that lesson, the 10 trade analogy, I wish someone had beaten that into my head, that first year of my trading because every trade I made was the most important trade I’d ever made in my life and it cost me to make all sorts of mistakes of, “Oh my gosh, I don’t want to take a loss.”
Or, “Hey, I know I’m right on this one. I don’t want to lose on it. It just caused me so many issues that someone would really beat that 10 trade analogy.” “Look, you’re going to make 10 trades. Some are going to be right, some are going to be wrong, you have no idea which ones.
The ones that you think are going to be winners are going to be losers, the ones you think are going to be losers, they’re going to be your winners, but at the end of the basket once you get out of all those 10, what were your results?”
That’s really what trading is all about. It’s not about the individual trade. “Look, you have to do the individual trade, but it’s about the overall results over a number of trades.” Hopefully, hopefully this has helped you out a little bit.
Like I said, I wish someone is there to beat this out of my head when I was just a pup. That’s my job to unleash it on you guys. All right, hey thanks for the great session. I think this really helped everyone out. This is probably going to be it for the end of the week unless you want to contact me by email. Hopefully everyone has a great, great weekend and take care everyone. Goodbye.