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Friday, August 9, 2013

Don’t Bring Band-Aids to the Trading Desk


“When you are in a boat that springs a leak, you don’t drill another hole to let the water out.” – Tony Saliba, from Market Wizards

I read a blog post a few months ago about how to deploy an options “repair strategy” on a commodity futures position that was losing money. I don’t think the author had any clue about what trading is about. He called it a band-aid strategy. It occurred to me that the whole article was written to help his clients (and probably the author) avoid the feelings around taking losses.

There are no band-aids in commodity trading. Although written with extreme detail on how to overlay a few options to an existing outright position that was losing money, I would not try fix a position by adding other options or futures contracts.

The Best Ideas Are Simple

The best ideas are very simple to understand and simple to execute. If you have a losing position, get out when you start losing money. Adding an option to a commodity futures trade creates drama. What happens when your new “synthetic position” starts losing money? What will you reach for then?

If you have a losing commodity futures position, don’t try to create a spread by buying or selling a deferred contract. This creates drama too. Unless you are familiar with spreads, it will also create more drama. How do you know that the spread is not trading near full-carry?

If you have a losing position, get out of it. You will be able to see more clearly and without emotion while you don’t have the position still going against you. By doing so, you won’t waste valuable mental energy on a losing position. You will cut the opportunity cost by getting out of the loser and finding another trade. Most importantly, you will conserve your capital.

Don’t bring band-aids to the trading desk. Leave them at home. This goes for systems traders and investors also.

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