A Word on Risk Management

In my excitement to position myself for this move we see happening this week, I chose to overlook a common risk management principle in order to capitalize on what might be a year end run in stocks. While the reasoning was right, and the initial entry and move I nailed, I am still in the process of seeing ideas play out, but am stuck in the lull of waiting for the trades to pay out.

The risk management principle I am referring to is diversification. Normally, I am pretty well spread out in the trades I take. I might have a couple correlated trades on, but I usually enter them at different times, so I can build profits on the original position before looking to add another. I try to select fast upside candidates in at least a half dozen various groups. At present, I am levered to Solar, Social Media, and Materials – all of which are at the threshold of investor indecision.

This time around, I entered in multiple correlated trades nearly simultaneously. For the most part, the ideas worked right out the gate, but now we see stocks pull back a bit this week, and multiple option positions decay simultaneously. No way around this. It sucks. However, if the objective hasn’t been met, and neither upside or downside exit rules have been met, this is where sitting on hands becomes difficult.

I refer back to past situations like this and you’ll see how my blog has been feast or famine. The ideas over time have been great, but in dealing with options, you are penalized by time. This is why we always refer back to risk management principles, and that is because leveraged instruments can chew up big sums of capital if you are not careful. All year it has been the same story here. We put on trades. We have weeks where accounts are up double digits. We celebrate. Market pauses. We get quiet. We take some trades. We wait. We drawdown. We get patient. We want to capitulate. The market moves. Our trades explode. We celebrate.

With the luxury of hindsight, my mistake recently has been ignoring my diversification rule. This time around, it makes the waiting a little more uncomfortable.

OA