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Trades with Too Much Complexity

February 17th, 2009 | BAC bad trade FAS FAZ INTC investing

In the interest of full disclosure, I have to cover my bad trades as well as my good. Anyone can crow about their winners. Here’s the anatomy of yet another bad set of trades I closed out today.

At the end of the first week of February, I went long FAZ at $45. At this point I’d been piling up shorts into the rally and the ever-declining FAZ seemed to be ripe for a turnaround. After holding over the weekend and watching the futures turn up in anticipation of the stimulus package, I got nervous and decided I needed to hedge long. As FAZ dropped to about $40 last Monday, I actually went long FAS and bought some BAC May $10 calls. The lame motivation there was that I expected some extreme daily volatility that would end with the financials continue their rise up, so the byzantine logic was that I’d have a chance to kick a FAZ rally as doubt rose, then cash in on the rebound when the stimulus details came out. I couldn’t day trade during this period, so the complexity came from trying to lock in trades with limit buys

The flaws (more like a comedy of errors) are compounded: being long and short at the same time with vehicles you shouldn’t carry overnight, buying derivatives on a broken bank, adding complexity and too many moving parts to a theory that could have been greatly simplified had I picked a single trade that was likely to work, believing that there might be something in the plan that the market would like. Traders talk a lot about “context” and the context that helped make me stupid here was that I was way short and the bulls were making noise like this could be a significant run that I had to hedge. Just got on tilt.

So BAC fell, as did FAS. The 11% loss in FAZ that I had when I added FAS was effectively baked in with the hedge, but as the week went on, the ETF sawtooth effect compounded the problems. Rather than save face immediately and admit the bad trades, I tried a couple of times to sell premium on both FAZ and FAS (out of the money) but didn’t get my ask. After averaging down a little bit on BAC, I gave up and spent the weekend analyzing my trades from the last five months.

I learned that while my winners outnumbered losers by almost 3:1, the average loss for a loser was about 33% greater than the win on a winner. Since I give a lot more play due to the volatility of the last several months, it didn’t totally surprise me, as I had a couple of big losers. Rather than set tight stops (which I may eventually come to—since it’s the conventional wisdom), I do need to execute a lot more discipline and cut my losers earlier.

Today I followed through. With the futures down big before trading, I tried to dump my FAS pre-market (not recommended) but only got out when the market opened at $6.79, saving another 11% in downturn over the $6 close (but locking in a painful 36.7% loss overall). I dropped the BAC calls next, dumped for a painful 50% loss. FAZ rose 24% today (and is up 50% from when I bought the FAS), so I’ve worked through the FAS loss and started in on the BAC loss.

Tomorrow (Wednesday), if we’re down, I’m looking to cover my tech puts (PALM and AAPL) and buy some INTC calls (RSI is really, really low, so looking to wait until the stock is in the $12s again), but let my other puts run (NDAQ, X, MA, BBY). As I type, the futures are up, so I may have to start plotting revenge for later in the week.

Viewing 3 Comments

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    Nice work! Like I said, if you have a conviction, they stick by it. I let mine go too soon on $ESI $APOL short.
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    If over 5 months your winners outnumber your losers 3 to 1 that is exceptional! Did you go back and see what your profits would have been with various stop levels or different criteria for closing your positions?
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    I haven't yet. I would have avoided a 100% loss on all my USO calls, and probably saved some bad moves with GOOG calls. What's hard to tell is how many times I would have been stopped out on trades for which I averaged down--I think it probably would have been close to a push. If I could find a good source of historical bid-ask on options, I could figure it out.

    A great example is my recent X puts. I bought a batch at @ 3.10, then another @ 2.10. Soon after the second buy, the bid-ask was something like 1.65-1.80 at one point (which would have triggered a 40% stop on the initial batch). I held, and later sold both lots at 3.10 for a 23% overall gain. I count that as one win of around 47% on the second batch, and a loss of transaction costs on the second batch. Had I stopped at 40% loss and ended the same way (i.e., held the 2.10 batch until 3.10), the overall trade would have been an overall -2% loss.

    I repeated that pattern several times, averaging down on puts and calls for AMZN, SPY, NDAQ, BBY, etc. A tighter stop on the X trade would have stopped me out of both trades for a 20% loss.

    My strategy would be totally different if holding stocks though, or in times of more normal volatility. I would then go with tight stops and be satisfied with a 40% win percentage.

    3:1 is crazy--even factoring out the 15 in a row at the start, it's still about 2:1. The only thing I can say is that I was short on 85-90% of my trades during a time where there was a 30%+ drop in the market, so execution had little to do with it...it was primarily due to being on the right side of the trends.
 
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