The Art of the Strategy Pivot
It's very hard to time markets and it is also very hard to see a bear coming or a bull starting - especially when you are in the thick of things. When you zoom out after the fact, there are always some great lessons to learn and that can help you in the future.
I didn't time the bear market that started in January 2022, but I was prepared for a change in the market trend. My Fractal Energy Indicator was telling me something was up. In fact, in my annual Year in Review webinar for students, I predicted a large sideways to down market. If you zoom out and look at things over the last 12-15 months, that is exactly what we are in.
But, I still was trading deep out of the money puts and put spreads because they had been so effective for the last several years. When the market did fall preciptously, some of my positions were caught in the drop causing me to have to roll then out and move positions lower. I still have some left to manage as I write this, especially in tech, but so far, I am managing the challenge of them and mitigating losses. I fully expect that it will take into 2023 to unwind some of these. I've had it happen before and will just methodically work through them.
One thing I did share at the beginning of 2022 with my students and started doing in mid-Janaury was to pivot to selling wide, out of the money Iron Condors on shorter time frames (5 and 20 days out). My reasoning was that if we were going to be in a sideways to down market, adding trades beyond a month out would have a better chance of being attacked and I could achieve a higher velocity of money by turning my cash over faster with smaller returns that would add up to larger returns. I created two new strategies: Target 100 and Double Double. The goal of Target 100 was to achieve 2% returns on capital risked each week and the goal with Double Double was to create a 4% return on capital risked each week selling further out. In contrast, my typical return on risk per trade prior was 12-20% - so it was a big pivot. But, if you do the math, 2% per week on capital risked is a 100% return per year and 4% is 200%. Now, I'm a realist and know that not every trade will work out as planned and some weeks may just be risk off weeks, but if I am able to achieve 40-50% (basically half of the targets), I would be happy, especially in a bear market.
After trading the strategies for 5 months, I am excited to say that my students and I have not had a losing trade yet. We have had a couple that we had to manage pro-actively, but have been able to consistently win with the strategies. These strategies work well because of the higher volatility we have in the markets right now, so there will probably be a day when they are not as effective, but that would mean I can go back to my other strategies and trade them as they work well in low IV environments.
The important lesson is that "You cannot trade the market you want, you have to trade the market you have." This means that you have to recognize when it is time to pivot. This doesn't mean that you throw away your strategies or abandon them for new ones. I am still selling options like I've always done. It does mean, that you need to be realistic in trading what is working in the markets for the type of markets you have. You will still find opportunities for your different strategies, some just may trade easier than others depending on the type of market you are in.
Ask yourself, how can I pivot or adjust my strategies to maximize my success in the markets in front of me? Then go to work and figure out how to adjust them.
To succeed in trading, you must have an "edge." An edge can come in many forms or be multiple components of a strategy. In fact, my edge comes from multiple aspects of my strategies. First, I sell options which puts the odds in my favor just by the trades I choose. Second, I have very specific entry rules that help me to time my entries and sell at levels that boost my odds even further of winning. Third, I have solid defensive strategies that keep me profitable in the rare times I am wrong or during massive moves like a bear market.
But the biggest part of my edge is used as part of my entry rules and it is my proprietary Fractal Energy Indicator. One thing I have found over the years is that the more indicators and signal metrics you put on a chart, the more you lose. It's not hard to understand because too many indicators conflict with each other and lead to overanalysis or bad timing of trades. I know, I used to work with 8 indicators on a chart!
About 12 years ago, I was working with some other professional traders and our goal was simple - to find a way to know when a chart was about to trend or not. We looked at a lot of common indicators and tested them, but none of them worked consistently. Then we came upon the Choppiness Index indicator and it was close to what we were looking for. We tested it and then got the code and made very specific changes to it to creating an unique new indicator that was able to show when a chart was "charged up" and ready to trend or "exhausted" and done trending. I then took the indicator, made further code adjustments and started looking at how it worked across different timeframes - hence the name Fractal Energy. I was able to essentially see trends before they started or when they were exhausted looking at the different time frames, the Fractals. This worked well and helped me to time my entries much better.
After a couple of years of working with it, I had a good system going when I noticed a correlation between the energies and Bollinger Bands. I noticed that I got my absolute best entry opportunies when the prices were at or near the bottom Bollinger Band and the energy on the 1 year daily chart was exhausted. I started to track my trades using this setup and some other criteria I used to set my trade levels and found that I was able to win over 90% of the time. It was amazing - with just one indicator and the help of the Bollinger Bands, I was able to boost my win rate to skyhigh levels. And it was so much easier to manage.
Nowadays, I've taken that concept and several setup types I've identified using the energies and created the 5 different strategies I use and teach to students all over the world. And one of the biggest lessons I teach them is the one I learned so many years ago - the lesson of simplicity and focus in giving you an edge. I trade the way I do because it wins the most. It's not sexy or flashy. In fact, much of the time is downright boring. But that is another secret of professional traders, their strategies and systems are setup to consistently win and profit and are almost robotic and boring. Forget what you see in the movies - focus on how you can simplify and put the odds in your favor as much as possible. That's the real secret to make a living in the markets.
If you want to learn more about the Fractal Energies and how I use them, I invite you to click here and try a FREE 2 Week Trial of 12 Minute Trading. Here's to your success!
Great traders know that the biggest challenge and obstacle to trading success is not the markets or their strategy or any outside force. No, the biggest challenge is between their ears.
Simply put, emotions and emotional decisions destroy trading profits. And that is why the best traders spend a lot of time working on their mindset and understand how to separate emotions from logic.
It is a process traders have to go through and it never really ends - you just get better at controlling your emotions and impulses. And it comes in most handy during corrections and bear markets.
I sell options. I don't buy anything. Not stocks, options, or any other security. I sell options because I get paid up front to take on risk and I can control how I create my wealth and income. Over the years, I have learned a lot about how to control and manage emotions. Here are 3 secrets I've learned that help the most.
Have a Clear Set of Rules
No matter what trading strategy you have, you should have a clear set of rules for entry, defense, and profit taking/exit. Rules help keep emotions in check because they give you a plan to follow. Your job is to simply execute. For example, if your rules state that you don't defend a trade until a specific level is hit, and a stock moves against you in a big way, but does not hit the level, you don't execute defense. Emotionally, it may feel horrible and may cause you to want to act on impulse to do something, but your rules will stop you from doing so. Your job is to follow them. And many times, you will find you win the trade. If you want to learn more on how to develop a clear set of rules and strategy, grab a copy of The 5 Key Elements of a Winning Trading Strategy Here
Don't Fall in Love with Any One Trade
A trade is just a trade. If will either win or lose. Don't fall in love with it or get attached to it. If you have rules and follow them, this will help you. Inevitably trades will go against you and you will have losers. Don't think you have to make back your loss on the same stock or underlying you lost the money on. I've seen this so many times where people "feel" like they have to keep playing a stock the've been losing on to make back their money. It's like they have to beat the stock to put it in its place and show they are better. That's crazy. Your goal should be to find and trade the best setup per your rules and strategy. Never get emotionally involved with a trade.
Your P&L Means Nothing (If You Sell Options)
This one may not apply to you, but it does to me. Because I sell out of the money options, my P&L will fluctuate wildly with swings in the market. One day, I can be up 6-figures per my P&L and the next day down 6-figures depending on what is happening. What matters is price. Is the price approaching or at the levels I've sold? If not, then I am fine. I just need to let time work for me. I also know that if a trade does go against me, I have defensive rules that I follow. If I managed my trading by the way my P&L moves, it would be a nightmare. Instead, I look at the amount of cash I have in my account relative to what my starting amount was. That tells me if I am losing or not. And I can manage around that cash keeping myself profitable. If you sell options, don't use your P&L as your main guage of success.
I get asked a lot about what is needed to create a great trading strategy. My default answer is to just grab my free E-book on the subject. But, a better answer is that most traders make things much more complicated than they need to be. We think that putting more indicators and trend lines in use somehow makes a strategy better. I mean, with all those indicators and fancy patterns highlighted on the charts, it's more sophisticated, so it must be better, right?
Wrong. I have found that more complex trading strategies are made to be, the more they lose. And you can understand why. If you use 10 different indicators, they are going to conflict with each other and show false signals because they all work differently.
The key to a great trading strategy is simplicity and the consistency of that simplicity. Instead of trying to add things to a chart, we should be looking to add as little as possible and only keeping the things that work consistently. It's really the essence of the 80/20 rule. 20% of your efforts, generate 80% of your results. 20% of your indicators lead to 80% of your profits.
For example, years ago, I used to work off of 5-6 different indicators on my charts, but over time I noticed that there was a relationship between only 2 of them that consistently gave me the best entry signals in the charts - my proprietary Fractal Energy indicator in conjuction with the Bollinger Bands. The energy indicator gave me great signals when charts were ready to trend or were exhausted ending a trend and the Bollinger Bands gave me a great signal on the direction things would go. Using those two together and dropping the rest made things much simpler and I consistently won more trades.
If you are developing a trading strategy, you should definitely get a copy of my 5 Key Elements E-book, as it will help you, but most importantly, you should continue to ask yourself, "How can I make this more simple." If you do that, you will find it much easier to build a strategy that wins more often and is easier to manage.
Years ago, I was introduced to Bo Yoder's 6 Stages of Trader. (www.BoYoder.com) The stages show the progression of trader's from where they typically start to where, if they can stick with it, achieve mastery. What I love about the stages is that Bo made them easy to understand so traders can have a good idea which stage they are in and what the next stage looks like and so on. I have used this in my own progression as a trader to help me in getting to my next levels as well as when I coach traders. It is great tool for deciding where students are in their development and showing them the next stages and discussing how we get there. Below are the 6 Stages. Take a look and figure out what stage you are in. More importantly, take a look at what the next stage looks like and start thinking about what you need to do to get there!
Stage One – Mystification
This is where the neophyte trader begins. He has little or no understanding of market structure. He has no concept of the interrelationship among markets, much less between markets and the economy. Price charts are a meaningless mish-mash of colored lines and squiggles that look more like a painting from the MOMA than anything that contains information. Anyone who can make even a guess about price direction based on this tangle must be using black magic, or voodoo.
Stage Two – The Hot Pot Stage
You scan the markets every day. After a while (sometimes a good long while), you notice a particular phenomenon which pops up regularly and seems to "work" pretty well. You focus on this pattern. You begin to find more and more instances of it and all of them work! Your confidence in the pattern grows and you decide to take it the very next time it appears. You take it, and almost immediately your stop is hit, and you're underwater for the total amount of your stop-loss.
So you back off and study this pattern further. And the very next time it appears, it works. And again. And yet again. So you decide to try again. And you take the full hit on your stop loss.
Practically everyone goes through this, but few understand that this is all part of the win-lose cycle. They do not yet understand that loss is an inevitable part of any system/strategy/method/etc., that is, there is no such thing as a 100% win approach. When they gauge the success of a particular pattern or setup, they get caught up in the win cycle. They don't wait for the "lose" cycle to see how long it lasts or what the win/lose pattern is. Instead, they keep touching the pot and getting burned, never understanding that it's not the pot (pattern/setup) that's the problem, but a failure on their part to understand that it's the heat from the stove (the market) that they're paying no attention to whatsoever. So instead of trying to understand the nature of thermal transfer (the market), they avoid the pot (the pattern), moving on to another pattern/setup without bothering to find out whether or not the stove is on.
Stage Three – The Cynical Skepticism Stage
You've studied so hard and put so much effort into your trading and this “universal failure in the patterns only when you take them” causes you to feel betrayed by the market, the books, the materials, and the gurus you tried to learn from. Everybody claims their ideas lead to profitability, but every time you take a trade, it's a loser, even though the setups all worked perfectly before you played them. And since one of the most painful experiences is to fail when success looks easy, this embarrassment is transformed into anger: anger at the gurus, anger at the vendors, anger at the writers, the seminars, the courses, the brokers, the market makers, the specialists, the "manipulators." What's the point in trying to analyze and improve your own trading when there are so many dark forces out to get you?
This excuse-driven blame game is a dead-end viewpoint, and explains a lot of what you find on message boards. Those who can't pull themselves out of it will quit.
Stage Four – The Squiggle Trader Stage
If you don't quit, you'll move into the "squiggle trader" phase. Since you failed with patterns and so on, you figure there's some "secret weapon", a "holy grail" that's known to the select few, something that will help you filter out all those bad trades. Once you find this magical key, your profits will explode and you'll achieve every dream you ever had.
You begin an obsessive study of every method and every indicator that is new to you. You buy every book, attend every course, sign up for every newsletter and advisory service, register for every trading website and every chat room. You buy more elaborate software. You buy off-the-shelf systems. You spend whatever it takes to buy success.
Unfortunately, you stack so much onto your charts that you become paralyzed. With so many inputs, you can't make a decision, particularly since they rarely agree. So you focus on those which agree with the direction of the trade you've taken (or, if you're the fearful sort, you look only for those which will prove to you how much of a loser you think you are).
This is all characteristic of scared money. Without a genuine acceptance of the fact of loss and of the risks involved in trading, you flit around like a butterfly in search of anything or anybody who will tell you that you know what you're doing. This serves two purposes: (1) it transfers to others the responsibility for the trade and (2) it shakes you out of trades as your indicators begin to conflict. The MACD says buy, the STO says sell. The ADX says the market is trending, the OBV says it's overbought. By the end of the day, your brain is jelly.
This process can be useful if the trader learns from it what is popular, i.e., what other traders are doing, and, if he lasts, how to trade traps and panic/euphoria. And even though he may decide that much of it is crap, he will, if he doesn't slip back into the Cynical Skepticism Stage, have a more profound appreciation -- achieved through personal experience -- of what is sensible and logical and what is nonsense. He might also learn something more about the kind of trader he is, what "style" suits him best, learn to distinguish between what is desirable and what is practical.
But the vast majority of traders never leave this stage. They spend their "careers" searching for the answer, and even though they may eventually achieve piddling profits (if they don't, they will of course eventually no longer be trading), they never become truly successful, and this has its own insidious consequences.
Stage Five – The Inwardly-Bound Stage
The trader who is able to pry himself out of Stage Four uses his experiences there productively. The trader learns, as stated earlier, what styles, techniques, tactics are popular. But instead of focusing entirely on what's "out there", he begins to ask himself some questions:
What exactly does he want? What is he trying to accomplish?
What sort of trading makes the most sense to him? Long or intermediate term trading? Short-term trading? Day-trading? Trend-trading? Scalping? Which is most comfortable?
What instrument -- futures, stocks, ETFs, bonds, options -- provides the range and volatility he requires but is not outside his risk tolerance? Did he learn anything at all about indicators in Stage Four that he might be able to use?
And so he "auditions" all of this in order to determine what suits him, taking all that he has learned so far and experimenting with it..
He begins to incorporate the "scientific method" into his efforts in order management. He learns the value of curiosity, of detached interest, of persistence and perseverance, of taking bits and pieces from here and there in order to fashion a trading plan and strategy that are uniquely his, one in which he has complete confidence because he has tested it thoroughly and knows from his own experience that it is consistently profitable.
He accepts fully the responsibility for his trades, including the losses, which is to say that he understands that losses are inevitable and unavoidable. Rather than be thrown by them, he accepts them for what they are, a part of the natural course of business. He examines them, of course, in order to determine whether or not some error was made, particularly one that can be corrected, though true trading errors are rare. But, if not, he simply shrugs off the loss and goes on about his business. He understands, after all, that he is in control of his risk in the market.
He doesn't rant about his broker or the specialist or the market maker or that vast conspiracy of everyone who's trying to cheat him out of his money. He doesn't attempt revenge against the market. He doesn't fret. He doesn't fume. He doesn't succumb to hope, fear, greed. Impulsive, emotional trades are gone. Instead, he just trades.
Stage Six – Mastery
At this level, the trader achieves an almost Zen-like trading state. Planning, analysis, research are the focus of his time and his effort. When the trading day opens, he's ready for it. He's calm, he's relaxed, he's centered.
Trading becomes effortless. He is thoroughly familiar with his plan. He knows exactly what he will do in any given situation, even if the doing means exiting immediately upon a completely unexpected development. He understands the inevitability of loss and accepts it as a natural part of the business of trading. No one can hurt him because he's protected by his rules and his discipline.
He is sensitive to and in tune with the ebb and flow of market behavior and the natural actions and reactions to it that his research has taught him will optimize his edge*. He is "available". He doesn't have to know what the market will do next because he knows how he will react to anything the market does and is confident in his ability to react correctly.
He understands and practices "active inaction", knowing exactly what it is he wants, exactly what it is he's looking for, and waiting, patiently, for exactly the right opportunity. If and when that opportunity presents itself, he acts decisively and without hesitation, then waits, patiently, again, for the next opportunity.
He does not convince himself that he is right. He watches price movement and draws his conclusions. When market behavior changes, so do his tactics. He acknowledges that market movement is the ultimate truth. He doesn't try to outsmart or outguess it.
He is, in a sense, outside himself, acting as his own coach, asking himself questions and explaining to himself without rationalization what he's waiting for, what he's doing, reminding himself of this or that, keeping himself centered and focused, taking distractions in stride. He doesn't get overexcited about winning trades; he doesn't get depressed about losing trades. He accepts that price does what it does and the market is what it is.
His performance has nothing to do with his self-worth. It is during this stage that the "intuitive" sense begins to manifest itself. As infrequent as it may be, he learns to experiment with it and to build trust in it.
And at the end of the day, he reviews his work, makes whatever adjustments are necessary, if any, and begins his preparation for the following day, satisfied with himself for having traded well.
The knowledge proved through research that a particular price pattern or market behavior offers an acceptable level of predictability and risk to reward to provide a consistently profitable outcome over time.
Many years ago, I was taught the "4 Phases of the Market" and understanding them has made a huge difference in may trading and investing over the years. Once you understand them, you can use them to your advantage. The 4 Phases happen on a micro-level and macro-level. For example, you can go through all 4 phases in the span of a month on smaller chart time frames. On a macro level, they are the phases of bull and bear markets. They are as follows:
Disgust is the end of the 4 phase cycle. It is when there is significant uncertainty and volatility with enough selling to make things painful in the markets. This stage "feels" horrible and like it will never end. It is most notable on big corrections such as 10% or more and bear markets. Everything is negative and it seems there is no end in sight for the carnage. You can also go into disgust on shorter timeframes with
3-5% moves in short periods of time such as a week or so. The telltale sign of this phase is fear and uncertainty. The end of Disgust is one of the best times to sell options in the markets because of the volatility and depressed levels.
This comes after Disgust in the form of a rally "in disbelief." Everything has been so negative and has seemed like there is no way anything positive can happen - and then the market (stock, index, etc.) rallies and holds the rally. Sentiment is that it cannot hold and many times it doesn't. You can get a lot of confirmation of Disbelief during the Disgust phase as rallies are faded, but when things reach the deepest levels of Disgust is when Disbelief really happens. Pay attention to the sentiment and prevailing narrative of "the herd", when it seems all hope is lost and the world is going to end (OK maybe a little over-exaggeration, but you know what I mean) - that is when you should be prepared and look for the Disbelief rally.
Once the Disbelief rally holds, it becomes somewhat of a self-fulfilling prophecy in that early adopters (the Pros) see it and start to get back in. Still, the herd thinks it cannot hold. They stay on the sidelines as they miss the beginning of the rally, but much to their "disbelief" it continues to hold. Things start to "feel" better and markets get back to more normal action. After a little while, the rally begins to reach "Acceptance" and it draws more people back in. You can always tell acceptance when the fear begins to fade and markets revert back to normal type market action (not wild swings, etc.). You can also tell by sentiment in that people that were scared are now dipping their toes back into the water. This phase also lasts the longest.
This phase is most easily recognized when things get really hot again and it seems like everyone is making money in the markets. "You can't lose!" This is a great time to be in the markets and take advantage, but you must be very weary that "Disgust" is lurking and coming next. Telltale signs of Euphoria are risk assets being piled into. Non-traditional assets suddenly are all the rage and people who are not investors piling into the markets. The old adage, "When you barber or dentist starts giving you stock tips, or brother in law who has never traded before, start to give advice, you are usually in Euphoria" and probably closer to the end. Look for markets to go parabolic on the charts and further than anyone expects prior to the end of Euphoria.
Once you understand how to recognize the 4 Phases of the market, it will make a huge difference in your investing and decision making around it. As I write this, we are in early 2022 in the Disgust phase. I cannot say how long it will last, but I am excited about the opportunity to "be greedy when others are fearful" and take advantage of selling into the corrected levels it presents!
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I came across this great article from Tradeciety.com titled "Scientist Discovered Why Most Traders Lose Money" and it grabbed my attention. The conclusion of the article is not surprising and I've spent a lot of time over the years teaching students how to manage this one major area that drives the most loss.
But, before I share more about, here are some eye-opening stats from the article:
Just understanding the pitfalls above and avoiding them can make a huge difference in your trading.
But the biggest reason traders lose money is not any of the above. It is because they trade on emotion and do not have a solid ruleset and trading plan to keep them grounded. As I stated at the beginning of this article, I have spent years teaching students that the biggest obstacle to trading success lies between their ears. You must separate emotion and logic and have a tried, tested, and solid ruleset/process for you trading - and then you must be disciplined to follow it. That is how you keep emotions in check. And that is how you become a profitable trader and investor.
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A lot of people ask why I don't buy stocks or options. It's a good question and my explanation may make you question why you would as well.
For most retail traders and investors, the traditional way they try to make money from the markets or are advised to make money in the markets is by "buying low and selling high." On its face, this makes sense and works if executed. The problem is, as most traders find, it is not that simple. The overwhelming majority of people who attempt to trade for a living lose money. In fact, according to statistics, 80% of all day traders quit within 2 years. And only 1% of all day traders are consistently profitable. The reason being is that buying low and selling high is extremely difficult to do consistently.
Why? Because you have to be right. And being right consistently in the hardest game in the world, is very hard.
I was no different than anyone else when I first stated trading. I thought I could "time the market" and I found like most people do, that while once in a while, I would get a win - I would end up giving it back on subsequent trades and end up making no money or losing.
But, after a couple years of trying to figure it out. I started to ask some questions and they led me down the path to being a consistently profitable trader.
Here are some of those questions and answers:
Going down this path was a huge eye-opener for me. I was stacking the odds against me by buying anything in the markets. I was literally starting in a hole.
And the other big "aha" was sellers get paid. Think about it - when you buy a stock or option, you are taking on all the risk and forking over the money up front. A seller gets paid to take on risk. I really liked that.
I then asked, who are the sellers? Well, one way to be a seller is to take a company public on the exchanges and sell shares. That wasn't happening any time soon. Another way is to be an accredited investor and get in on an IPO. In my early 20's, I wasn't there yet.
So, I began to investigate how to be a seller and came across some specific types of trades that allowed me to be a seller in the markets. Specifically, naked puts, covered calls, and credit spreads. I started first with covered calls and naked puts and had some good success. I then graduated to selling spreads, condors, and other types of sell trades. And just buy choosing these types of trades, I put the odds in may favor giving me a 67% chance to win and make money from the start.
I didn't stop there because I had still had a 33% chance of losing money. So, over the years I created advantages such as my proprietary Fractal Energy Indicator which signals when the energy in a chart is going to trend. I came up with solid, tested rules for entry, exit, and profit taking. And in doing so, I boosted my odds of winning trades over 90% in many cases. But, even with that, I still had a chance of losing, so I created defensive systems and rules to protect me in case a trade goes wrong. Because of this, I have much more control over my success as a trader than a traditional investor. Is it perfect? No.
No system is, but it has served me and my students all over the world well for over 15 years.
Will selling options pay 1000% returns? No, selling options can pay great returns, but think of them more like consistent base hits that add up to more than the occasional home run. That is the key to a winning strategy, consistent, compounding profits with very few and minimal losses.
Learn to sell options, put the odds in your favor, and start compounding your profits!
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