People enjoy seeing their “worlds” on TV or in the movies. Viewers love to debate how accurately (or not) being a lawyer; EMT, doctor or nurse; or a cop is depicted.
Less common but equally true is Wall Street and trading. Billions is the TV gold standard. In movies, two titles, both now over 35 years old are the most beloved: Wall Street (“Greed is good, greed clarifies…”) and Trading Places (everyone’s introduction to frozen concentrated orange juice-FCOJ). And honorable mention for the more recent Margin Call which is very good, but not iconic and lacks characters remembered or loved today.
Trading Places is awesome. It’s ginormously good and fun. But besides that, if you paid attention it was a mini trading education and a primer on supply and demand.
<Spoiler alert!!! – although should one really be concerned about that for a movie that came out in 1983?>
The Duke brothers’ explanation of how brokers function and supply & demand to Eddie Murphy (Billy Ray Valentine) in the back of the limo is great. Their example of pork futures and “bacon, like bacon in a bacon, lettuce and tomato sandwich,” justifies the movie right there. It’s that funny but also accurate. But the climactic trading floor scene rewarding our heroes, Valentine and Dan Ackroyd (Louis Winthorp…the third) and wipes out the Duke brothers is supply and demand in action and nicely depicted.
The Dukes are commodities market makers and brokers. As part of this, they are also proprietary traders, i.e., they trade their own accounts. But in their case, greed isn’t good. They pay for an illegal advance copy of an orange crop report to gain inside information. Valentine and Winthorp learn of the plan, and behind the scenes maneuver the substitution of a phony report stating the forthcoming orange crop would be low. This forecasts a low supply of oranges to make FCOJ, so FCOJ will become much more expensive. Meanwhile, the real report will say the crop will be normal, so prices will actually remain relatively stable in the short- to mid-term.
After getting the phony draft report, the Dukes act on it the next day, when it’s scheduled to become public a few minutes into the trading session. They start aggressively buying FCOJ at the open, accumulating FCOJ futures contracts. They expect FCOJ prices will soar once the (phony) crop report about a low orange harvest comes out (lower supply and higher demand = higher prices), resulting in a huge profit.
The Dukes start aggressively accumulating and other brokers and traders pile in since everyone knows the Dukes and figures “they know something.” The buying fuse lit by the Dukes illustrates another well-known trading concept, “FOMO,” the fear of missing out. So, while the Dukes and other traders are paying higher and higher FCOJ prices, they believe they’ll be rewarded when the official report is released and prices spike.
But it’s not to be. The real report’s issued, and everyone realizes there’s no coming price surge. In fact, FCOJ prices were already driven far too high by the buying frenzy. Then the fun really starts…
The traders stand silently for a few seconds after the report is broadcast, realizing their predicament and they’re about to get smoked. Then, one of our heroes yells out at the top of his lungs an order to SELL SHORT a slew of FCOJ contracts, knowing that will set off a selling cascade. The panic bubbling beneath the surface is ignited and a selling frenzy starts as everyone who just bought FCOJ futures (at inflated prices) looks to dump them and limit the damage, and prices come crashing down.
As the wild selling ensues, our heroes gauge the panic on the floor, the order surge and how prices are descending. They wait, they wait, they wait and when they sense the time is right, they now yell out orders to BUY THE SHARPLY DISCOUNTED FCOJ FUTURES, which serves two purposes:
Q: What do these have in common? Unicorns; The tooth fairy; Santa Claus; Politicians prioritizing the public good against their own self-interest 🡪 A: All are, of course, mythological figures.
Here’s another: Trading services and discretionary traders claiming “real” success with win rates of 99%, 93%, 87%. Good luck with that.
No discretionary trader achieves success shooting for rates like that. The only beneficiaries of these claims are those making them to people hungry to believe them.
Before continuing, note the word “discretionary.” This refers to individual retail traders, like us, like you. We evaluate charts, determine entry & exit criteria, manage trades, and manually execute them. We don’t have black boxes doing algo, high frequency trading. We’re not quants. Discretionary vs non-discretionary trading are entirely different worlds.
Here’s an obvious truth: trading is about making money, not about “being right.” In baseball, offense really isn’t about a .300+ batting average. It's about either knocking in runs or scoring them. Of course, you need baserunners to score runs and in trading you need to be right a “certain amount of time” to be successful. But like almost everything in life, it’s not binary – it’s how much, to what extent, and how frequently.
Many traders, if we really went to the effort, could have lofty win rates – maybe not 90%, but certainly 75-80%, because that amount of time, our trades go green at some point. So if we closed those trades with stupidly low profits, they’d be “winners.” But….to what end?
In business, net results come from the sum of outcomes. You aggregate money brought in and subtract what goes out. In trading that’s Winning Trades minus Losing Trades. Winners pay for losers, and only then are there profits. But if you have $300 losses and a bunch of $50 winners, is that really the foundation of a robust trading method? Is that sustainable? In the real world, can you really be right 93% of the time, pay for your losers and run a business where losing trades are, by design, part of the recipe? It’s really insulting to one’s intelligence to put that out there.
There are three ways successful discretionary traders operate, with the latter two the most frequent.
A small number of people scalp intraday, often profiting on small moves magnified by throwing large volume at them. Either way, it’s not a life and certainly no way for most of us who love trading want to do it, especially when it’s our livelihoods. There’s nothing wrong at all doing that, but it’s impractical for most people.
Middle-ground positive trade frequency and reasonable reward-to-risk ratios
A well-planned system where the average win rate is a “realistic” percentage, and the average win-size is a “reasonable” multiple of the average loss. For example, being right 40-50% of the time & the average win-size is 2-3 times the average loss. So, for every 10 trades, here are sample scenarios:
Depending on your trading style and trading frequency, maybe you do this every month. Maybe every two week. Maybe far less often, but you trade a larger account so have more money in each trade. The numbers can be extrapolated to your personal situation.
Sometimes, especially with certain credit spreads in options trading, you may have some high probability trades with low or even inverted reward to risk. This is okay because these trades are rooted in math and facts. Not fiction and intelligence insulting marketing claims.
In baseball terms, this approach is like a singles and doubles strategy. You aim for consistency and moderate drawdowns when things don’t go right (which they inevitably sometimes will). You avoid being unduly stressed, especially when starting out with real money and then shooting at a financial target. Done right, you can make a very, very nice living doing this, or have an awesome supplementary source of wealth generation.
“And Now for Something Completely Different”
This is geared at catching fewer, but (much) bigger moves. But it is NOT necessarily high-risk, high-reward. Rather, when done right, it involves cutting off ill-performing trades very quickly and taking a large number of (very) small losses. This is often characteristic of a trend-following strategy.
These systems feature lower “trading batting averages” (win-rates), but (much) higher average wins per trade. There are often multiple “stabs” at a trade, aiming to catch the start of a big move, and trying multiple times if the setup fails but remains valid. After entry, there are sometimes add-ons to grow the position. Returning to baseball, this is like swinging for home runs. Such systems often see win rates of 15 or 20%, but average win/loss ratios of 7-8:1 and higher, sometimes much higher.
The upside is obviously mega-results when things work. The downside can be larger drawdowns, as well as being battered psychologically since as human beings we want to be right.
In future pieces we’ll talk about the elements of a good trading system and realistic win rates and reward-to-risk ratios.
But for now, we’ll leave you with this. Do you notice in both the “Realistic” and the “Completely Different” scenarios, there’s no mention of 87%, 93% or 99% win-rates?
Q: Do you know why? A: Because unicorns and the Tooth Fairy don’t trade.
$BRX (Bitcoin Liquid Index) -- a couple of people today asked us about Bitcoin. So here's a 2-part analysis.
Passive income…You own a financial instrument or “real” property to eventually profit from its sale, but also make ongoing income from it. The two most common examples are:
Covered calls are like collecting rent on real property. You own shares of ABC stock, letting you safely sell a call on ABC to someone who thinks ABC is going up. For example, you own 100 ABC shares currently priced at seventy. If you sell an ABC 75 call, expiring May 21st, the buyer has the right to buy ABC shares at the strike price (75) anytime between the purchase date and May 21. This is referred to as “exercising” the option. This right is a choice to buy ABC at 75, but not an obligation. That choice exists for a limited, specified time span, ending at the option expiration date.
A call becomes worthy of exercise if ABC’s share price exceeds the strike price, since why would you buy ABC for the $75 strike price if it’s selling in the open market at $72. (there’s one situational exception we won’t go into now).
The call-buyer benefits if ABC’s shares rise enough before the expiration date (technically reaching 75 + the amount paid for the call), either:
As an ABC covered call seller, you are obligated to deliver ABC shares if the buyer elects to buy them using the call that was bought. Your aim is not to have to do this, but you must be ready for the contingency. The option premium you received is payment for this obligation. But already owning the shares, you’re set.
If by the end of the contract ABC doesn’t reach its strike/exercise price – rises only “a bit”, stays flat, or falls the call becomes worthless. The buyer’s premium is lost and since generally the market is a zero-sum game (it is here), as the seller you win. That’s the aim of the covered call.
Selling covered calls is great due to an option being “a wasting asset, i.e., part of what gives an option its value is how much time is bought for the contract life. But as the time passes, the time value degrades and evaporates. So as the seller you keep the premium if the price of ABC doesn’t reach the contract/exercise price by the specified date. All the while the call you sold is losing its time-value as days and weeks pass.
As anyone who has ever bought options has learned, it’s not enough to be right about a stock direction prediction; it also has to be right IN TIME. That is why for most people buying calls tends to be a losing exercise. If call buyers are generally losing, then call-sellers (who know what they’re doing) are generally winning.
What’s bad for the call-buyer is good for you as the seller, since in a perfect world the option is worthless when it expires. Or, if you want to buy the option back early (there are reasons to sometimes do this), you can do it at a much lower price, keeping the difference between the higher price it was sold and the lower price it was bought back for to close the position.
A savvy trader or investor owning ABC stock can sell ABC calls several times/year, even every month or more often, and collect premium, i.e., extra income. When done intelligently and without greed (trying to collect too much at one time), this can be very profitable with a bit of attention.
Below is a recent example of a typical, no-drama covered call with an unexciting blue-chip stock, Coca Cola (KO). The stock as of 2/22/21 pays a quarterly dividend of 0.41/sh. This position shown, lasting about a month, collected 0.47/share in premium. This monthly premium is equivalent to about 14% more than the three-month dividend (0.41). Over a quarter the call premium is equal to a bit under 3 ½ extra dividends.
Done properly, covered calls are highly beneficial when not “trying to do too much.” They actually
can’t fail” in terms of suffering an actual loss on the option trade. Doing them properly avoids having the stock needlessly called away, resulting in undesirable, associated tax consequences.
In the example, KO’s price never reached its strike/exercise price (53). The option lost its entire value and we kept the premium received when we sold the covered-call.
So, covered calls are a great passive income strategy when you own shares of stock or ETFs.
But...what if you don’t own shares of stock, which are needed for covered calls?
How can you get some of the benefits of selling calls just described, without owning shares and without laying out money? We’ll start talking about that technique, called credit spreads, in Part 2.
Robinhood is facing backlash for appearing to aid institutional investors over individual traders after the popular investing app blocked users from purchasing shares in GameStop and other companies that experienced a price explosion in January.
GameStop’s share price shot up from about $30 in early January to more than $300 last week as retail investors drove up the price against hedge funds and other institutional investors. Institutional investors had previously shorted some 140% of GameStop’s existing shares on the assumption that the security would decrease in value.
According to data compiled by The Box, Robinhood earned about $675 million in revenue after sending the customer’s orders to “market makers.” Many of the “market makers” are hedge funds or other institutional investors, according to the Financial Times.
Trades on Robinhood are commission free. But to generate revenue, trades are sold to “market makers” who often use their position as the middle man to generate a profit off the information received from Robinhood.
For example, when you buy a share of Tesla on your phone, Robinhood sends that order to a trading giant like Citadel Securities and receives a few pennies in return. Citadel, meanwhile, completes your trade and makes a few pennies itself.
Robinhood has long branded itself as an accessible platform that provides free financial services for its users. Its mission statement includes a pledge to “democratize finance for all.” But the company makes money by selling its order flow — information about user transactions — to third party clients who actually enact trades with access to user data.
What Is a Short Squeeze?
The Investopedia definition is A short squeeze occurs when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall, to buy it in order to forestall even greater losses. Their scramble to buy only adds to the upward pressure on the stock's price.
To understand the Robin Hood and $GME situation you have to understand a short squeeze.
I am follow the $GME story but not trading it currently.
But we are discussing it heavily in the chat room so I thought I would share various charts we have been reviewing.
One of the greatest trading books ever written is Reminiscences of a Stock Operator.
The original book was published in 1923, but in 2010, an Annotated Edition was produced by Jon Markman. This edition reveals the truth about Jesse Livermore and provides colorful, historically accurate commentary on the characters, places, and events that have made Reminiscences such an enjoyable and educational read for generations.
The foreward to the Annotated Edition is written by legendary trader Paul Tudor Jones. At the end of the book, Jones answers a few questions about his relationship with the book and its themes. Here is one of the insightful questions that was asked to Jones. I found a profound meaning in his response. I hope you discover it as well.
Question: Part of the appeal of the book is Livermore’s journey of self-discovery as a person and as a trader. Have you had the same experience as a trader and portfolio manager, or was your path easier or harder?
Paul Tudor Jones: Probably the best lessons to be learned from this book come from his repeated failures and how he dealt with them. In the book I think he lost his entire fortune four or five times. I did the same thing but was fortunate enough to do it all in my early twenties on very small stakes of capital. I think I lost $10,000 when I was 22, and when I was 25 I lost about $50,000, which was all I had to my name. It felt like a fortune at the time. It was then that my father flew up from Memphis and sat me down in my New York City apartment and began lecturing me as lawyers do. He commanded, “Leave the gambling den behind. Come home and get a real job in a safe profession like real estate.” Of course, I did not, and the rest is history. And real estate these past few years has been about as safe as shooting craps to pay the rent, so I was twice blessed. If I’d have taken my father’s advice, I might have lost all of my money again these past few years in my fifties.
Anyway, I think it’s no coincidence that our greatest champions, our greatest artists, our greatest leaders, our greatest everything all seem to have experienced some kind of gut-wrenching loss. I think their greatness, in part, was fashioned on the crucible of that defeat. Two years before Lincoln was elected as maybe our finest president, he lost that monumental Senate race to Stephen Douglas. To a certain extent, I think that holds true in my field as well, and I am leery of traders who have never lost it all. I think that intense feeling of desperation that accompanies such a horrifically deflating experience indelibly cauterizes great risk management reflexes into a trader’s very being.
There are two unpleasant experiences that every trader will face in his lifetime at least once and most likely multiple times. First, there will come a day after a devastatingly brutal and agonizing stretch of losing trades that you’ll wonder if you will ever make a winning trade again. And second, there will come a point when you begin to ask yourself why it is you make money and if this is truly sustainable. That first experience tests an individual’s grit; does he have the stamina, courage, guts, and smarts to get up and engage the battle again? That second moment of enlightenment is the one that is actually scarier because it acknowledges a certain lack of control over anything. I think I was almost 38 years old when one day, in a moment of frightening enlightenment, I knew that I really did not know exactly how and why I had made all the money that I had over the prior 17 years. This threw my confidence for a jolt. It sent me down a path of self-discovery that today is still a work in progress.
Good traders focus on entries and exits, discipline, market analysis, risk management and position-sizing in executing a robust trading plan.
But interestingly, many of our subscribers often breathlessly ask,
“What’s on your watchlist”, like THAT’S the holy grail.
Of course, we want to start with trading instruments with good volume, sufficient average price movement, appropriate volatility levels for a given option strategy, and a couple other criteria. This leads to a good GENERAL watch list.
But over time we’ve found specific symbols are better trading vehicles for certain purposes versus others. For example, some are better candidates for:
For example, EBAY is often choppy intraday with smaller timeframes, but in higher timeframes it’s a solid performer for intraweek swing trades. It’s on our short to medium-term swing trade list. Or INTC often stalls out and is range-bound for long periods, making it a perpetual member of our credit spread watchlist.
At PTL we share our regularly updated Sweet Spot Equity list featuring stock and ETF symbols with low share prices, sufficient (but not insane) price movement, and good average trading volume. These are subdivided for intraday-only, swing-trade-only, or either style. We post long and short symbols that represent good candidates for buying puts and calls. Another for selling vertical credit spreads.
So, the next time you think about your watchlist or updating IT (SINGULAR), consider how you trade, and create specific watchlists (PLURAL) and monitor THEM. They’ll match up better with what you’re doing.