Trading Lessons

Lessons in Trading

We've all learned a few things about trading over the years. Share what you've learned and benefit from the experience of others!

Any time you put your money into the markets, you run the risk of having it taken away from you. Over the years, we've all lost some. That's just your tuition in the school of hard knocks. We've also all made some (hopefully). Unfortunately, we tend to keep our lessons to ourselves, each of us repeating the same mistakes others have made and reinventing wheels that others already use to cruise to market gains. Wouldn't we all be more efficient and effective if we pooled our knowledge? If you can learn from someone else's mistake without repeating it, or repeat what someone else has found to be effective, with your own money, that's more money for you.

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Here's a trading lesson I learned the hard way...

There was a time in late 2000 when I was trading a lot of bull put spreads. A bull put spread is when you sell an expensive put and buy a cheaper put. This gives you a net credit on the spread, and then you just hope that the underlying stays above the price of your short put. One advantage of trading credit spreads is that you can save on commissions if both the long and short puts expire worthless. If that happens, you only pay the commissions to enter the trade and pay no commissions to exit the trade, since they simply expire.

There are three potential outcomes with a bull put spread:
1. If the final price of the stock is above the strike price of the short put, things are great, because both puts are worthless and simply expire. Mission accomplished.
2. If the final price of the stock is below the strike price of the long put, it's a bummer, because you lose; however, your loss is limited to the difference between the strikes of your short put and long put, since the long put serves as a hedge for your short put.
3. The third scenario is the real danger zone, however. If the underlying closes in between the strike prices of your two puts, something highly dangerous happens. Your short put is in the money; you will get assigned the underlying stock at the strike price. BUT -- and here's the gotcha -- the long put that was your hedge now expires worthless! You have now bought a stock at a price higher than its market price, AND you no longer have any downside protection!

This happened to me with a now defunct stock called LHSPF a few years ago. My optimism and blind faith that the market would recover (which sounds like another trading lesson!) cost me a very painful $15,000! Take advantage of my Cliff's Notes from this painful lesson rather than having to relive it. If you put on a similar credit spread and the stock is in between the strike prices, don't be hopelessly optimistic. At least consider that the stock could be on its way down. It may be wise to pay the commissions and close the trade. And don't let yourself get exercised on a credit spread unless you are really sure that's what you want to do! After all, that's probably NOT the reason you placed that spread trade. And that middle area can be no-man's land.

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Do you have a lesson that you can trade with others? It can be about technical analysis, fundamental analysis, money management, placing trades, managing trades, market sentiment, seasonality, your own attitude, whatever. You've picked up a lot of experience over the years. Share it here and save others from the same pain you endured. Or if you've discovered something that works, share that and allow others to follow the trail that you've blazed.

Here's the deal: Write up your trading lesson. Email it to tradinglessons@optioninsight.com. I will compile all the lessons into an ebook. If your lesson is included as part of the ebook, you will get a free copy of the ebook containing dozens of other lessons offered by fellow traders. By submitting your trading lesson, you acknowledge that your submission becomes property of Grey Matter and includes the right to reproduce and publish it.