The Most Overlooked Cause of Trading Losses (And How to Avoid It)
As a trader, I want to make money.
I know that to do that consistently requires hard work and discipline.
Obviously if we need to work hard we can’t be lazy.
But in between hard work and laziness lies another factor — one that could be the most overlooked cause of trading losses.
I suspect complacency is the No. 1 factor that consistently hurts traders’ profits. The biggest reason might be because most traders aren’t aware of it, even when it’s affecting them.
Complacency, according to the economist Tyler Cowen, means standing still.
Cowen was interviewed by NPR after the release of his book The Complacent Class in 2017, and he stated: “People have grown more risk averse and are reluctant to switch jobs or move to another state … and the desire to innovate — to grow and change — has gone away.”
Complacency explains the economy’s slow growth over the past 20 years.
It also explains why many analysts and traders make bad decisions.
If I’m complacent, that means I expect tomorrow to be just like yesterday.
But markets and the economy change every day. Expecting no changes is a dangerous position to be in.
Yet, that’s where we are.
Inflation data was released yesterday. The report noted that inflation at the wholesale level jumped 1% in July, dimming hopes for a slowdown in price increases.
Over the past 12 months, prices at the wholesale level are up a record 7.8%, surpassing the old record of a 7.3% gain set for the 12 months ending in June.
As a consumer, I know inflation isn’t good. I will either accelerate buying decisions if I expect inflation to continue or I will defer buying if I expect inflation to subside.
Federal Reserve officials are trying to convince us everything’s fine, that no action is needed.
They urge us to be complacent by insisting inflation is transitory.
This is leading economists to follow the Fed’s lead. They insist everything will be just fine and inflation will return to normal levels.
But complacency extends beyond just economists.
Complacency affects the stock market. In regards to inflation, companies will see earnings change as a result of higher prices.
If they pass price hikes on to consumers, earnings will rise.
If the company can’t pass costs on, earnings will fall.
Yet, Wall Street analysts are ignoring this reality. Inflation is rarely mentioned in their reports.
So how does this affect you?
Many traders will be complacent and assume stock prices will keep going up.
This will lead to taking on larger position sizes. And when the market turns, the result will be large losses.
I’m not complacent. I am always watching for changes in trends and in market structure.
I identified a change in market structure that affects my One Trade strategy, and I just told my subscribers about it.
It’s not easy to change. But it is costly to ignore the facts and be complacent.
With the high level of complacency I see among economists, analysts, and traders, I believe those of us who adapt to market conditions will enjoy a profitable future.
As a final note, Cowen added in his interview:
“If you cease being challenged and you think your way of life is the only way, ultimately that way will become weak, it will be subject to less improvement, you will enter a kind of bubble and continually be surprised by the challenges the outside world keeps on throwing at you.”
Never assume you know everything. Always assume you’re missing something. Reading True Options Masters, or really anything will keep your mind sharp and always on the lookout for some angle other people and traders aren’t seeing.
Stay nimble. When something’s not working, shake yourself out of apathy. Knowing when to adapt is what separates a true options master from the rest of the herd.
Michael Carr, CMT, CFTe
Editor, One Trade
Chart of the Day: The Big 3!
This chart compares the three main U.S. stock indexes over the past three years, based on popular ETFs.
They are the SPDR Dow Jones Industrial Average ETF Trust (NYSE: DIA), the SPDR S&P 500 ETF Trust (NYSE: SPY) and the Invesco QQQ Trust Series 1 (Nasdaq: QQQ), the last of which measures the Nasdaq 100.
Over the last three years, the Dow has grown by about a third. Meanwhile, the S&P 500 has grown by half, and the Nasdaq has doubled.
We all know the Nasdaq has broken out since COVID-19 forced the world to go digital, but this chart shows that trend began about several months before the pandemic hit the U.S.
Ever since the tech wreck in 2000, we think of the Nasdaq as the most volatile of these indexes, but over the last three years, in some respects, it’s been the least volatile. There have been periods where the Nasdaq goes up in a straight shot.
Meanwhile, the Dow is clearly lagging. It moves roughly in lockstep with the S&P 500, but the moves are abbreviated.
This is what puts the S&P 500 in sort of the “sweet spot,” and why Mike is changing his One Trade strategy to trade SPY exclusively.
With SPY, we get larger price movements to make fast money with options. Larger price moves mean we are less subject to options decay on our premiums.
But there is another benefit. SPY options expire three days a week. DIA and QQQ only have options that expire on Friday.
This makes trading SPY much more flexible. I am excited to see how this change will improve the performance in One Trade. If you haven’t given this premium research offering from Mike a look yet, now is a great time to do so. (Note: the video hasn’t been updated, so it still refers to DIA, but the strategy is otherwise the same).
Chief Editor, True Options Masters