Irrational Pessimism

Seth FreudbergGeneral Comments, Seth Freudberg's Blogs8 Comments

While being irrationally exuberant over a short winning streak of options trades leads many traders to recklessly ramp up their capital levels leading to devastating, or even fatal, losses, there is an opposite problem, which is not necessarily fatal, but certainly leads to futility.

“Irrational pessimism” is when you lose confidence in your trading strategy when there is no good reason to do so. This is the flip side of irrational exuberance and it can lead to a faulty decision to abandon a great strategy.

Instead of wallowing in a loss of confidence about a strategy after a loss, I recommend to my options mentoring students that they sit down and challenge their doubts about the strategy with questions like these:

  1. How many winning months did I have under my belt before I experienced this loss? If I made money employing this strategy in the majority of the months in the past, why would I think that only this month is valid and all of the winning months are dismissed?
  2. Did I back test this trade for at least three years, with realistic  and honest assumptions for slippage and commission and was it a highly profitable strategy during the period back tested? If the answer is yes, then why would you suddenly think that the strategy is invalid because of one losing month?
  3.  In live trading, paper trading or back testing  this winning strategy were there losing months in every year traded? If so, why do you allow yourself to lose faith in the strategy when something completely expected occurs?

Options income trading is a business. I don’t know of any business model that involves all revenues and no expenses. Do you? If we can all agree on that and if you realize that losing months are just “paying the bills” for an otherwise great business, then we’ll have the courage to trade with confidence in the next expiration cycle and continue to employ our winning strategies.

8 Comments on “Irrational Pessimism”

  1. This is a great article. I think it says balance is what we are all seeking and NOT just in trading. I think this syncs right in with “One Good Trade” in that it’s a process we are seeking and that process should be there within every trade. It’s a process, I think, where there’s not too much elation or too much pessimism, just a process where we go on to the next trade. Here’s an interesting video that talks about Evan Longoria just going onto the next pitch. There are distinct similarities between high level sports and trading. Thanks Seth, great article..

  2. I hate losing but I needed to come to grasp with “losing a battle but winning the war”. Just don’t let the battle be your Waterloo.

  3. Kode9, it is my personal opinion that your hypothetical has a logical flaw in it. Including the results of traders who leave a firm in the measurement of the firms’s ability to successfuly train traders, would be the equivalent of including the batting averages of players cut by a baseball team in the team’s aggregate batting average for the year.

    I think the better measurement is the aggregate performance of the traders who put in the hard work, stayed balanced, remained optimistic, found what trades they were good at and concentrated on refining and improving those trades each and every day. I’d take the bet on those traders every day of the week.

  4. The article was just what I needed to hear and that cartoon is hilariously perfect. I had recently put a cash cow trading system off to the side due to fears for the potential of worst case drawdowns despite having never seen anything close to this in either backtesting or actual practice.

    Naturally, the system dusted itself off and began winning again….but without me.

  5. It happens to all of us. If the trade is an options strategy, you might want to consider some far out of the money puts every time you place the trade, so that if a market meltdown occurs, the vols will pop in a big way and those puts will become surprisingly valuable, offsetting losses from the core position. I’ve seen traders of market neutral positions make a profit during major sell-offs as a result of the far out-of-the money puts “coming alive”. Just a thought for you to consider–if it makes it easier to get back onto the horse.–Seth

  6. This is an excellent article. I’ve been trading the Powershares QQQQ options for 7 years. It’s the only stock that I trade, therefore I’m very familiar with the patterns/movements of this stock. I use to daytrade, but I didn’t want to deal with the anxiety and confinement to my computer, so I developed a strategy and backtested it. It’s quite simple and it’s been extremely lucrative. During an uptrend, I set my stop loss at .17 below the previous day’s low. In a down trend, my stop loss is placed .17 above the previous day’s high. Why .17? I found the QQQQs will go as low as .16 from the previous day’s low/high then it will turn around and continue the trend. I made the mistake of employing this strategy during earnings season…BIG MISTAKE!!! As you know, stocks are all over the place during earnings season, so my stop loss was constantly getting triggered. Eventually, I abandoned my strategy and went back to daytrading. I HATED IT! I had to come to the realization that my strategy worked and made me a boat load of money, but I should not use it during earnings season. I’m happy to say I went back to my strategy, and I’m raking in the cash.

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