This is a question that has been coming up in the Inner Circle Membership. I want to address it in-depth in this article because how you react to your credit spread trade going against you will massively impact your profitability! And let’s be honest, you are trading credit spreads because you want to make money, not lose it. As always, let’s dive into the data.
Based on the historical data available to me and the strategies that I use, a put credit spread trade will go against you 24.8% of the time. A trade going against you means that the stock goes below your breakeven price for the put credit spread. However, you will win roughly 90% of your put credit spread trades using one of our strategies. This means that even if a stock goes against you while you are in the trade, you may not lose money by expiration.
If you are trading a put credit spread strategy with a 90% win rate, and you sell when the stock goes against you, you will lower your win rate from 90% to 75.2%. That is a massive difference in the credit spread world! This is because your wins are way smaller than your losses. That means you will experience roughly 20% more losses by selling early instead of holding until expiration like your strategy dictates.
So, what are the practical steps to follow when a trade goes against you?
- Remember Your Trading Strategy
Tell me if this sounds familiar? You are trading credit spreads with a strategy, but you don’t have much experience with the strategy. You see the stock go against you, you are down over 50% on a single trade, you start freaking out, you try closing the position and realize you don’t know how to, you finally close out of your trade, and look back a week later and realize that your trade would have hit the max profit and expire worthless.
Too many times, traders (myself included) let emotions control them and sway them from their trading strategy. My advice is that you find a strategy that is historically proven to be profitable and master it! That means you paper trade it, trade it with one contract, review the backtests, and commit to following through.
- Don’t Let Emotion Dictate When You Sell
The key to success in the trading game is having complete control of your emotions. As traders, our emotions jump all over the place, but we should not let that affect our trading decisions. It is best to be stoic in this regard.
One of the most profitable hedge funds in the world right now is called Renaissance Technologies. They are a quant fund which means that they create computer models to trade stocks. Why does this work? Because it removes human emotion. My advice is to master a strategy, only do what your strategy says and get accountability for when you don’t.
- Potentially Double Down
There is an idea that I have mentioned before called the Shadow Strategies. They are simply the strategies that you can follow if the trade goes against you. There is a shadow function for each trade strategy that I talk about in the Inner Circle Membership. I also talk about them in other articles on this site.
Regardless, these shadow strategies give you very profitable and high win rate trades that can be taken when the stock goes against you. Always ensure you are using proper risk management which means that you are putting no more than 10% of your account in any one trade. If you are below the 10% per trade rule and you understand the shadow strategy, then you can double down on the position.
In conclusion, there is nothing wrong with taking a loss and selling early especially if the trade isn’t going in your favor. However, you should not be letting your emotions trump the rules of your trading strategy.
Thanks for reading 🙂
Austin Bouley
CEO & Chief Strategy Officer