How to Review Your Trades

11/20/2014 8:00 am EST

Focus: OPTIONS

Incorporating a trade review process into your option trading plan is a good way to learn about yourself and your option trading methods, while also improving your trading skills, according to Seth Freudberg and Michael Schwartz of SMB Capital.

One of the hardest things to do while attempting to become a profitable options trader is to find a strategy that you are comfortable with and then sticking with it long enough to give you a chance to play out over many trades. Many of us believe that we can purchase an options trading course or read a book and instantly be on the path to profitable options trading. But what typically happens is, after a few bad trades, the person moves on to try to find the next best thing whether it is another options trade or some other type of trading strategy.

One of the most important elements in determining if your options trading strategy has a trading edge is to develop a schedule and method of tracking and analyzing your own performance. You can learn so much from tracking your trades. But if you keep changing from one method to another, there is nothing to track and therefore nothing to form the basis of a learning experience.

As a matter of fact, many traders have noticed that the simple act of reviewing trades and tracking performance, in and of itself, can stimulate a major improvement in their trading. When learning how to trade options as a beginner, sticking with a particular options trading strategy, instead of abandoning it too quickly, will give you the fortitude to stick with the system during inevitable losing streaks and draw-downs in equity.

What exactly is meant by "tracking our trades" and "trade performance"? The easiest way to answer this is that one should be able to determine, after completing the trade tracking document that you have created, the answers for these two things: how did you do and why did you do it?

"How did you do?" relates to your numerical trade statistics at a minimum: number of wins, number of losses, average profit of a winning trade, average loss of a losing trade, largest winner, largest loser, etc. By knowing these you can calculate your expectancy, which is the amount you expect to make on every trade.

The formula for trade expectancy is: (win % x average win amount) - (loss % x average losing trade). For example, if  a trader is using a method that wins 65% of the time and the average win is $225 and the average loss is $300, the calculation would be as follows: (.65 x $225) - (.35 x $300) = $146 - $105 = $41. So this system has an expectancy of $41 every time you put on a trade.

The other aspect of tracking your trades is the "why did you do it" question.

Can you easily review your trades and find out why you made your individual trading decisions? Do you take screen shots of charts before, during and after the trades? Do you write in a journal or put notes in your Excel spreadsheet?

Regardless of the specific method used, tracking our trades is a critical element of successful options trading for two reasons. First, you will be amazed at how doing so makes you stick to your plan because you are documenting your decisions, and you tend to not want to report-to yourself-a foolish, emotional decision. So if you have a tendency to bend your rules, this will surely help.

The second reason is that a review of your trading activities will help you improve your results over time. As we teach in our options foundation program, we are not just suggesting the process of documenting and tracking statistics. We are suggesting that you conduct, at least, a quarterly review of your options trades to determine ways in which you can improve your results. For the reviews to hold merit, the review and analysis must include a reasonable sample size that also traverses multiple types of market conditions. Learning to manage and adjust your options trades over different scenarios and market environments is a key (and necessary) skill development process you cannot learn in a book.

We can't promise the world or even immediate profitability when you start to incorporate a schedule to review your trades. What we can promise, though, is that you will learn a lot about yourself, and your option trading methods, while also improving your trading skills.

By Seth Freudberg and Michael Schwartz of SMB Capital

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