It's Never Better to Be Lucky Than Smart

03/05/2014 8:00 am EST

Focus: OPTIONS

Options expert Seth Freudberg of SMB Options Training Program expounds on a mindset, which has the potential to wreak havoc with your trading account.

“It’s better to be lucky than smart.” I’m not sure how that one got started, but I have to count that as one of the most foolish expressions in the English language.

First off, what does it even mean? That if you have no intelligence or experience, that the only thing you have left is “luck” and you had better hope it breaks your way? Doesn’t sound like much of a business plan to me. It sounds more like a recipe for disaster in almost any endeavor in life, and it certainly runs counter to our culture and philosophy at SMB, where we stress preparedness and practice above all. And if it means that sometimes you can do something very dangerous and come out of it unscathed, okay, I can accept that as a possible outcome, but hardly as a desirable situation to put yourself in.

A case in point came up recently in a mentoring session I was holding with one of the students in our options foundation course. He had placed an iron butterfly, and subsequently turned it into an iron condor through the proper application of the adjustment plan that we teach for butterfly trades. He then proceeded to, in my view, gamble very dangerously with the position. After “condorizing” the butterfly, we teach that it is advisable to roll the short strikes of the iron condor further out of the money if the market continues to run in the same direction, counting on the market to eventually reverse its direction. If the market’s direction does not change, then the trade will be exited at an acceptable loss. If the direction does change, the “widening” of the condor will have allowed the trader to survive the adverse market movement and then slowly recover and ultimately win the trade in most cases.

This particular student instead did nothing after the initial correct adjustment. The trade subsequently not only went past its stop, but was in grave danger of becoming a major rip. Yet no action was taken. Ironically, as it turns out, the trade ended up recovering and showing a very handsome profit by the time the trader closed it. But as his mentor I was not at all happy with the trade. Yes, he made money. He was lucky—this time. But I warned him that ignoring a trade and essentially going into what I call “hopeville” will lead to his blowing up his account one day—guaranteed. That’s because if you take a major rip on a trade where you are relying on luck to save you, you will most likely lose everything you made, and more. So all of those lucky “saves” by the market were only setting you up for an ultimately disastrous outcome.

A true trading mentor will not give a trainee an “attaboy” for simply making money on a trade. In fact, it is the mentor’s obligation to disapprove of a dangerous practice that just happened to result in a positive outcome in one particular case. I honestly would have been happier had the trade made much less of a profit on that trade, but followed our disciplines in the process. That learning experience would have helped him to grow as a trader. Ignoring a trade is not a learning experience, and the money made on that kind of trade can, in fact will, cost you much more money in the long run. It can lure you into complacency. It can lure you into thinking that indeed it is better to be lucky than smart. And it might be in the very short run, but in the long run I guarantee you it is not. Your account will vanish very quickly if you don’t value intelligence over luck.

By Seth Freudberg, Director, SMB Options Training Program

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