Today we’re going to talk about managing losing trades with this example that I had in my account. I had a losing trade of over $25,000, states Markus Heitkoetter of Rockwell Trading.
I want to show you how to manage losing trades. In this article, we are going to talk about:
Number One: How to manage losing trades.
Number Two: We will talk about how to deal with losing trades.
Number Three: How to fix losing trades.
Number Four: We’ll talk about when you should get out of a losing trade.
Managing a Losing Trade
Nobody likes to talk about losing trades, right? But that’s what we do here.
Those who know me, know I’m about real trades and real money. This includes when losing trades happen.
What exactly is happening with my Lordstown Motors Corp. (RIDE) trade? Why is this trade in such bad shape?
Last week (as of March 15, 2021), the Hindenburg Report came out with a report titled, The Lordstown Motors Mirage, Fake Orders, Undisclosed Production Hurdles, and a Prototype Inferno.
Hindenburg are famous short-sellers, meaning that they are betting on a market, or stock, to go down. Therefore, they are making a case for why they are taking a short position right here in RIDE.
Let’s take a look at what happened to this stock.
First of all, I already sold 47 puts and got assigned at 21.50, so right now I own 4,700 shares at a price of $21.50 each.
On March 15, 2021, it was trading at $16.34. Obviously, I am down here, and on March 12, 2021, is when the report came out.
But here’s one important thing that you need to understand: It’s never the news that’s moving a stock, it’s the reaction of traders to the news that’s moving the market.
How to Deal with Losing Trades
How did traders react to it? It’s really important to understand that there’s always a reaction to a report. This goes hand-in-hand with how to deal with losing trades, so let’s see how traders reacted since this report has been released.
If you take a look at a five-minute chart, you see that on March 15, 2021, this is where we opened right here on the left-hand side, and ever since it has been going up.
So, the initial reaction was not good. This is where it goes back to trade what you see and not what you think.
So, what happened here? The reaction was a quick move down, but then we found a bottom, so it’s looking good.
Let’s talk about what’s next, and what can we expect from here.
Next is that RIDE reported earnings on Thursday (March 18). Now, they have not issued a statement yet, and you might be wondering why.
I see three possibilities right now that are going on here. Either they’re scrambling and they’re saying, “Holy cannoli, they caught us with our pants down. We have four days to craft a response.”
Or they could be adjusting their earnings report, and here’s what I mean by adjusting. Now, part of the allegations that Hindenburg had here when we take a look at RIDE, is that they say, “Well, there’s a bunch of fake orders.”
If Lordstown Motors was planning to start their earnings call and say, “Oh my gosh, we have so many orders,” that’s probably not the best thing to do.”
You know how you sometimes prepare a presentation, and then last minute you make a few changes? So, this is what could be happening there, adjusting their earnings report.
Or number three, they might say, “You know what, we won’t even worry about this because we have amazing news that is coming out on Thursday. We got this.” They could tell us something like they’re moving the production date from September to July or something like this.
Anyhow, these are three possible outcomes, and this is where it goes back to trade what you see, not what you think.
Now, I could go and speculate which of these three things it is, but I want to be absolutely honest. I don’t know. I absolutely don’t know, but I will show you my plan.
I am very famous for flying so-called rescue missions and being able to rescue trades that are in trouble.
How to Fix Losing Trades
So how do you fix losing trades? There are two ways:
Solution number one is to just cut your losses and say, “You know what? Before it gets worse, let’s cut the losses.” However, this is a bad idea when trading The Wheel Strategy, which is the strategy that I’m trading here.
Solution number two is where we can try to fly a rescue mission, and I want to show you what exactly this looks like, and I want to give you a very specific example with RIDE so that you know exactly what to do.
First, let’s go back in history. Let’s take a look at RIDE and what I did. Above are my transactions that I did on RIDE.
On February 16, I sold 47 puts, this means 4,700 shares. This was at a strike price of 21.50, so this means that I now own 4,700 shares at a price of $21.50.
Right now, I’m down $24,275 on this position. So, what are my options right now?
When we look at the chart and we go out a little bit longer term, I see that there’s some support level at 12. This is where prices touched the 12 level a few times.
In fact, I actually feel that there’s a support level at 13. So here is one thing that I could do.
One of the possibilities is I could sell more puts at a lower strike price. This is where I’m using The Wheel Income Calculator in the PowerX Optimizer.
RIDE, at the time, was trading at $16.17. What if I sold a strike price of 13? Earlier in the morning I was able to get $0.50 for it, so we can plug these numbers in the Wheel Income Calculator with an expiration date of March 19, and it tells me that I should trade 77 options based on my account size of $500,000.
If the stock keeps plummeting, and let’s say on Friday the stock closes below 13, I would get assigned. Now I would own more stocks. If the stock trades below 13 on Friday, I would own another 7,700 shares and I would have bought this at $13.
Now let’s talk about an important concept here, and the important concept is about the cost basis because now my cost basis is being reduced.
I would have 4,700 shares, and I bought those at $21.50. Then I have another 7,700 shares, and I bought those at $13.
Now we find our new average price. So, 4,700 times 21.50 equals $101,050, plus we’re now taking the 7,700 times 13, and this is another $101,100. If we add these two together, it comes to a total of $201,150.
Take the grand total of shares of RIDE I own which is 12,400 shares, then the $201,000 that we paid for these shares, divided by 12,400, this brings the average cost per share down to $16.22. This is the so-called adjusted cost basis.
Let’s take a look at this. If this would go down to $13 here, all it needed to do in order for me to break even again is go back to the adjusted cost basis of $16.22.
Now, what do you think? Is that reasonable? I mean, you see that it’s already trading at $16.32. So I think it’s way easier for this stock to go back up to $16.22 than it is to $21.50.
Even though there is some math, it is really important that you understand how to fix losing trades and how to manage losing trades. So, $16.22 is my adjusted cost basis.
Now, here is a really beautiful thing. I already collected premium for RIDE, and this is where I want to show you how much premium I already collected.
I sold 47 puts for $0.42 ($42 per contract since options come in packs of 100). 47 times $42 is $1,974, $1,974 is what I collected.
I also sold the March 5 call for $0.30 ($30 per contract), 47 times $30 = $1,410, I collected an additional $1,410.
I did even more because I just kept selling calls against my existing position. So here I sold 47 of the 23 calls for $0.35 ($35) for a total of $1,645 collected in premium, and if I wanted to fly this rescue mission, I would have sold 77 puts for $0.50 ($50) and would have collected another $3,850. The total premium collected is $8,879.
Now we have to divide this, so divide $8,878 by now 12,400 shares, that’s another around $0.72 per share that I have calculated in premium. This now adjusts my cost basis by bringing it down another $0.72.
My cost basis of $16.22, minus the $0.72 is $15.50. $15.50 is now my cost basis if I would have flown this rescue mission.
Now the question is, “is it possible for RIDE to go back up for 15.50?” I believe so, but right now I am waiting. I am waiting for the earnings call on Thursday before making a decision on whether to fly a rescue mission or not, but if I do fly one, this is what it would look like.
When Should You Get Out of a Losing Trade?
I know, this is where some people say, “What if it keeps going down?” So, let’s talk about this.
When should you get out of a losing trade? Let’s keep using RIDE as an example.
When we should we get out if, hypothetically, RIDE keeps falling? What if RIDE goes all the way from right now 16 down to 12, or maybe even 10?
Let’s do the math. Let’s say RIDE drops to $12, how much money would I be losing?
Well, I told you my adjusted cost basis for the shares that I’m owning then would be $15.50. It’s $15.50, minus whatever the current price is, so here in this case $12.
This means that I have a loss of $3.50 per share, and since I do have 12,400 shares, the total loss would be ($3.50 per share times 12,400 shares) $43,400.
$43,000 would be my loss if it drops down to $12, and if it drops down to 11, you can do the math, right?
So, again, the account that I’m trading is a $500,000 buying power account. This is where I personally would consider bailing if my loss is at $50,000, which is about 10% of the account.
Now, I want to give you full disclosure. It has never happened since I’ve been trading this strategy that I had to bail on a trade. I’m just telling you; it COULD happen.
But right now, since I’m down $25,000, I’m not too concerned about it just yet. It might be completely different for you. It’s different for everybody, and you define the max loss that you’re willing to take on a trade.
Year to date, I’ve already made $53,000 on this account. And this has been only 8 or 9 weeks of trading. So, yes, if this happened, I would give back the profits of the last two months.
But you see, as I said, for me, it hasn’t happened yet. It can happen, but it hasn’t happened yet. I’m positive because if I would be a pessimist, I would get up in the morning and be miserable, right?
Summary
Here’s a quick summary for you of what to do, and what you can do in your account, if this happens to you.
The first step is don’t panic. Don’t panic, I’ve said it over and over again. Analyze what happened, and what is happening, right? How are traders reacting to the news?
What I see here in RIDE is that they’re actually shaking off the news. It has been going up throughout the day. It doesn’t seem too bad, and this is why I keep saying, “You got to trade what you see, not what you think.”
You see, what you think doesn’t matter. How do other traders react to the news?
The next steps are to figure out what are your possible options, then decide on your plan of action. My plan of action for RIDE is that I will wait until Thursday’s meeting.
Learn more about Markus Heitkoetter at Rockwell Trading.
