Market volatility continued to set record lows (as measured by the $VIX) – and the market indices continued to set record highs. It was easy to get lulled asleep. And, I know better, as I’ve been engaged with the market for over 25 years. The market will act in an unexpected way when you least expect it!
Over the last several months, I added long positions in stocks and ETFs I also sold put options on stocks and ETFs I wouldn’t mind owning at lower prices, and simultaneously, sold some covered calls. This strategy works well in flat to slightly bullish markets. That is, it works great until it doesn’t.
Starting in early February, the market began to sell-off and volatility exploded higher. Not only did my long stock and ETF positions lose value, the short put positions experienced losses (at an even greater velocity than the equities). These positions moved more than I had expected, and consequently, the unrealized (paper losses) were larger than I planned for.
Emotionally this was tough to watch. To make matters worse, I was on a business trip which led to a feeling of having less control (real or perceived). I’m sure this has never happened to you, right?
How did I not see the volatility coming? As traders, we have all seen this movie before. We know how it starts, and ends. It’s like when I watch my favorite movie Field of Dreams, I know that if Ray “builds it, he will come”! It repeats time and time again.
The unrealized losses led me to ask one key question: Am I going to be OK financially, based on my long-term goals of paying for college for my three kids and having an active lifestyle in retirement?
In the spirit of self-evaluation and development, I pulled together a shortlist of what I learned over the last week. If you can learn anything from the pain I experienced, great.
What went well?
Although I was unprepared to see the unrealized (paper) losses, I wasn’t over-leveraged. My trading allocation and risk plan worked. If you haven’t taken steps to clearly identify your risk management and exit strategies for your trading positions, I encourage you to do so. Now.
- I had the right amount of capital decked against shorter-term trading vs. longer-term investing. If you haven’t done so recently, take a look at your trader vs. investor allocation.
- I lost sleep the week I experienced those losses, but not because of the paper losses. It’s because I’m currently teaching my 16-year-old daughter how to operate a non-self-driving automobile. If you’re losing sleep because of market volatility, it may be time to reduce risk. (And, if you’re teaching your child how to drive, maybe you can explain to me why merging onto the interstate is so hard!)
What didn’t go so well?
- Mistake #1: I didn’t fully expect the unexpected. I had on higher risk positions, and I was on business travel. This made it tougher to actively manage risk and led to a feeling of having no control.
- Mistake #2: Emotionally, I was unprepared to see a large short-term drawdown in my trading account, even though I could ‘afford’ the losses. This was painful.
- Mistake #3: I have spent a lot of time and energy learning about trading and active investing, but I haven’t spent enough time on long-term wealth planning.
My key takeaway, and what all traders should do
My recent drawdown led me to re-evaluate my overall financial health and long-term plan. I started by using some of the advice tools and services offered by Schwab.
All of this helped me answer the question, “Am I going to be OK financially?” The process was simple – and didn’t require a huge time commitment.
My result: Yep, I’m doing just fine. My plan was stress-tested based on different market scenarios and my probability of success (paying for college and retirement) is high. My long-term asset allocation looks good. The amount of trading versus investing assets is appropriate based on my plan. I’m saving the right amount of money for retirement. I’m on track. (OK, my college savings plans may be a little light. Have you seen the cost of college these days?)
If you’re a trader, and you trade all or most of your investable assets, I encourage you to take a step back. Take some time to review and act on your long-term financial plan and ensure you have a clear delineation between short-term tradable assets versus long-term investing assets. For many, active trading is fun or is even considered a hobby. Trust me, I get it. But, hobbies are way more enjoyable when you can afford them.
You may think to yourself, “I’m a tough and cool trader, I don’t need long-term planning. I have the markets all figured out.” You may be right, but it’s also worth having a plan. Try it. Having a plan may even allow you to engage or trade more.
OK, I’m going back to trying to figure out this market. Please send us your comments or questions.