lystn

Hey everyone, this is Kirk here again at Option Alpha and welcome back to the daily call. Today’s call, we are going to be talking about false positives and false negatives and why they cripple, literally cripple options trader’s ability to stay consistent. This one is a favorite topic of mine. Literally, I’m actually just really excited. I’ve sat up in my chair. I’m so much more alert talking about this topic because I love talking about this. I think that this is a huge problem in the investing world. I myself fall prey to it too, so it’s not like that it’s… I'm not superhuman and I don't have your false and negatives or downsides to how I trade, but I recognize that this is a huge problem with people and it’s this false positive, false negative that you get in trading. Here's how it works. When you make a trade and even if it's a completely bad, stupid, dumb trade, you could still make money on that trade. There’s probably a pretty good change maybe even that you make money on that trade because something happened that was out of your control, you didn’t really predict, but worked in your favor. Now, you have this false positive that, “Hey. When I made this trade, I made money.” And then it happens say twice or three times or five times in a row which we've seen before that people are making the same bad trade, but they end up winning five times in a row and they have this false sense of positive outcome. I’ll look at their trades or they’ll send them over or I’ll have a coaching session with people and I’ll say, “Look. These are really bad. You should not be making these trades. They’re too big a position size. You’re not taking enough premium. You're not balanced.” But they say to me, “Well, Kirk, I’m still making money on these. These have all worked.” I'm saying, “Yeah. It’s only been three weeks or it’s only been four weeks. You have a false positive sense of success here. These trades are not going to work out long-term.” And so, that’s something that I think is really, really important to understand, is that when you get yourself into a trade and if it wins or if it loses even, that doesn't mean necessarily that the trade was good or bad. That's why we publish so much research and we now have back-testing software that allows you to do this for yourself. Look at the long-term prospects for a trade or a strategy or a setup. What does it do on a long-term basis? If you’re making trades at the 70% chance of success level, you don't know when your 70% winners are going to come. You could have let’s say out of 10 trades, you know you should have about 7 winners and 3 losers. Well, the first 3 trades could be losers. That could encompass an entire quarter of your trading because you’re trading three times, three expiration cycles. That could all be losing trades. And then you stop and you say to yourself, “Well, this is a losing strategy.” But that's a false negative. You are falsely assuming that that trading strategy has a negative expected outcome when it doesn’t. You just have to keep trading. Then you keep trading and then you have 7 amazing quarters or the reverse happens. You have 7 amazing quarters to begin with or 7 amazing trading cycles and you think to yourself, “I'm superhuman. Nothing is going to happen.” And then you have what happened in the beginning of February where we had massive, massive movements in the market, huge drawdowns in a lot of people’s accounts because they were totally one sided. And that again, created that false sense of positive outcome. Just trade everything bullish or the mantra heading into February before everything happened was, “Everything is up. Nothing bad can happen. The markets can’t go down.” Volatility always stays low, so a lot of people were short volatility, just flat out naked short volatility. And so, I think that that's where this topic comes into. Just try to reassess what you’re doing. Literally try to look at it as a business. People just get into this thing and they think it's just this hobby. They call it a business, but they don’t. They get into it like hobbyist. If you were going to open up a restaurant, you’d look at – “Do people in that area go out and spend money on dinner?” If you’re going to open up a high-end restaurant, you’re not going to do it in a town that people don't usually go out and spend money on a high-end type dinner. It’s just commonsense. Use our back-testing software, use our auto-trading software to figure out what works and then start to replicate that strategy and be consistent and confident in the numbers that they’re going to work out over time. Don’t believe or don’t fall prey to those false positives or false negatives that you might get. It might be cool to win on a trade where you didn’t do something right, but don’t assume that it’s going to happen every single time. As always, hopefully this helps out. Until next time, happy trading!