A couple of weeks ago I mentioned in a webinar that I was placing a ‘trade-like’ bet on the Wimbledon tennis championships, and outlined how I would de-risk the entire bet.
Now the championships are over, I’ll explain what I did, why, and how it relates strongly to our style of trading.
Step One – Trade Setup and Entry
So, on the first day I saw that Roger Federer was at 7/1. This means for every dollar/pound I bet, I would get back 7, plus the original stake. Effectively that means a multiple of 8 on my original investment.
Choosing this ‘trade setup’ was easy. Federer had just won a prestigious grass court tournament, was now used to his oversized racquet, was in peak condition and a serial winner. Furthermore his draw was easy for the first week, meaning that by week 2 his odds would inevitably shrink.
The type of bet was a ‘cash out’ which means I had an easy exit strategy. If Federer’s odds did come in, I could close my position in profit with a single click.
Step Two – Managing the Trade
For the first week I sat tight as Federer’s odds barely moved. Yet he was playing sublimely, not even losing serve. No need for me to do anything.
By the time he reached the semi-finals he’d only lost one service game and was starting to get proper attention. By now his odds had shrunk to 3/1.
Step Three – De-risking the Trade
As the players walked onto the court for the semi-final I had the choice to stick or twist. Bearing in mind that Murray was a worthy opponent we were now in the realms of whoever would perform best on the day. At this point you could literally flip a coin, yet I was already sitting on a position that I could completely de-risk.
So I cashed out with a 60% profit and re-deployed the profits back on Federer. I now had a zero risk trade and could enjoy the match, which he won at a canter and after which his odds were virtually evens.
At this stage I could have taken profits before the final, but given that this was a bit of fun I let it ride in the knowledge that I couldn’t lose on my original stake no matter what. If I’d tried harder I could have deployed a more sophisticated strategy, but that would feel too much like the day job!
Ultimately he lost the final but I was able to watch his dismantling without any undue stress.
Similarities and Distinctions with Trading
Of course this situation wasn’t a carbon copy of trading, but there were some clear parallels that serve to illustrate our trading philosophy well.
- The initial setup was favourable. In this case a high probability setup (but not a dead cert) from the outset – that’s the same with any trade. With trading we look for our specific high probability setups.
- The money at risk was relatively low and was clearly definable. Of course a sporting bet carries a higher relative risk than any of our trade setups, but at least it was still definable and limited.
- When the bet reached a conservative ‘profit target’ I de-risked it. In trading terms this was like adjusting my initial stop to breakeven. I could elaborate but I’m sure you get the message.
The message is this: I’m not a gambler in the common perception of the word. But I do take calculated risks when I see excellent odds. This goes for all my endeavours. And when I see that I can de-risk a position, I’ll often do that sooner rather than later, while also playing for a ‘P2’ windfall.
What about where we are now in the markets?
Well, as I mentioned in yesterday’s video, the markets are currently rather elusive and we’re now firmly in earnings season. This means I’m happy to sit tight for a while and see how things play out. I only want to trade the best setups, the ones I have had researched extensively and are proven over many years.
In the following weeks I will have completed my earnings research. We already have a great straddle strategy which is now deployed in OptionEasy. We also have the phenomenal ‘Post-earnings gap-up and OVI-Flag’ setup in FlagTrader.
But the OVI also gives us an excellent chance of directionally playing earnings in a similar manner to my Federer wager, ie with very good odds but strictly limited risk. I’ll have more news on that hopefully by the next earnings season, but the initial findings are very encouraging.
For example, from a sample of almost 50,000 trades (that’s an enormous sample) initiated within 10-days before earnings, 69% of them are profitable the 10-days after earnings, using the most basic of OVI criteria. This is a phenomenal number for a baseline study, but there is still work to do in terms of streamlining the sample size, examining the average wins vs. losses, and how to limit the risk from the outset. Still, the 69% hit rate for a baseline study is yet another overwhelming illustration of how the OVI does identify individual stock sentiment … in this case pertinently either side of a news event.
So let’s see how earnings play out this time around and I’ll be in contact again soon.
All the best