While we all hope to get the maximum profit out of every single trade, most of us are happy to simply get A profit - especially on the majority of our positions.

If you think trading a single position perfectly is challenging, now imagine how difficult it would be to book the maximum potential profit on every single trade you've ever deployed (insert dizzy-eyed emoji).

The chances of that are so slim you'd probably have better luck answering the question, "How many grains of sand exist on all of earth's beaches combined?" - and guessing correctly on the first try (or ever, for that matter).

While the above scenarios may all seem ludicrous in their level of impossibility, they also help drive home the fact that trading volatility (a probability-based approach) without a trade management strategy is equally irrational.

To wit, imagine a trader that isn't employing a systematic trade management strategy (i.e. a disciplined and consistent approach to closing trades). Certainly no stretch of the imagination.

Using manual trade management (i.e. a one-off approach), that trader is effectively asserting that his/her experience and intuition (and ability to constantly monitor the markets) gives them the best possible chance of maximizing the potential profit of every position in the portfolio.

But didn't we just agree that the achievement of that goal is so improbable it's almost laughable?

So if manual trade management is theoretically sub-optimal, then what are the other choices?

If you are looking to delve into his question, then a new episode of Market Measures is undoubtedly worth a few moments of your time. On the show, the hosts present a side-by-side comparison that really hammers home the value of a disciplined, mechanical trade management approach.

In order to illustrate this unequivocal truth, a study is conducted by the Market Measures team which compares the historical performance of a simple trade management strategy as compared to hypothetical trader that managed each trade at the most optimal point for producing the maximum potential profit.

This second leg of the backtest was intended to provide a glimpse at how the trading results would look if every decision taken for every position was theoretically perfect. While we know that would be impossible to achieve in real life, the goal was to analyze the results of “being perfect” against the results of simple trade management strategy.

In order to produce the findings necessary for this analysis, the backtests utilized simple 16-delta short strangles in SPY (using data from 2005 to 2018). The only difference was that for one backtest the positions were closed mechanically with 21 days-to-expiration (DTE).  For the second backtest, the strangles were managed at the optimal moment needed to produce the maximum P/L (using the benefit of hindsight).

The results of the study are shown in the graphic below, with the 21 DTE management strategy presented side-by-side against the “perfect” one-off trade management approach:

Picking the Top

While the 100% success rate of the “perfect” one-off trade management approach is impressive, it’s obviously not realistic. In fact, the Market Measures team estimated that trading every position in a fashion that would produce the highest possible P/L would be akin to winning the Powerball Jackpot 22 times in a row - in terms of probability of occurrence.

Looking at the disciplined trade management approach, we see that even a simple strategy like managing at 21 DTE produced a still impressive success rate of 73%. Additionally, this approach requires far less market vigilance and stress due to its mechanical nature. Moreover, the 21 DTE trade management approach also produced a high average P/L, and one that wasn’t dramatically different from “being perfect.”

Due to the strength of this research, we hope you’ll take the time to review the complete episode of Market Measures focusing on trade management when your schedule allows. If you are looking to learn more about this topic, we also recommend reviewing a previous series dedicated to trade management on From Theory to Practice as well as the recurring series Trade Managers.

If you have any questions about trade management philosophies, or a specific position, don’t hesitate to leave a message in the space below, or reach out directly @tastytrade (Twitter) or support@tastytrade.com (email).

Thanks for reading!


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.  


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