Adjusting a 'Trade Gone Bad'
- Written by Carley Garner
An Oscillator is an Oscillator, in the Long Run
We have concluded that a short term moving average crossover, such as the 3 and 7 day, provides good indication of upcoming price moves but should only be acted upon if confirmed by a trend following oscillator such as the MACD using an 8 and 20 day exponential moving average with a 9 trigger. A combination of a MA crossover and a slower indicator is a better judge of the underlying trend relative to a quicker oscillator such as stochastics and may help traders avoid premature reaction to false market moves. Keep in mind, that these are simply personal preferences you may be comfortable with alternate oscillators and as long as you use them consistently should yield similar results in the long-run. This is because all oscillators are simply mathematic equations representing what has already happened in the market and are likely equally as effective, or ineffective, depending on how you use them. The combination of oscillators used should be determined by your risk level and personality combined with comfort level.
Along with help from an oscillator, it is also important to note any known support and resistance areas. A break out with a close near the high or low suggests that the market will continue in the direction of the move but it certainly isn't guaranteed. As you can see, the rules of option trading are extremely ambiguous. Accordingly, repair strategies take a great deal of instinct and self-control.
A quick thinking trader can quickly mitigate, or even eliminate, losses on an unfavorable trade by converting the naked put into a bear put spread. In this example, buying a 10300 put will not only guarantee limited loss on the downside, depending on the time value left on the trade and other market conditions, it may be possible to profit on the adjustment even though the trader was 100% wrong on the direction of the market.
However, as you will soon see, this is a lot easier said than done. After all, it is entirely possible that the market could bounce shortly after buying the 102 put causing a loss on the adjustment as well as the original spread. Additionally, markets tend to gyrate rather than going straight up or straight down making both entry and exit of the adjustment very confusing. Another factor working against this type of adjustment is the likelihood of increased price volatility leading to inflated option premium.