Rules Are Rules, Except When They Aren't

Sean McLaughlin
June 12, 2024

OK, the title of this note is a little tongue-in-cheek.

But let me explain.

I’m a rules based trader. I’m nothing without my rules. Without rules, I’m just a trader pissing in the wind, driven in multiple directions by my volatility and ever-changing emotional reactions to my intraday PnL.

That’s no way to live.

Once I committed to being intentional about every trade I put on, my trading jumped to a new level. This process includes a thoughtful rationale for my thesis, position sizing, stop loss, and profit-taking levels.

So these days, whenever positions are moving either for or against me, I take comfort in knowing that I don’t need to make any new decisions – even as my emotions tug at me to do something! I already know what to do because I laid it out in my original trading plan.

And for me, that works 95% of the time.

Why not 100%?

Because nothing is perfect. Not the setup. Not me. Not the rules. Nothing.

Occasionally, I need to use a little discretion. Thankfully, not often. But when I do, I do it from a position of strength.

This is on my mind today because I currently have two positions on (one bullish, one bearish) that are flirting with my exit criteria. And if I’d followed my rules and my plan to a “T”, I’d be out of these trades right now.

But I still have them on.

Why?

One reason that applies to both is that each is a defined risk position. I know what my maximum loss can be and I accepted that loss. I don’t want to take a maximum loss, or give back all my gains (nobody does), but I’m comfortable knowing that if it were to happen, it would be a minor blip on the radar when viewed in totality of all trades I complete this year.

In my bullish trade, a second reason I continue to hold is that I’d already sold half of my position at a predetermined level for a profit, which has locked in guaranteed gains for me. And my current stop level is one that has been raised since I originally put the trade on. Both facts earn this position a little bit more latitude when it needs it – like right now.

In my bearish trade, a big reason for my interest in the trade is that there is a catalyst on the horizon (an earnings release) that was a big reason for me putting the trade on. It is my belief that the earnings reaction will push the stock in my direction to turn this into a profitable trade.

But the earnings release isn’t slated for a few more weeks. While the stock has flirted with my chart-based exit, the value of the spread hasn’t hit my other stop out (losing 50% of its value). My risks are defined and volatility is rising, which plays favorably with the value of this spread, so I’m continuing to hold. For now.

I’ll cry “uncle” if the spread finally loses 50% of its value. At that point, it’ll be pretty clear the options gods are not smiling on my trade.

It’s important to note that breaking my rules is not my default reaction to losing trades. I don’t change my mind simply because I’m losing. That would be a terrible habit. And I don’t have a rule or a trigger that tells me when to break my rules. It just comes from 25-plus years of trading experience.

When you’re in this game long enough, you learn to trust your gut sometimes.

 

Sean McLaughlin | Chief Options Strategist, All Star Charts

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