Nick’s Note: Imagine you’re a game show contestant and offered a $2,000 cash prize or a chance to exchange it for what’s behind the curtain. What would you do?
Longtime PBRG friend and master trader Jeff Clark says that’s the dilemma many traders face. In today’s essay, he explains what he’d do in this situation…
By Jeff Clark, editor, Delta Report
Readers of my Delta Report made a lot of money in March…
We closed a call option trade on one of the world’s largest investment managers, Invesco (IVZ).
I recommended my readers buy call options (meaning they’d profit if the price of the underlying stock went up) in February. We closed that trade in March. All told, we made 125% in just over a month.
Not bad.
But after we closed our trade, IVZ continued to climb. The stock picked up another 10% a few weeks later.
I mention this because readers occasionally write in asking, “Why did we close that trade? We could have made even more if we had held on.”
Let’s Make a Deal
Imagine you’re a contestant on the game show Let’s Make a Deal.
Monty Hall pulls you out of the audience. He waves $2,000 in your face and says, “This is your money. You can take it and keep it right now, or you can trade it for what’s behind the curtain.”
Of course, you know from a lifetime of watching daytime television that there’s a 50% chance that what’s behind the curtain is an all-expenses-paid trip to Mazatlán—valued at $5,000—and a 50% chance that it’s something virtually worthless, like a farm animal.
What do you do?
If it’s me… I’m taking the cash.
I’m thinking, “I came here with nothing. There’s a 100% chance I’ll leave here better off if I take the money. There’s only a 50% chance I’ll leave here happy if I take what’s behind the curtain. Either way… my life isn’t going to change dramatically. So I’ll take the $2,000 and be happy no matter what.”
Here’s another line of thought…
“I came here with nothing. The worst case is I’ll leave here with nothing. But there’s a 50% chance to increase the return on my prize by 150%. The odds justify that trade. So I’ll pick what’s behind the curtain.”
Here’s the thing… There’s nothing wrong with either decision. All that matters is how you view the consequences of the trade.
I’ll Take Happy
I’m going to be happy if I get a $2,000 windfall profit. I might be slightly more ecstatic if I win a trip valued at $5,000. But I’ll feel like an idiot if I give up the $2,000 and go home with a goat.
So I’ll pass on “ecstatic.” I’ll take “happy.”
Not everyone thinks that way—which is why we love watching game shows.
Let’s apply this thought process to the stock market…
Every time I close a trade, in the back of my mind, a little voice asks, “What happens if it moves even higher?”
This is the equivalent of Monty Hall asking if I want to keep the $2,000 or trade it for what’s behind the curtain.
I know for sure that I’m happy if I close the trade right now. I don’t know if I’ll be happier or feel like an idiot later.
So I almost always choose to err on the side of happiness.
Now… if this is your only time on a game show… if it’s your only chance to make a trade in front of Monty Hall, it’s understandable if you choose what’s behind the curtain.
After all, it’s your only shot to maximize your gains.
I get it.
But the stock market isn’t a game show. We have trading opportunities almost every single day. The secret to longevity as a trader is to consistently take the money when it’s flashed in front of you.
You might feel a tinge of disappointment if a trip to Mazatlán is behind the curtain. But you’re still heading home with more money than you had before.
Be happy. At least you’re not going home with a goat
Regards,
Jeff Clark
Editor, Delta Report