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The reason for that is just like any other business. Any other business, if they had the opportunity to buy stock… Let’s say they had a gift store. If they had an opportunity to buy stock to put in their store at a very low cost, but this opportunity is only available for a few days, because there are other people who are interested in this stock – but you could get it very cheaply, maybe 50% cheaper than you could normally buy it – you would need the capital available to make that purchase, as the opportunity became available.
That’s what we need to think about in this business. When our prices start to run up toward our breakeven points, in our portfolio, we need to make changes to our business, in our portfolio, so that we have the capital available to take advantage of those opportunities. Many times, a position that runs up against our breakeven points is an opportunity to add to our current positions.
It’s a smart allocation of capital, to take advantage of those opportunities. Not only that, but you could think of it in this way too. Not only are they opportunities, but also, it is an indication that our trade is broken.
If you owned a restaurant, and you had a deep-fry cooker, and it broke, and your business really depended on that piece of equipment – well, you would have to have the capital available, to go out and purchase that piece of equipment. It’s very important that you have that piece of equipment, in order to continue running your business.
If you couldn’t purchase it; if you didn’t have the capital to purchase that piece of equipment, it is possible that you could go out of business. It’s the same thing in this business. If you have the capital available to make adjustments to your position when they run up against your breakeven, that gives you an opportunity to stay in business. If you don’t have the capital, you may have to close out the position at a small loss, and just call it a day.
That’s why we don’t suggest using all of your capital to initiate positions, when we begin building our portfolio. We start our portfolio out on some basic positions, but we always make sure that we have capital available. Working capital, in any business, is extremely important. We have the working capital to take advantage, to fix broken trades, as necessary.
The fourth risk that I want to talk about is overtrading, or over-adjusting. One of the principles of the business, and one of the truths of the market, is that prices fluctuate. Of course, we never know exactly how prices will fluctuate, but we know that they do fluctuate.
If we take a look at a current chart, of the Dow Jones Industrial Average, you’ll see that yesterday, we had an extremely large run up in prices. In fact, they were up almost $200, yesterday. Today, they were up another $115. Now, they have backed down quite a bit. In fact, they backed down to the point that it is below this 200-day moving average, which we had kind of determined to be somewhat of a resistance point, as well as the 13,100 level.
Technical analysis is interesting, in that it’s fairly simple. You have support and resistance points. You have support. You have resistance. You have resistance. You have support. That is pretty much all you need to know, as far as technical analysis goes, for the type of business that we run. That’s pretty much it.
Prices do tend to fluctuate. Sometimes they go up. Sometimes they go sideways. Sometimes they go down. Adjusting positions becomes an art of knowing when exactly to make those adjustments. I would say that once you get to the point where, anytime between your breakeven and one of your peaks of your profit picture – maybe the final 1/3 or even 1/4 on each side of your profit picture, just before your breakeven, would be an appropriate time to make an adjustment.
If you make adjustments too often, then you’re really over-trading. Prices do tend to fluctuate. They will go up, and they will go down. You want to try and keep your profit picture and your price pretty much centered. If it goes off, you want to do a little adjustment. You don’t have to do a large adjustment.
In this IWM position, we have actually made a number of adjustments. I like to adjust using the IWM because the spreads are so small. You can see on the May 08 73 call here, the spread is only a penny. If I had to do another adjustment, I would like to do it here.
The same thing on the put side. You can take a look at the 72 put here. It’s a one-penny spread. These spreads are so small that it makes it very easy to make an adjustment in your position, and still have a profitable picture. The IWM is an excellent vehicle for making adjustments.
Another ETF that is really excellent for making adjustments are the QQQs, the NASDAQ 100 ETF. Again, the spreads are very small. I currently don’t have any positions on the QQQs. But if I had to make an adjustment, I might use the QQQs to add as an additional position, if the opportunity became available.
Those are the four risks of this business. I think it is important that you understand those risks. I have talked about concentration of risk, allocation of capital, overlapping trades, and over-trading and over-adjusting. The key point is, they’re only necessary because of price risk.
Price risk means that the price is going to move up or down against you. If there was no price risk, you would have absolutely no problem with concentration of risk. You would have absolutely no problem with overlapping trades. You would not adjust anything.
You would have no problem with allocation of capital, because you would simply put your positions on at one price, and remain there until expiration. You would have no risk of over-trading or over-adjusting.
All four of the risks in this business really have to do with price. Prices will fluctuate, sometimes wildly, sometimes moderately, but they always fluctuate. They never stand still.
If it wasn’t for price risk, none of these other four risks would even be a consideration. Because price is a risk, we really have to pay attention to these four risks. Those are the four primary risks of this business.
All of them are easily managed. Concentration of risk is easily managed by spreading out, as I have shown you in this IWM position, across a number of different strikes. Many of these represent adjustments. If we take a look at our Diamond position, we still have our one iron condor position on. We didn’t make any adjustments to the Diamonds.
If we take a look at our SPY position, we had to do one adjustment, which was an overlapping iron condor. That was it. The IWM is actually the ideal vehicle for adjustments, because of the spread situation that I told you about. There is really an art and a science. The science is the numbers. The art is knowing when to adjust.
That’s it for today, guys. Trade with confidence.