Featured Article

Think About the Opportunity Cost

GabeVelazquez
Gabe Velazquez
Instructor

Do you remember the last time you put on a trade without an actual hard stop? You know, that trade where you promised yourself that you would get out (no matter what) if the particular stock or futures contract traded past a certain “drop dead” level.  In theory, this tactic seems fine, but the reality is that this rarely works as emotions too often play a role in the decision.  In this scenario what happens most often is that when the price nears that so-called drop dead level, you relax the stringency of executing an exit and end up staying with the trade. You do so until the point at which the pain of holding this trade becomes unbearable. This is the breaking point; the only course of action here is to liquidate the trade.  After it’s over, you feel frustrated and disgusted because you didn’t follow the rules, and to add insult to injury, your exit marked the point at which the market turned.

When you stop to think about how much negative energy was expended in holding on in the above scenario, you realize that if an actual stop was in place, and a small loss was accepted, the focus could immediately be shifted to looking for new opportunities. Instead, all those good trades were passed up because of the emotional distress placed on that bad trade, which coincidentally, didn’t start off as one. The big loss ultimately taken in the trade, using a mental stop as it’s referred to, coupled with the missed trades are opportunity costs that may never be recouped.

Once a trader has moved beyond using mental stops and placing actual stops in the market, the next challenge is to honor the stops and take the inevitable small losses in stride.  Some newer traders have a hard time moving on beyond those losses.  They spend far too much time and energy thinking about the loss to their detriment.  A better use of time would to quickly get over the loss a move forward by seeking out fresh new opportunities.  This is also opportunity cost that can be mitigated by embracing risk.  This can be addressed by sizing trades appropriately. This means taking on the type of risk that one can live with, so that the losses don’t have negative repercussions for other possibilities.

The next and most obvious opportunity cost is finding what you would deem a great level, marking it off on the chart and then, as price reaches the level, not taking the trade, only to see it work.  This happens for various reasons, the first one that comes to mind is that the confidence in spotting levels has not been fully acquired, and therefore more honing has to be done in that respect.  The second may be that the risk is not fully accepted, and the grip of fear has taken hold causing the trader to not take action.

The bottom line is that opportunity cost comes in many forms, but at the end of the day, it boils down to having a well defined plan and the discipline to execute it.  This is not something you haven’t heard before, however many people do not want to take the time or invest in real training from professionals because they feel they can do it on their own, which may work for a very small percentage. However for most the opportunity cost of trying to figure it out alone is much too great.

Until next time, I hope everyone has a great week.

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.