One Lesson Every Trader Can Learn from the NBA Finals

Four nights ago, you witnessed history.

And in case you didn’t, here’s what happened…

The Cleveland Cavaliers were down three games. Now, in the history of the NBA, no team has ever come back from a deficit of three to win the championship series.

But on Sunday night, they beat the odds and became the first team in history to accomplish that feat and have been celebrating ever since.

Now you may be wondering what the heck the NBA finals have to do with you – and your money.

And the answer is…

Everything.

Here’s why…

How to Beat an Unfavorable Win/Loss Record

There will be times in your trading career when your wins over your losses during a particular period will make you question the validity of your trading process.

And after a string of, say, three losses in a row, you may start questioning the trading strategy, money management plan, and technical signals you’re using. You may even start to question yourself and start to view trading as a daunting task that you, much like the Cav’s,  need to overcome.

In an interview shortly after the Cavaliers made history, NBA most valuable player, LeBron James, was asked what he did differently in game five and for the rest of the series that he attributes to the shocking turnaround.

He said (and I’m paraphrasing) that he went back and studied film from the games, changed his mindset, and changed his game plan. Clearly… it worked…

And we can apply that lesson to our trading in three easy steps…

1) Believe this will not last. Every trader and every trading system goes through rough patches, especially when the markets are shaky. But, like the Cavaliers, you’ve got to know and believe that it isn’t permanent and that things can – and will – turn around for the better.

2) Check your money management rules. This is important because you want to make sure that you’re not risking too much on losing trades and making too little on winning trades. And you do this by keeping your risk per trade the same across all trading strategies.

We’ve talked about risk management before… And the first and foremost thing I told you (and tell all of my students) is to practice first using a theoretical $25,000 account while risking no more than 2% on any one trade. The point of this is to ensure your account can handle four to five losses in a row – without being wiped out.

For that $25,000 account, 2% is $500. So in this case, the most you could lose if you lost 100% on five trades in a row is $2,500. As much as that $2,500 loss would still hurt and not make you happy, it would still only result in a 10% loss in your account.

And that means you’ve still got 90% of it left to work with once you would hurt and not make us happy it will result in just 10% of the account being lost and you still have 90% of it left to trade with once you’ve evaluated things and are ready to get back to trading.

3) Make sure you’re following your rules.  

You should step back and evaluate your trading plan, but once you’ve got your plan, you want to make sure you’re following your rules and not changing them depending on how a trade is going.

Here’s an example…

After looking over the paper trades he was making, one of my students found out that he was actually buying-to-open option trades based on data from my tools that wasn’t the ideal data to use for the specific trades he was making.

One of my proprietary tools, Money Calendar,shows the average move a stock or exchange traded fund (ETF) has made for a profit in nine of the last 10 years.  This amount can be extrapolated and used as a gauge to assess where the stock should be over a specific time frame.

For example, say a stock is showing an average upward profit move of five points over the next 24 days, and it has made that move in nine of the last 10 years. The stock closed at $54, and a price target can be assessed at $59 (an average five point move higher added to the closing to the closing price of $54 equals $59).

Now, when using my tools, one can get a percent to doublecalculation on an option that expires shortly after this 24-day time frame as a result of the data crunching. Not only will it give you the percentage the stock needs to move higher or lower in order to double, it also gives you the corresponding price as well.

If the percent to double says the stock needs to move higher to $64 in order to see a double, then this option isn’t the one to trade (unless you can settle for whatever theoretical profit the tool shows you the option will have when it gets to $59). And there are times when the tools show that a 0% chance to double within in a certain time frame. At those times, it’s best to just move on.

In the case of my student, he was using the right tools but not the right data to make his trades. So keep this in mind… just because the tools and data you’re using may show a price at which a stock or ETF needs to hit for a double doesn’t necessarily mean it WILL double. And remember one of the options rules we’ve discussed before – you need to know where a stock or ETF will go and by what time frame it should take to get there before you get into your trades.

There a couple of other things you can analyze when reviewing your “trading film,” too. For example, are you taking your profits too quickly?

You always want to be cautious about when you should take your money and run. A string of losses could make you antsy and quick to pull the trigger on your next trade that shows even a slight profit just so you can take those gains and feel better. But if you take a smaller and faster profit, your risk to reward in your portfolio (that 2% maximum risk per trade) becomes unfavorably skewed.

Also… are you reducing your stop loss percentage? You want to be cautious about this, as you may find that a tighter stop results in even more losses – and faster losses. If this happens, you’re putting your account – and your trading confidence – at risk.

So follow LeBron’s lead. Go look back at your trades and run the scenario again with different profit and loss numbers in place. If it improves your results, then maybe apply that adjustment to your trading technique and money management plan. If it doesn’t, then stick with your back tested results or move on to a new strategy.

Consistency is Key

There are many different ways to trade today. You can have your broker place your trades for you, use an auto trader, or use a professional trading recommendation service. The one thing you should always keep in mind is that the timing may not be the truest assessment of the viability of the process each and every time. And when it comes to options, in particular, just seconds can could change the outcome of a potential winning trade.

Trading is not about winning each and every time. No trading service will be right 100% of the time. You will take losses sometimes, too. What’s important to remember is consistency.

Let’s say a trading process of yours or a trading service give you the following win/loss results (This isn’t an actual record of anything – I’m merely using this as a means to illustrate the point of consistency):

W, L, W, W, W, W, L, W, W, L, W, L, L, L, W, W, L, W, W, L, L, W, W

This is 23 trades of which 14 were wins and 9 were losses. This is a 60-61% winning percentage. And what professional and successful traders will about risk to reward is that you can have less than a 50/50 winning percentage – and still realize profits.

Now if you got a string of four wins in a row, (highlighted in the green box), you’d be more apt to ride through that stretch of three losses in a row, (highlighted by the red box).

However, if you started out with those three losing trades, you might not be too happy with the trading system and process you’re using.

Lastly, look at what this means to a trader who is using a 1:1 reward to risk management style. When risking no more than $500 on a trade, you can lose 100% of that that $500, but you can also make $500 if that trade works in your favor. Either way, you are risking no more than $500.

Using the example above and this $500 risk amount per trade, let’s take a look at what this means for that hypothetical $25,000 account…

14 wins = $7,000 (14 wins x $500 per trade)

9 losses = $4,500 (9 losses x $500 per trade)

This results in an overall PROFIT of $2,500, despite the nine losing trades. And for a $25,000 account, this equates to a 10% rate of return (2,500/25/000 = 10%).

It can be tough to take losses, as no one likes to lose money. It can be easy to think that you picked the perfect trade when it works and easier to think that your entire trading process or system is wrong when it doesn’t.

So you want to make sure you do what LeBron did and evaluate your trading process, money management and trading plans, and try to see if there’s an area where even a slight mistake was made. Then, make the necessary adjustments to your trading game plan.

Rest assured I do this myself. I trust the strategy and refer back to my back testing if I start seeing trade after trade of unexpected results.

I gain my confidence in this process, which is why I wanted to talk about it with you today. Losses are never fun, but a small batch of unfavorable trades shouldn’t make you completely abandon your process.

What truly matters in the end is your long-term success and consistency.

Good Trading,

Tom Gentile