A Contrarian's Methodology

  • Avoid trading on excessive leverage
  • Leverage can be a good thing
  • Building versus Averaging

SUFFOCATING - I thought I'd take some time today to talk a little more about my strategy. I am always stressing the importance of trading on low leverage. We all are tempted to trade with leverage and I have been guilty myself in years past. But ultimately, it can be very dangerous to establish a position on leverage. If the market moves quickly against you, the air gets a lot thinner and it can be rather suffocating. When we lose air, we don't think right, and when we don't think right, we are more inclined to panic. The stress of dealing with an out of the money leveraged position can be more than daunting and it is something that should be avoided at all costs.

WIN, WIN - Now as a contrarian, I am always looking to go against a trend, and I will always look for trends that I believe are close to exhausted. But that doesn't mean the trend can't continue and this is something I try to be positioned for rather than afraid of. And so, whenever I establish a position, it is initially with no leverage or exceptionally low leverage. If the position moves my way from the outset, it's a win as I am making money. But if the trend continues to run and the initial position trades out of the money, I am able to get excited about building into the position as the extreme trend stretches some more. The other day I joked on Twitter that the danger of being a contrarian is that when you are wrong, it only looks that much sweeter. But in understanding this, I incorporate it into my methodology and try to put myself in the best position to continue to build into a position without the stress.

The air is a lot thinner when managing an out of the money leveraged position. Via @joelkruger

DISTINCTION - Again, it is important to make the distinction between my strategy and averaging a losing position. I am not averaging a losing position. When a trader averages a losing position, he knows he is wrong and hasn't planned to stay in the trade. Instead of exiting for a loss, he panics and puts more at risk. With my strategy, I start small and have every hope of being able to build into the position. Ultimately, I am able to keep my risk low and allow myself the opportunity to capture larger moves without any meaningful stress. This has proven to be an effective approach for me and one which I believe is worth consideration. To sum it up, the strategy allows me to be conservative, but also gives me the chance to get more aggressive if the trade becomes increasingly compelling.

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