Last weekend a couple of subscribers offered differing points of view regarding conservatism in trading. One, who comments with some regularity suggested that my investing approach was too conservative and defensive for his blood and mentioned that it was unlikely that I had made my money placing collars. Another subscriber and long time investor wrote and took the position that defense and conservatism is an important ingredient in successful investing.

The disparity between the two views points out something that I always address with my individual coaching students. We are all different and we should formulate a trading plan that is specific to each of us. The fellow who argues for a more aggressive style may well be better served by employing more aggressive strategies provided he has the stomach for the risk and truly appreciates the risk he is undertaking. I have found that an aggressive approach entails higher risk than a conservative approach and I am on board with Will Rogers who once said: "I am more interested in the return of my capital than the return on my capital." As Warren Buffett reportedly said when asked how to make money in the markets: "Don't lose." The first rule for all investors, therefore, should be to recognize the importance of staying in the game. I have known and spoken to many aggressive traders over the years who are no longer trading because they lost all their trading money.

That, of course, does not mean that a trader should not use aggressive strategies. It simply means he should use them wisely. He should be prepared to cut losses quickly when things go the wrong way. Little is riskier in the trading world, for example, than buying a stock. When we own a stock we are at risk of losing our whole investment. If anyone doubts that, just look at Enron, Lehman Brothers, Bear Stearns, or Washington Mutual. Does that mean we should not buy a stock? Certainly not, but when we do we should be aware of the risk and, in my view, take measures to reduce the risk by doing something. We could have a stop in place, for example, or buy protective puts, or at least have an alert that we follow and sell when our predetermined exit point is hit.

Blind risk taking may well result in disaster. As the conservative investor wrote, she learned to be conservative over years of investing. I have learned that lesson as well. My aggressive subscriber suggests you can't become wealthy trading collars. He is both right and wrong. Placing a collar is a way to preserve capital and if one just places it and does nothing else, he is correct. However, if one places a collar and then trades the option legs dynamically as I do, he is dead wrong. I recently had a collar on a stock (BIDU) that dropped more than 100 points yet I realized a fairly hefty return because I did just that. Understanding is the key. We can be defensive and conservative and still be quite successful in our trading. We can also be aggressive and may also do well, but when we are being aggressive we must realize we are upping the ante and exposing ourselves to large losses.

Good Trading!
Bill Kraft

December 13, 2008

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