Real-World Example: When A Bad Trade Becomes A Good Setup
Learning to trade can be quite
expensive. Professional traders will often talk about the “tuition”
that they paid to learn to trade. But after this initial schooling and tuition,
does the learning stop? This leads to the difference between the good trader and
the average trader.
To me, a good trader is not one who is always profitable or always wins, but it is also one who
learns from his or her mistakes. While a trading error can be expensive, it is
necessary to look on the bright side; it’s a learning experience. This is one of
the expenses of our trade, no pun intended
Live and Learn
Each time that I take a loss on a
trade, the first thing I do is look back at the trade and figure out what went
wrong. I ask myself the following questions:
- Why did I take the trade?
- Did it meet the requirements of my
trading technique and systems? - Did the pattern fail?
- Did I stick to my plan?
- Did I look at different time frames
before opening the position?
To answer these questions, I look at my
entry point and my exit point and determine why each of them was chosen. If I
determine that my entry was a result of an attempt to catch momentum, but
without seeing any setup, or if my exit was a result of fear, then I immediately
know what went wrong. Rule number one: Only take a trade when you have a reason
to trade.
A key problem in trading is sticking to
the plan. Most professional traders have found some sort of trading system or
technique that works for them. Losses are often a result of trading outside of
the plan.
Moreover, I find that the biggest reason
traders go out of business is because they do not stick to their plans and they
do not adhere to their stops. From my own experience, as you may have read in my
interview in The Best: Conversations with Top Traders, I can tell
you that nothing is more detrimental to a trader’s mentality and account balance
than letting a bad trade get worse.
Getting Back To Good
Something that I have learned from my
experience in the futures market is that it is not hard to turn a bad trade into
a winner. In the futures market, it is easy to go from short to long or long to
short. For example, if a trader is long two S&P contracts, he can sell four
contracts and instantly go short, all in one transaction.
In the stock market, it is crucial to
keep the same mindset, because often a bad long position will make a good short
position, or vice-versa. This is because many of our trades are actually
countertrend. For example, when buying pullbacks, a trader may be buying into
the dip. In the case of a breakout, if the breakout fails to set new highs, and
retraces, it would likely be profitable to be on the other side of the trade.
Real-World Example
Recently I was looking for a long
opportunity based on a five-minute chart of the e-mini S&P futures. The
futures had been trending upwards since the low from the previous day. After
trading within a channel for 12 price bars, I was shopping for an entry based on
the next bounce off the trendline. As I was about to transmit my order, I
noticed that the next price bar traded outside of the channel that I based my
entry on. I paused.
This price action reminded
me that I had not examined different price charts for resistance levels.
Quickly, I turned to a bigger picture chart to make sure that I had trends in
two time frames in my favor. With just one glance, I quickly saw that the true
trend was in fact down. The short-term rally on the five-minute chart was simply
a small countertrend bounce off the bottom trendline. I pulled my order and did
not take a position.
Looking at the chart, I
quickly realized that, in fact, this was a more ideal short opportunity. The
combination of the futures hitting the top of the 60-minute downtrending channel
and the break of the five-minute uptrending channel resulted in a beautiful
setup. All morning I was looking to go long, but in only a few moments I
realized that it would in fact be a short opportunity.
My interpretation of the
charts was in fact correct. After the futures broke out of the channel, they
moved almost 30 points lower, making for a very handsome short play.
The
Moral of Story
There is nothing wrong
with making mistakes in your trading. It is often said that to be a professional
trader only needs to be right 30% to 40% of the time. This is correct, so long
as you cut your losses short and let your winners run.
Once you cut your losses,
it is time to move on to better opportunities. Some of your best shorts may
result from bad longs. Turning a bad trade into a good setup is good for both
your mentality and your account balance.
Most importantly, learn
from your mistakes, and do not allow history to repeat itself.