Wednesday I felt like a genius…then came Thursday

In trading, no matter what anyone writes or says, everyone has good trades
and everyone has bad trades. I think that it’s easy to read “professional”
traders commentaries and think that all they do is win, win, win. Of course,
when people write or speak about their trading experiences they want to
highlight what works and, after all, that is what people want to hear or read
about as well. We are all looking for information on how to be successful
traders, right? Just remember this, the real key to being a successful trader is
to be able to have bad trades but still make money overall.

If you control your risk well, and you have a strategy that works, the key is to
not lose your capital so that you can still continue trading your strategy even
after several bad trades. I’ve highlighted the way I handle risk as “Risk is the
Currency of the Markets” Nonetheless, I wanted to show a bad trade that I’ve

What a bust! Although, I do not use my personal emotions for trading decisions
(notice how I even try to separate my emotions from me as a person even when I
write!), these types of trades can really get to you! This trade was a “great”
mean reversion set-up for multiple reasons. The night before I entered this
trade, I had done all of my homework. So, on March 22, when the stock gapped
lower to 65 (from 72), I was even more excited. I love that type of stuff, a
strongly trending stock, a series of down moves in the short term RSI, the stock
is above it’s 200-day moving average, and then gaps below all of the short term
moving averages forming a “Window” (for an explanation on windows, see the
trading markets web site). This is heaven. I calculated my risk for the stock
based on the this recent volatility and bought the April 55 calls with very
little premium. That day, at the end of the day, I felt like a genius. The stock
went up from 65.45 to 74. I can live with one day win like that, right? Well, I
trade using rules and systems, and in terms of my rules the 2 period RSI just
wasn’t high enough for me to exit the trade, even though I had a windfall
profit. Well, if you look at the chart above you can see what ensues the day
after. The stock gapped down to 62, ouch! I eventually exited the trade on 4/17
at 61 for a $4.50/share loss.

But the real key to this trade is that you can learn from it. All of my trades
that have “adverse” moves that our outside of statistical norms. I look at that
closely. That is how you/I become a better trader. Furthermore, learning from
bad trades works much better for your own trades than from my trades or anyone
else’s for that matter. You can read all you want, but your faults are different
than my faults, are different from Dave Landry’s faults, are different from
Kevin Haggerty’s faults–you get the idea. Additionally, your own trades are
personal to you, you know what you were thinking at the time. This is why you
must keep a trading diary so that you can look at and analyze your trades, and
more importantly, learn from your trades.

For me, I learned from this trade that even when a trade looks like a slam dunk
win (or loss) after one day–everything can change. I extrapolated on this and
thought that everything can change not just with a trade, but with my account
and with the markets. Things can change suddenly and violently. Because of this,
I’ve learned that I must look at the change in volatility of my stocks on a
daily basis. If volatility is increasing dramatically, I must reduce exposure
accordingly. I only want about 1% risked (of my account value) on any one trade
at any time. Obviously, this is not an exact science, but you must adjust your
positions sizing with violent market/stock moves to accommodate changes in risk.
Just because you bought X number of shares 5 days ago, it doesn’t mean that you
should still have the same X number of shares one week later (if there has been
significant changes in the stocks behavior). You must always be prepared for
what can happen so that whatever does happen still leaves you with free capital
to invest in the other great trades that are out there.

Good Luck

Steven Gabriel