Saturday, December 16, 2006

How to deal with the "Losing streak"

Dedicated to my friend CHELOBES from TradeGuild - good trader, great guy, better father and even better person.

Firstly, I need to make it clear - I don't want to scare anyone away, BUT - loosing is an integral part of trading. PERIOD.
Does not matter "how good YOU are" or "how cooperative market is", everyone WILL have to deal with loosing trades. ANOTHER PERIOD.

There are multiple ways of dealing with losing position
  • a. Cut your losses at the certain -% point, most widely known advise is 7-8% on closing basis. It is very important - and really easy to do if you don't have love affair with a piece of "electronic paper" going on - I, personally, never do.
    As a matter of fact I am so "not connected" to what I trade - that I may close every position I have just solely for the "I want to go on vacation" reason. Not even a LONG vacation, I might want to fly to Bermuda for a weekend to play golf with my former "BlackJack Buddies" ( They play, I drive that ridiculous car around the course - I hate golf ). Why? I don't want to worry about "how market and my portfolio is doing while I'm having fun. How do I have to relax if I'll be holding Treo in my hand?

    Another very important reason for closing loosing trade A.S.A.P. is that it is close to impossible ( for me it IS impossible - I'm too emotional, not about loosing money, but about "been wrong" part ) to THINK CLEARLY when agonizingly watching you "hard to come money" disappear. GET OUT, CALM DOWN, RETHINK, REGROUP.

  • b. Stop trading after 4 or 5 loosing trades in a row ( this is another popular advise ). If nothing wrong with you something is wrong with the market - slow down and figure out "WHAT" is wrong. Mostly it is just another "switch" and you have to sit it out.

  • c. My personal "strategic" favorite - variable position sizing.
    I don't trade "number of shares. NEVER. This is an AMATEUR thing! 1000 shares of .50 stock versus 1000 shares of $50 stock WILL put you in the poorhouse. PERIOD.

    I trade "amount". My initial position during the course of "normal" trading is 1/6 of my total portfolio value ( no margin considerations ). Lets call 1/6 of portfolio value "X amount".

    So, when the time is right I'd open position for 1*X
    If market will confirm I might add in increments of 1/2*X up to 3*x on the way of my trade ( depending on long or short ), but never will add on the way opposite to my trade - ANOTHER SURE WAY to the poorhouse.

    Here is an example.
    I open 1*X position at $20, it goes to $26. Since I always want to keep ( this is my personal number ) at least 1/3 of the profit on the trade - I have $4 "safety margin", here I might add 1*X at $26 to the total position size of 2*X, but here is a kick - IF TRADE START TO GO AGAINST ME - I will have to close it at $24 - no questions asked and keep 1/3 of the trade profit.
    The good news is - if trade continues to work the way I expect I'm squeezing few ( not double or triple ) extra $$$.
    The bad news is - as I keep adding to moving position - my "safety margin" becoming smaller and smaller and I have to watch it constantly. The max I can go to is 3*X ( This is "swing/short term trading talk", not a "day trading" - Day trading is a totally different ball game, I do day trading from time to time, but NONE of the picks on this site is intended for day trading - all of stocks I post are "short term")

    Now I'm getting to the "loosing" part. If I have 4-5 loosing trades in a row I might:

    1. Use "b paragraph way" and take a break ( this is an extreme measure in case if I feel like "vigilantly" - and the only outcome of "revenge trading" is BIGGER losses. While I'm off the market I'll try to forget that market exists and spend most of my "at home time" listening to the very rare find I fell in love with many years ago.

    2. My preferred way - I will decrease initial position size to 1/2*X or even 1/3*X AND I will be out of loosing trade way before 8% rule, mostly at about 2-3%.
    This way if I continue to be confused by market action my losses will be limited. That is what some famous trader ( Jesse Livermore? ) called "probing"

    I prefer this way since market is not constant, nothing is, market is full of talented and rich players, way better than I am, and since I don't want to "beat the market", but rather "flow WITH the market" and using this strategy helps me to get back "in the flow" with minimal damage. ( If I use #1 "stay out of the market" way - I risk missing the major "flow" and getting back in just in time for another "switch"