An update, and a trade post mortem

It’s been almost a month since I went to cash.

At the moment, I have a couple of shorter term swing trades on, but essentially I’m very much cash-heavy. I wait now patiently for the market to once again favor my preferred style of trend trading, and in the meantime, I keep the lights on by scalping quick trades intra-day.

The only way to have longevity in this business is to be trading with an edge. A “hunch” is not an edge. A “feeling” is not an edge. Having a trading plan (regardless of your time-frame), having a risk management strategy, and having self-discipline – those are edges.

My comfort zone is trading off the weekly. It’s where I feel most at home and in my element, and that’s been the case for most of my investing/trading years. I’ve spent time developing and refining that process and I now have a bankable edge.

Where I am most out of my element is day-trading. Which is not to say I can’t day-trade, or that I’m not successful at it, just that it’s not my preferred arena. And that became ever more apparent to me this week. Yes, the week was a profitable one, but that does not mean that each my trades were good trades.

Just because a trade was profitable does not necessarily mean it was a “good” trade. Conversely, just because a trade was not profitable, does not necessarily mean it was a “bad” trade.

A “good” trade is one where you adhered to your trading plan, employed a solid risk management process, and used discipline to execute it all…regardless of the outcome. In fact, having a profitable trade where you did not stick to your rules is quite dangerous: It teaches your brain that bad habits and sloppy trading will be rewarded, which might be true for a trade, or two, or three, but it won’t work over the span of hundreds of trades.

And so in the spirit of openness, self-flogging, and hoping others learn from my errant ways, I bring you my last trade of the week, on Friday.

My day-trading system gave me a clear short signal for $SPY about 40 minutes into the trading session, which I took (check). I took the right trading size (check), entered my hard buy-stop order (check) at the right price (check) and should the trade work, I entered my hard order to cover half my position (check) and at the correct price (check!).

And then I waited.

It didn’t take long. About 15 minutes later, the trade worked in my favor, and my buy order to cover half my position filled. At that point, I followed my plan, which is to then raise my stop (lower it, in this case, as I was short) to break-even. Now, no matter what, the trade is a profitable one based on the first half that was covered.

So far, so good!

And then the wheels fell off the bus. The plan is to then patiently ride out the second half, taking as much profit as possible (or get stopped out), before I get a signal to close the trade. But I didn’t do that. For whatever reason, I chose to cover the remainder far sooner, thus not capturing the bulk of the potential gains. Now, sometimes the trade reverts, and I’m stopped out, and there are no further gains to capture. But the risk/reward of this strategy only works if I have the patience to find out.

Think of it this way: If you risk $1 to make $0.50, that’s a terrible risk/reward ratio that will ultimate send you to the poor house. You would need to be successful twice as often as you’re not in order to simply break even, never mind actually make money. Bottom line is, you don’t want to risk more than you could potentially make.

In my trade example, I risked $1 and ended up making $1.25 on the trade (not literally – I’m using these numbers for ratio purposes), which while profitable and more than my initial risk, is still poor, if you extrapolate that over hundreds of trades with a 50% to 60% success rate. Had I stuck to the plan, I would have made $2.75 on this particular trade, which is nearly a 1:3 risk/reward. Ultimately, I think anything with an average of more than 1:2 is in the ballpark.

But the larger issue is why did I not adhere to my plan, and why did I close the trade early? To answer properly would turn into a small novel. I have no difficulty at all following my trend-trading trading plan and system to a ‘T’. It’s when I’m outside of that comfort zone that I can be far more prone to a lack of discipline. It’s a work in progress. It’s a weak spot for me, which I recognize and am working towards. It doesn’t happen all the time, but it shouldn’t happen any of the time. For me, the steps I take to work on it include a lot reading, especially chapter 2 of Mastering The Trade, by John F. Carter, an excellent read on the psychology of trading. Because the problem wasn’t with my system, but with my mind.


2 thoughts on “An update, and a trade post mortem

  1. I would define “trading edge” as consistent profitability. A trading plan only has an edge if it produces consistent profits over time.

    I agree that a good trade is one that follows the trading plan without deviation whether it’s a winner or not.

    “Think of it this way: If you risk $1 to make $0.50, that’s a terrible risk/reward ratio that will ultimate send you to the poor house. ”

    This is an interesting thought that many folks have, but whether that’s a good trade or not depends of the amount of edge your system provides.

    For example, with no edge, you have just a 50/50 shot at being right or wrong. At 50%,, risking $1 to make $0.50 is a bad trade to make. Now let’s say you have an 70% edge- where 7 trades out of ten are winners. At that rate of return, you win $3.50 for every $3 lost, making it a good trade. If your edge is higher than 70%, the return will be even greater.

    Mastering the trade is a good read.

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