Monday, May 09, 2005

It just needs 1 trade...

to break you.

You have 50k in your account and you don’t believe me? Statistics tell you other wise! Forget it. It doesn’t matter how much you have in your account!

1 dumb trade can break you.

And they happen to all of us. Experienced or novice, it doesn’t matter. We all do our real dumb trades. Just that to experienced traders they don’t happen so often and that an experienced trader is better trained to put it behind himself emotionally, accepting, that what he did was his 1 dumb trade, he is allowed to make a year and that now he is back on track.

Often they happen after vacations, when you are eager to get all the lost opportunities back, to jump into the market, showing yourself you still have this great streak you had right prior to your vacation. But the market has changed and instead of tiptoeing into the market, you plunge in head on. Defending your belief, scaling into bigger positions, than you traded before, holding overnight, as during your vacation you decided to become a swing trader going for the home-runs and no longer be content with nickles and dimes.

But it also happens after you see a big drop or spike caused by fundamental news, catching a lot of traders wrong footed. Then the normal rules no longer apply. There are just shallow rebounds, but nothing to get you back on track in case you entered using the regular rules.

Take the Euro plunge on Friday caused by an exceptionel good jobs-report. No one expected it and Euro dropped around 170 ticks from the highs. If you expected a rebound after 120 ticks, which is a sure bet usually and added to your position, when Euro went down further, you are now deep red. Sure you can try to explain to yourself, that the reasons for the Euro to rebound to the 1.30 area are there, that we have this or that pattern forming on the daily and weekly, which warrants holding a deep red position over the weekend.


But what would you tell your trading buddy, if you saw him trading like that?

You would tell him, stop it! Was there any reason at all, remaining long this chart, if you entered around 1.2880, after the momentum drop and a rebound did not come forward?

Sure, it’s painful making a trading error, sure it will cost you more than just the regular cost of doing business, when you now take this stop.

I can be wrong!
Euro can go back to over 1.2900 and I have seen these reversals as well. But right now the trend is down. The trend was down, when he entered the position and the entry long was based on the expectation of a countertrend to develop.

While switching timeframes might be warranted, and also scaling into a position can be a good entry strategy, I have painfully learned, that you should not mix trend and countertrend trades.

If you go with the trend, you can use wider stops and big targets. If you go countertrend, you use a small stop and you watch your position carefully. If the countertrend does not materialize, you are out, as the trend proved to be too strong. A countertrend starts, because traders like me and you decide, enough is enough and we have our fixed targets at 10–20 ticks. Sometimes bigger fish joins us and a countertrend starts. But sometimes that’s not enough and the countertrend dies. You can see this nicely on the chart, when around 1.2855 a countertrend was tried, but died as the selling was too strong.

So make sure, that you recognise your 1 dumb trade early and cut off the hand, before you lose your arm. We traders are like octopus, we can grow back a hand, it takes a while but it can be done. Growing back an arm or leg takes longer, and once you lost more than that, you are in trouble, because to make back a loss of 50% of your account you will need to double it afterwards. If you have 10k and lose 10% you still have 9k and you can make back 1k in a few days or a week trading like you always did, but if you lose 50%, your account is at 5k and you need to make 100% just to get back to where you started.