Its all about risk management

I posted the chart of MDVN earlier today. I will post it again for the benefit of those who haven't seen it yet. Here it is.

Yes, it can happen. It can most certainly happen. It is a trader's worst nightmare. No matter how good a trader you are, it can happen to you. It can happen to the best of us. The scary part is not that it went down over 60% for the day. Big deal! But the fact that it gapped down over 60% and hence, those who were long coming into today, didn't even have a chance of getting out for a reasonable loss.

How do you escape something like this? Basically you can't. Like I said, it can happen to the best of us. But there are certainly ways you can minimize the effect of a loss like this. Firstly, I try not to trade any pharmaceutical stocks. A drug accepted or rejected or any announcement by FDA and it could gap either way. Like what happened with this one. But that doesn't mean that this couldn't happen to a stock from any other sector. Where does that leave you? Read on.

In the end, its all about risk management. Its all about the risk/reward ratio. I like to think that if you take care of the risk, the rewards will take care of themselves. That's why I take my profits quick and losses even quicker. But that's just me. A very important part of risk management is position sizing. And if I can "implement" position sizing with a small trading account, there is no reason why all you readers can't do so with your accounts. Here is how it would have helped you in a situation like this.

Say, I don't believe in position sizing and I went all in a stock like this. And the stock gaps down 60%. Ouch! Now to break even, I will need 150% profits on my remaining capital! Tough, isn't it?? Could take you years to break even after a loss like this.

Now let's consider the alternative scenario where the maximum I allocate in any position is 10% of my trading capital. That's still a pretty aggressive strategy if I have a large trading account. Again, my stock gaps down 60%. But now, due to my allocating only 10% of my trading capital in this stock, I suffer "only" a 6% loss on my total capital. To breakeven, I need a gain of 6.3% going forward.

150% vs 6.3%. Think about it!

Why you should never go all in any single stock?

Imagine waking up today holding this overnight.....



Daily review and position update later this evening

Trade what you see, not what you think

As short term traders, it is important that we trade what the market gives us, rather than what we expect the markets to give us. The bottom line is that no matter what we think, the market is always right. This philosophy becomes especially important in these choppy markets, where frankly speaking, most of us have very little clue on what the market is going to do next. As I am sure you readers know, the last couple of weeks or so have been especially hard for trading. Most traders had been expecting markets to touch MA(200) and here we are, overbought for at least the last two days, and trying to regain MA(50). To give my own example, as you regular readers know from the daily reviews, I have been leaning bearish for the past couple of weeks, but as of now, I am up over 30% on the trades made during this time period. And here is the punchline - all by going long.

The point is as retail investors, who are we to fight the markets. What influence do we have on the markets? Zero. Nada. Zilch. Yet, many of us think that something is wrong when the markets are not doing what we expect them to do. Like I said before, the market is always right. You might be the greatest chart reader in the world but if you are a prisoner of your opinions and refuse to bow to the markets, either you will end up blowing up your trading account or sitting on the sidelines watching other lesser traders make money. How did that happen? The others perhaps traded what the markets gave them. They kept an open mind. Chart reading is highly subjective. For the large majority of the charts, a person who is long a stock can paint you a bullish picture and a person who is short the same stock can paint you a bearish picture, all by looking at the same chart with the same indicators. That is why it is so important that you have the stop loss point firmly decided before you enter a position - the time when you are going to be most objective while reading a chart. Once we enter a position, the emotions involved with holding a stock, namely fear and greed, begin to play their parts in us interpreting the charts.

Don't get me wrong. I am not bashing chart reading or technical analysis. No way! Just the opposite in fact. The same charts and chart reading skills that had me leaning bearish the last couple of weeks made me go long the individual stocks and make decent profits in the last two weeks. It is just that my overall opinion of the markets was just a basic guideline for me whereas, as a short term trader, what was more important and took precedence was the individual chart setups and how the market was behaving the instant I took position in a stock. Both view points helped me make money. The short term view point - individual chart setups - made me decide when to enter a stock and the fact that I should go long. The larger view point - overall market opinion - made me take my profits early and take smaller positions which prevented me from getting stopped out of trades during these choppy markets, a very distinct posibility.

That's pretty much what I want to say here - Don't trade with blinkers on. Don't become a victim of your own viewpoints. Trade what the markets give you. It is nice, actually important, to always keep the bigger picture in mind but don't let that get in the way of taking and making  the most of the opportunities that the markets are offering you.

Take care and good luck trading!

Confessions of a recovering trader Part 1

As I started to write this, it came to my attention that this is the 50th post of this 3 week old blog. Trust me, dear readers, I wish this post was written in happier circumstances. Actually, strike that off....the circumstances are still happy. We should never let our trading emotions or results define our lives. So, let me rephrase that....I wish this post was written in a happier part of my trading life.

Firstly, since this is still a new blog and to truly get this post, you readers have to understand where I am coming from, let me start off with a short introduction. I hope the regular readers would forgive me for digressing. Dear readers, like most of you, I am not a full time trader. I trade a four figure account. I dream of the day I could have enough in my trading account to bid adieu to the blasted pattern day trader rule but that's not going to happen anytime in the near future. Like most of you, I started by losing money but I didn't give up and learnt from my mistakes, hopefully like most of you too. For more on this, please click on the label introduction to your right. I still make stupid mistakes. I am nowhere as good a trader as I want to be and I know I can be. I have improved enough to be up over 170% last year after commissions. And no, I dont trade penny stocks. Yes, all you readers who trade with a small account, knows commissions are perhaps the biggest drawback of trading with a small account. I started this blog finally three weeks ago to fulfill my long held, but always neglected, goal/plan of starting a trading journal. The aim of this journal is to make me grow and improve as a trader, and if you readers can benefit from my experiences, all the more better. I have nothing to sell you and don't ask you for anything. Even if I am up 100% the next month (I wish!), I am not going to charge you for sharing my stock picks or watchlist. And since I have nothing to sell, I have nothing to hide! I am brutally honest about my shortcomings as a trader and my losses. In fact, every week, I report my account status after commissions. How many blogs do you know who do that?

Which brings us to this post. If you are a regular reader of this blog, you know I have been in, and still am, in my worst trading slump for over a year. I refuse to offer the market conditions as an excuse. As short term traders, we are supposed to make money ever week, irrespective of whether the market is up or down. I blame myself. I made stupid mistakes, mistakes I thought I had grown past. But as all you readers who have traded for a decent amount of time now, market has a way of bitch slapping you and showing you your place as soon as you start showing the slightest signs of arrogance of overconfidence.

But more on that and how the lack of confidence has affected my trading, and how I am trying, sometimes desperately, to overcome this slump tomorrow. Its late now and the bourbon in my hand demands my full attention....I hope you readers will join me in my journey to become a better trader.

Take care and good luck trading!

P.S.: I would appreciate it, if you readers, could take a moment to answer the poll on the top right. Thanks! 

How to know when to exit your position?

This started as a quirky post but quickly turned into something probably more useful. I admit the post is based on personal experiences. Luckily, I do not make these mistakes any more....at least not very often ;). Enjoy!

1) It is time to sell when.....you find yourself using extra technical indicators on charts to justify holding your position that you didnt use to get into it in the first place!

2) It is time to sell when.....you find yourself going to yahoo message boards to see if someone has some positive news that you don't know!

3) It is time to sell when.....you find yourself justifying to yourself holding a position for fundamental reasons when you entered it for technical reasons!

4) It is time to sell when.....when you ask an "expert" on twitter or some blog to chart a stock checking for entry when you are already in it!

Let me know if you readers have any other such fun "indicators" and I shall add them.

Lessons from my mistakes

“All men make mistakes, but only wise men learn from their mistakes.” 

- Winston Churchill

The regular readers of this blog know that I had a brutal week last week and by now, also know of the exact trades I made. (For the uninitiated, please see here and here). But you also know of my determination to learn from my mistakes, and make last week the most "profitable" week. I have thought long and hard of my mistakes from last week, the kind of mistakes I thought I had stopped making, and reached some conclusions about where I went wrong and how not to repeat these mistakes in the future.

 

Here it goes.....

1) When I started trading actively about a year and a half back, my biggest problem was learning how to take losses. After I learnt how to take losses, the problem evolved  into how to deal with these losses emotionally. I am glad to say that now I am quite comfortable in taking a loss. But in going through my recent trades, and you can go through them too here, I have realized there is a disclaimer attached to the last statement.....I am "pleased" in taking the first loss. I am comfortable in taking a second consecutive loss. But after three or more consecutive losses, its starts affecting me and thus my trading. I start getting the feeling of trying and getting my money back from the markets which as we all know, is a very very wrong and quite possibly, disastrous emotion. Markets owe me absolutely nothing. So, this brings us to my first "rule"

 

Start trading real small after second consecutive loss.

2) The second rule follows directly from the first rule but involves two losses on the same day. You gotta know when to hold them and you gotta know when to fold them. Most importantly, you gotta know when to walk away.

Stop trading for the day if I take two losses on the same day.

3) Both the above rules apply to losses. But I have noticed that one has to be careful while doing well too. My account was up almost 10% for the month and ~ 175% in the past one year before last week. Trading seemed easy, in fact a little too easy - the easiest it has ever seemed. Looking back, this should have been an alarm bell ringing loud and clear right there. The markets have a way of bitch slapping you when you start showing even the slightest signs of overconfidence. So, that brings us to rule number 3.

 

Be extra cautious when in the middle of a hot streak and at the slightest sign of overconfidence, start trading small. 

4) I shouldn't have to explain this one to you readers if you have read the posts of last week.

 

Always have a stop loss in place for your positions if you cant follow your screens even for a minute. 

 

That's what I have till now. I will be labeling this post "lessons" for easy access in the future. I will be adding to this post in the future as I am sure I will be making more mistakes, but hopefully not the same ones. 

 

Let me know if you readers think I have missed out on something and should add some more "rules". Growing and improving together as traders is the whole purpose of this blog and there is no better way to learn than from each other's mistakes.