Last week, I received an email from a student asking my advice on whether I feel it is good practice to stop trading if one has lost a predefined daily amount.
In his email, he goes on to explain that he had been adhering to a "daily loss limit'' rule for some time. And the days he did lose the prescribed amount, he switched to simulator mode for the remainder of the trading day. Interestingly, he found that once he began his simulated trading, he would often make up his losses, and then some (in monopoly money). He also revealed that on one occasion, he transgressed, and ended up losing more than twice his allotted amount. This in turn caused him such emotional discomfort that it took him some time to get his mind back in the game. Since he was making up his losses after he stopped trading live, he was struggling with the idea that he should continue trading, and deal with the potential of incurring bigger loses.
This brings up several issues that are quite common to traders, particularly neophytes. One is the "could have, would have, and should have" conflict, which is where traders lament what they didn't do, or could have done differently. Quite often - if not forgotten quickly – this conflict can lead traders down the path of impulsive trading and a negative feedback loop that can be hard to squelch.
Similarly, when traders put themselves in a hole early in the trading day, the natural inclination is to want to recover all their losses, which in and of itself is fine. However, for some traders, the eagerness to gain back what they have lost elicits reckless behavior and excessive trading. Ironically, this only ends up exacerbating the loss.
If you've ever been in the aforementioned situation - and who hasn't at some point in their trading career - you know that sound judgment is clouded by the extreme need to get back the money we've lost. Moreover, traders that are only looking to break even after they've lost, more often than not, do just that.
Now, it goes without saying that you will not grow your account very much by breaking even on the majority of your trades; therefore, one should treat every single trade completely independent from the prior; without regard to whether it was a winning or losing trade.
This can only be done by having a rule that defines the maximum loss that can be sustained per trading day. The amount will vary depending on a trader's account size, and more importantly his or her tolerance for risk.
To make my point about how everyone has to have their own personal daily loss limit, when I'm teaching, I often joke that there are some folks in the room, who will lose a thousand bucks on any given day, and not even give it a second thought. Conversely, others will lose the same thousand dollars, and as a result, will have to take a Zoloft (anti-depression drug) to deal with the loss. Nevertheless, setting a daily stop loss is critical to survival in the longer term.
Along the same vein, it is also prudent to have weekly stop losses. One protocol I strictly adhere to is when my daily loss limit is triggered for three consecutive days, I cease my trading activity indefinitely. I take the time to clear my mind, diagnose whatever challenges I might be faced with, and begin the corrective process. Once I feel confident this has been achieved, I resume trading.
All in all, the response I wrote to the student was that having a daily loss limit far outweighs the psychological damage that he would endure if he were to take another big loss. Instead, he should focus on better execution and perhaps more patience.
Let's move on to a completely different topic. In last week's newsletter, I posted a chart of the S&P 500 in which I indicated was trading roughly 33% below its 200-day moving average. I remarked that it was a very rare occurrence, which in the past had preceded sharp rallies. By shear coincidence, the article was posted on Tuesday March 10, the day the S&P had one of its biggest rallies since November. As a result, I received several emails asking me for my prognostication of the market going forward.
The question on everyone's mind is whether Tuesday's rally marked the bottom, or just another bear market rally. The truth is, no one knows for sure, but I will go out on a limb and say that the preponderance of data certainly favors the odds that indeed the market is poised for - what I would deem - a tradable rally.
Let me explain: In the last two weeks, pessimism among investors reached levels that we haven't seen since the market crash of 1987. Furthermore, most so-called overbought–oversold indicators by most measures became grossly oversold. Additionally, company executives (insiders), who are considered by most "the smart money," are busy buying millions of shares in their respective companies. All the while, most investors are fleeing the stock market in droves. The government may also lend a hand in the rally argument, as they are likely to reinstate the uptick rule.
From a technical perspective, in the hourly chart of the ES (E-mini S&P) below, we see a change of trend clearly beginning to emerge.
Figure 1
Lastly, and perhaps the clincher, one of the major business news networks featured an article this week dedicated to showing investors how to profit from inverse EFT's (bear funds). In case you're not familiar with these products, they are closed-end funds that trade just like common stock, and produce gains as the market declines. Go figure, the market is down over 50%, and now they want to help investors with ways to short the market.
These are the primary reasons, in my view, that tilt the probabilities in favor of a short-term recovery for the market.
Until next time, I hope everyone has a profitable week.
If you have questions, comments, or you would like a specific topic covered, please email me at http://forexworlduk.blogspot.com
In his email, he goes on to explain that he had been adhering to a "daily loss limit'' rule for some time. And the days he did lose the prescribed amount, he switched to simulator mode for the remainder of the trading day. Interestingly, he found that once he began his simulated trading, he would often make up his losses, and then some (in monopoly money). He also revealed that on one occasion, he transgressed, and ended up losing more than twice his allotted amount. This in turn caused him such emotional discomfort that it took him some time to get his mind back in the game. Since he was making up his losses after he stopped trading live, he was struggling with the idea that he should continue trading, and deal with the potential of incurring bigger loses.
This brings up several issues that are quite common to traders, particularly neophytes. One is the "could have, would have, and should have" conflict, which is where traders lament what they didn't do, or could have done differently. Quite often - if not forgotten quickly – this conflict can lead traders down the path of impulsive trading and a negative feedback loop that can be hard to squelch.
Similarly, when traders put themselves in a hole early in the trading day, the natural inclination is to want to recover all their losses, which in and of itself is fine. However, for some traders, the eagerness to gain back what they have lost elicits reckless behavior and excessive trading. Ironically, this only ends up exacerbating the loss.
If you've ever been in the aforementioned situation - and who hasn't at some point in their trading career - you know that sound judgment is clouded by the extreme need to get back the money we've lost. Moreover, traders that are only looking to break even after they've lost, more often than not, do just that.
Now, it goes without saying that you will not grow your account very much by breaking even on the majority of your trades; therefore, one should treat every single trade completely independent from the prior; without regard to whether it was a winning or losing trade.
This can only be done by having a rule that defines the maximum loss that can be sustained per trading day. The amount will vary depending on a trader's account size, and more importantly his or her tolerance for risk.
To make my point about how everyone has to have their own personal daily loss limit, when I'm teaching, I often joke that there are some folks in the room, who will lose a thousand bucks on any given day, and not even give it a second thought. Conversely, others will lose the same thousand dollars, and as a result, will have to take a Zoloft (anti-depression drug) to deal with the loss. Nevertheless, setting a daily stop loss is critical to survival in the longer term.
Along the same vein, it is also prudent to have weekly stop losses. One protocol I strictly adhere to is when my daily loss limit is triggered for three consecutive days, I cease my trading activity indefinitely. I take the time to clear my mind, diagnose whatever challenges I might be faced with, and begin the corrective process. Once I feel confident this has been achieved, I resume trading.
All in all, the response I wrote to the student was that having a daily loss limit far outweighs the psychological damage that he would endure if he were to take another big loss. Instead, he should focus on better execution and perhaps more patience.
Let's move on to a completely different topic. In last week's newsletter, I posted a chart of the S&P 500 in which I indicated was trading roughly 33% below its 200-day moving average. I remarked that it was a very rare occurrence, which in the past had preceded sharp rallies. By shear coincidence, the article was posted on Tuesday March 10, the day the S&P had one of its biggest rallies since November. As a result, I received several emails asking me for my prognostication of the market going forward.
The question on everyone's mind is whether Tuesday's rally marked the bottom, or just another bear market rally. The truth is, no one knows for sure, but I will go out on a limb and say that the preponderance of data certainly favors the odds that indeed the market is poised for - what I would deem - a tradable rally.
Let me explain: In the last two weeks, pessimism among investors reached levels that we haven't seen since the market crash of 1987. Furthermore, most so-called overbought–oversold indicators by most measures became grossly oversold. Additionally, company executives (insiders), who are considered by most "the smart money," are busy buying millions of shares in their respective companies. All the while, most investors are fleeing the stock market in droves. The government may also lend a hand in the rally argument, as they are likely to reinstate the uptick rule.
From a technical perspective, in the hourly chart of the ES (E-mini S&P) below, we see a change of trend clearly beginning to emerge.
Figure 1
Lastly, and perhaps the clincher, one of the major business news networks featured an article this week dedicated to showing investors how to profit from inverse EFT's (bear funds). In case you're not familiar with these products, they are closed-end funds that trade just like common stock, and produce gains as the market declines. Go figure, the market is down over 50%, and now they want to help investors with ways to short the market.
These are the primary reasons, in my view, that tilt the probabilities in favor of a short-term recovery for the market.
Until next time, I hope everyone has a profitable week.
If you have questions, comments, or you would like a specific topic covered, please email me at http://forexworlduk.blogspot.com
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