9:30 AM New York Time. The US equity market just opened. Orders start flying through the time and sales window. The first candlestick is forming on the 5 minute chart. You are sitting there, anxious to place a trade, with your finger on the trigger ready to grab that $50,000 position.
In the background, CNBC is on and it just so happens that they are talking about the stock you want to trade. They just mentioned an analyst upgrade, which you think explains the large green candle that just closed. You have your news source open on one of your other monitors, and you glance over to see positive news coming out from the company in pre-market. You notice that the stock is soaring higher, up about 1.5% already today.
As if this wasn’t enough, you remember that your friend who works for a huge investment bank mentioned that this company was being bought by their fund managers, and he suggests that you grab some shares while you still can.
Then you get a message on Skype from your buddy that you trade with. He is bragging about how he just made a quick hundred bucks in a morning scalp on this very stock and that you should jump in and grab your couple hundred bucks out of it while it is ripping higher.
10:00 AM New York Time. The first 6 candles on the 5 minute chart have closed out and here is exactly what you see:
You noticed the strong up move we saw this morning and even saw the higher volume coming in on the last candle. You don’t really even think much about your trading plan or rules–not that they are all that structured in the first place–and you go ahead and pull the trigger–you enter the trade–and your emotions now kick into full motion.
You start to perspire a bit from your hands, but still have a firm grasp on the now slippery mouse. You are sitting about 2 inches away from the very edge of your seat, hunched over your desk, with your eyes locked on to the monitor in front of you. You haven’t blinked for the last 60 seconds, and when your cell phone on your desk starts to vibrate you simply push it aside. You are now in that trade that you cannot imagine going against you–after all they were just talking about this very trade on CNBC, on your online news source, with your investment adviser friend, and heck your buddy even just Skyped you about it.
You see your P&L start to jump back and forth between red and green. Price just keeps chopping a little above your entry and a little below. You become a bit nervous, after all you have about $50k sitting in this trade. But at this point in time you see no real reason to get out.
A few minutes go by, and price continues to jump up and down around your entry. Then, out of seemingly no where, price drops about 30 cents in just 2 minutes. You are now down about $150 in the trade, which isn’t the end of the world…yet.
10:10 AM New York Time. You take a look at your 5 minute chart again, this time you see a big nasty red candle moving lower. You still don’t panic and think to yourself that this must be a momentary pullback–after all they happen all the time. You justify staying in the trade just a bit longer, even though your stop loss was hit about 10 cents ago. Here’s what you see right now:
You sit back and wait wondering whether or not you should still be in this trade, but are hopeful that this trade will work out and reverse, bringing you some much needed profits.
10:40 AM New York Time. You are rubbing your eyes because they are so dry from staring at the screen. You are holding on to your position as you start to see positive signs. It is starting to move back in your direction, and you start to really feel like you have a chance of making some money on this position. You start to smile a bit, and your anxiety over the trade has gone away. You laugh and think how easy trading is–all you did was listen to CNBC, your news source, investment buddy, and you send a message to your buddy on Skype telling him that you are in a great position and ready to make some big bucks today.
You never really took much time to analyze the price action of the stock–to look at the candles and volume and to get a read of exactly what is going on from a technical and psychological standpoint in the stock. All you cared about is that this stock is hot right now and you are able to make some easy money.
You watch the chart closely, and this is what you see:
11:45AM New York Time. $!*$&. You find yourself thrashing about your office yelling every word in the book. You just closed out of the position for a $1,100 loss after the position went against you. This wasn’t the trade that just turns at the blink of an eye–oh no. This was a slow bleeder. This trade just kept creeping lower and lower and farther and farther against you until eventually you had enough. With every cent it moved lower you thought it would reverse but it didn’t, and finally you had enough and got out of the trade.
Not only did you just lose a good amount of money, but you just majorly damaged your trading psychology. You start to wonder how everyone else can make money on this stock but you manage to screw it up. You lie to your buddy on Skype and tell him you got out at your entry price for a flat trade. You tell your investment banker friend that you didn’t trade that stock at all since you took the week off. You close out of your online news program and turn off CNBC.
12:30PM New York Time. Now you are left to reflect on what you did–you are left to sit there and stare at the trade and stare at the huge loss sitting on your P&L. You reach out to a guy whose blog you have been following for a while and ask him what he thinks of the chart. He points out 3 simple things on the chart that you completely overlooked the whole time, and he shows you exactly how he would have turned that into a profitable trade.
You now realize that you turned to trading to be independent, but you really aren’t being independent at all. You are listening to everyone else around you but not trusting yourself or even educating yourself on how the markets work in the first place. You now see that if you want to be a successful trader, you will need to put in the time to learn about trading, gain the experience necessary to be a good trader, or find someone who will show you the way.
This exact scenario happens to thousands of traders every single day. Some of these traders reach out for help. Others simply continue the vicious cycle of getting into losing positions and eventually blow out their trading account.
If you find yourself in any of these situations, here are a few pointers for how to start to break out of this cycle:
1) The first problem this trader faces is waiting for a profound confirmation before entering their trade. In the first few charts above, this trader waited for 5 or 6 green candles to close out before they had enough confidence and assurance that price was in fact moving higher. They then got into the trade simply assuming that since price has started to move higher, it will continue to do so. However as we soon learned, this trader was getting in at the end of the up move and also has a terrible risk to reward ratio. In trading, the early bird often gets the worm, and if you find yourself waiting for profound confirmations of price reversals then you are likely to get into your positions way too late each and every time. Instead, try and take your trades when price approaches areas of support and resistance.
2) The next huge mistake this trader makes is not following their stop loss. They got into a terrible position in the first place with a horrible entry, and the only way to make this situation worse is doing exactly what this trader did which is ignore your stop loss. Whether you use physical stop loss orders or have mental areas where you know you need to close out of your trade, 99% of the time you should be following that stop loss exactly. When our emotions are running wild and there is a substantial amount of money on the line, we often don’t think clearly, which is why so many traders ignore their stop loss. Set your stop loss when your emotions are fully controlled (before you enter the position) and then be sure to follow it once you are in that trade.
3) This trader continues to reflect on their losing position. Once we close out of a position–it is over–and it is time to move on in the market to spot our next opportunity. Sometimes that next opportunity will occur in a matter of seconds, other times it may take several minutes or even hours. But whenever it occurs, you need to make sure your head is cleared of your last trade(s) and you are now prepared to move on to your next position with your mind’s full attention. Likewise, if you experience a disproportional loss, it often is best to step away from the markets for a bit, analyze what you did wrong, and make sure you correct that before moving on to your next trade. Sometimes the best thing to do after a trade like the one outlined above is to close up shop early and take off the rest of the day. This is a good way to prevent revenge trading.
4) Lastly, throughout this entire trading day, this trader was listening to EVERYONE except himself. If you are in trading, you should only be listening to one person’s analysis – yours. If you want to listen to someone else’s analysis, get hot picks from BillyBob’s Alert Service, or listen to the fund managers on TV, then give them your money to trade for you while you go out and work a conventional job. At the end of the day, when you are trading your own account you are the one responsible for your trading actions, and I for one feel a lot better when I can say that I am personally responsible for my successes or failures and not be left blaming someone else.