I wrote this piece for the WILKI (a meeting place for student and friends). I thought I’d post it here to illustrate:
a) The market can and will do anything. In my case, I did not stop and reverse. I prefer to see how the market behaves at a price rather than just place a straight stop (for entry or exit). I was tired my Saturday morning and went to bed 45 minutes before the close (4:00 am HK time; 3:00 PM EST). I had taken 1.5 normal size for a risk of around 1.0% with the stop at 1451.75.
I have to admit I also thought I was ‘safe’ on the shorts at 1343 and 1346. The market was trading at 1333 when I hit the sack. I placed stops at 1351 for the 1337 entries and 1357.75 for the others. BTW in the post below I said I missed getting stopped out by 2 points; I should have said 2 tics. I exited my remaining positions my Monday morning at 1457.75
b) Position sizing and risk control is everything in this game. No matter how confident, we’ll keep position sizes that risk minor damage to account should a black swan event occur.
I have made the original post on the ES setup available at: http://tradingsuccess.com/stc/
Friday’s price action is the reason I am not a ‘pure’ technical trader in the sense of the maxim: ‘the charts tell all’. That’s true with hindsight but hindsight is not of much use when we are seeking to make money from the markets.
Technical traders trade off patterns that over a large sample size repeat; it is this trait that provides us with profitable opportunities. But, as Chaos theory shows, the market is subject to inflection shocks – shocks that can change the market’s dominant direction – what Tubbs, Wyckoff, Livermore etc called the path of least resistance and I call ‘the dominant trend’. Such shocks can ruin the best historical patterns.
Pete Steidlmayer anticipated Chaos theory when he taught that fundamental events can be classified into 3 categories:
a) Expected events: the news is in the market and correctly perceived by the traders. This results in a sideways market. Traders sell whenever the market moves above value and buy when it dips below.
b) Surprise events: essentially acts of God i.e. events that come out of the blue but are events that have no lasting impact. Price moves away from value and when the shock is over, prices return to value. In other words, we see a sharp, sudden correction against the trend; like all corrections, the trend resumes once the correction exhausts itself.
The price activity after Chernobyl is a good example.
c) Unexpected events: events known but their impact appreciated by few traders. The event has changed the dominant trend and value will lead price. For me, the sub-prime impact was such a key event.
(An aside: For those that believe the FED will get the US out of the current mess by lowering rates, the insights provided by Tim Morge should prove insightful: http://www.moneyshow.com/msc/investors/playerCust.asp?v=1388&scode=01080)
This brings me to the last hour of Friday’s price action because of a possible Ambac rescue package. The details have to be worked through and have to be announced . This is expected Monday or Tuesday. The deal may fall through but I doubt it. Unlike the Buffett offer, this deal will be important to all parties, so like the LTCM bailout, I think the parties will strike an arrangement.
Assuming that this eventuates, the question we have to ask ourselves is: is the deal a ‘surprise’ or an ‘unexpected’ event? I believe it is the former. The deal will assist Ambac but will do little to assuage the problems so brilliantly set out by Brussee. (Hence my review the other day). In other words, we can still expect to see a bear market develop.
So if you are short, like I am, ‘so how?’.
I can speak only for myself: On Friday, I sold against a Market Profile Test Opening at 1446, and 1443 for 2/3 size. The remaining 1/3 I sold at 1337. I was stopped out of the 37s by the late rally and I missed being stopped out of 40s by 2 points. So, now what will I do?
A: Exit first thing Monday morning (Singapore time).
Why? The reason for this trade is gone; my views on the Ambac deal are irrelevant for this trade.
If the deal falls through or the market breaks for whatever reason, then I look at a new trade. My job as a trader is to control my losses. I have learnt the hard way that sitting on a losing position (because of some view) is a sure way to the poor house. The loss if I exit on Monday at around 1455 will be about 1.5%, well within my loss parameters. But if I hold the position, who knows what the loss may be?
Sure, there may be no loss but if the rally continues, at what point do I cut and what will that cost me? Certainly more than 1.5%. Sure, I may fail to get back in on this new break. But, there is always another trade at another time in another instrument. I can always recover the 15 or so points per contract lost on this trade.