BarroMetrics Views” Sitting Through Corrections
Edison asks:
“I read avidly (and trade along) your twitter posts.
But how do you sit through the gyrations of the markets when you have an open profitable position?
I refer to your (excerpted) post: of :
Post Market Comment July 14
Acceptance below 1083 suggests a move to 1072 to 1070
Stops remained unchanged at below 1005″
Thanks for the question, Edison. The answer is not that easy to answer. As traders we are faced by this conundrum. How to reconcile the statement:
“After making and losing millions of dollars…It was never my thinking that made the big money for me. It always was my sitting” (Jesse Livermore in Reminiscences of a Stock Operator)
with the saying
“Never let a profit turn into a loss” (e.g. considered by William Eng in “Stock Market Trading Rules: 50 Golden Strategies”)
For me the answer involves identifying the timeframe we are trading, knowing our Expectancy Stats and taking steps to psychologically accept the inevitable corrections to the open profits.
My trading timeframe for this trade is the 18-day swing (monthly trend). So, unless the structure of the market suggests that the original reason for taking the trade is no longer valid or my maximum stop loss is hit, I need to be prepared to suffer ‘noise’. The question then is: what is noise and what is profit that ought not turn to a loss?
Here’s where it’s important to know the stats surrounding your Expectancy Return.
(Avg$win x Winrate) - (Avg$loss x Lossrate) = Expectancy Return
In my case, for me to produce the profit I want over the long-term, I need reward to risk of around 2:1. Since my stop in this trade was about 40 points, I don’t have a profit until I have open profits of about 80 points, anything else is noise.
In the current trade, I have not seen anything to suggest that the original scenario (that we’d see a move from 1010 to 1220) was incorrect; and the market, as yet, has not provided enough ‘reward’ for me to say that I ought to exit part or all of my position. Under those circumstances, my remaining option is to accept the consequences of my choice. One way of doing this is to reduce the stress I know I’ll feel as the market’s correction reduces my open profits.
I have found that the best way of doing this is to visualize my being stopped out, seeing myself emotionally accepting the loss and seeing myself acknowledge that based on past results:
- This is merely one trade in the next 10,000
- As long as the ‘loss’ is within the Expectancy Return range, in the long run, the risk management plan will make my targeted annual profit.
By adopting this approach, I give myself every chance to remain open to market information that allows me to reassess whether or not the original conditions for the trade have changed. Should I decide that the market’s structure is telling me that, then I’ll exit the position, before my stop is hit. I may do this incrementally or immediately exit the entire position - it depends in how confident I am about my market interpretation.
A key to making the method work is to accept the loss when the market is going our way. Let me illustrate this idea with a story.
A few years ago, I had a student that had gone long gold. The weekly chart was impressive. We had moved to above the 78.6% retracement zone but below the 87.5 (start of the Primary Sell Zone) on above average range and closed on the highs. The daily chart showed a less sanguine picture. Over ninety percent of the move occurred on the Monday and Gold spent the rest of the week grinding up. For me that suggested we may see a move back to the bottom of value. If this occurred, the student’s stop would be hit. The loss would be small but for the student, I felt the loss open profit may be quite traumatic.
The student refused to even consider the possibility of market moving back down. And, of course, it did and stopped him out; and yes, the effect of the loss on the student was quite emotionally devastating. But as a result of the trade, the student learned to prepare for worse case contingencies and learned to accept the consequences of his choices BEFORE the consequences occurred.
I tell you this story because it shows that as traders, the time to ‘accept’ and plan for adverse possibilities is when things are going well. This way we are likely to make better plans and we are likely to be more consistent with our execution.
Refer this blog post to a friend or colleague…
