Monday, December 21, 2009

Thinking about the X trade

Bad trade. Started bad. Stayed that way. Not how I wanted to celebrate the Solstice.

The loss in closing my position in X was just wrong on several levels. Folly, I say. Folly!

I entered  the trade in a bearish position on Dec. 7, the day after a bear signal. From the standpoint of the technical analysis, it was a rational decision.

On Dec. 9 the stock reversed and gave a bull signal on a strong rise. Error #1 was not selling at market close on Dec. 9. My decision not to exit was based on resistance levels, a perfectly valid way of making decisions. Also, it was a net short option position, meaning that I made money every day that I held it. So, there's an added incentive not to be hair-trigger about exiting.

However, at the Dec. 9 close the stock was 4.4% away from my entry point in the wrong direction.

The rule of thumb on stop/losses is generally about 3% from entry. Any trader who goes further than that is verging on the nervy. Or possibly the clueless.

Whichever, I continued to hold the position expecting a reversal at resistance. There was a pause last week that seemed promising, and then today's breakout above  the pause level shattered all illusions.

Some good rules for exiting:
  • Close if the indicator you used for entry gives a contrary signal. In this trade, that would have meant a 4.3% loss on the stock. That would have gotten me out at the close on Dec. 9. Not wonderful, but only a third of what I lost by holding.
  • Close if the stock moves 3% or more from entry in a direction contrary to the direction of the position. That would have closed the position earlier in the day on Dec. 9.
  • Take the average true range -- an average of the price movements for past past (usually) 14 days -- multiply the atr by some factor, like 3 perhaps, and then make that the maximum that you'll let the price move away in the wrong direction from your entry price. If you multiply by 3, you can think of it as allowing no more than 3 days trading in that direction.
That's it. Lessons learned, and live to fight another day.

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