Loss in "Emotional Capital" Can Lead to a Crisis in Confidence (Part 4)

12/04/2008 10:04 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

I teach the traders I mentor that at this point, they need to walk away from the screen and take at least a 15-minute break. Their eyes are glazed over from watching the markets for too long, they are low on focus, and probably low on emotional capital. If they continue to trade in this state, the quality of the decisions they make will deteriorate and they are at real risk of doing serious damage to their trading account capital. In plain English, they could lose a lot real fast!

But this trader wasn’t thinking about taking a break…

chart

He took a look at the charts, and to his credit, saw a high-probability entry at an Energy Point. An Energy Point is the intersection of a down sloping line and an up sloping line. They generally act as price attractors and are also areas where price often changes trend.

He got short at the re-test of an Energy Point, against a down sloping upper Median Line parallel, and his initial stop order was hidden above a swing high, where traders looking to get short had likely left a good deal of limit sell orders. And though it’s not marked on this chart, his profit target was down at the lower Median Line parallel—a logical profit target that should net him about 1 ½ points in the bond futures.

Where did it all go wrong? His orders were set up perfectly. Everything was thought out logically and he entered the orders into the market via his trading platform perfectly. Price rallied to fill his limit sell order and then started to sell off.

But remember, he was running low of emotional energy. Price sold off enough to show him three or four ticks in potential profits, and for a few moments, he was sure the sell off he had been looking for had finally materialized. He was ecstatic!

That was his third mistake of the day. He was spending additional emotional capital on a trade that was just beginning to unfold, and he didn’t have the emotional capital to spend!

When price pulled back to his entry price, he was emotionally bankrupt. Now he was certain price was heading up to stop him out. He put in a limit buy order to exit his short position and was quickly filled. Then he cancelled all his orders. He’d managed to get out without losing any trading capital. But he’d spent a great deal of emotional capital and focus.

And worse, the bonds closed on their lows and then kept heading lower. And he was flat.

chart

I teach the traders I mentor that at this point, they must take a break and clear their head. If they are really smart, they’ll quit for the day.

He didn’t quit for the day.

As bonds continued to sell off, he added in a horizontal line that showed what we call the “balance” of the action. It’s a line with multiple highs and lows touching it, very much like a horizontal Center Line. When price breaks below this line, it is likely to be headed considerably lower.

Note on the chart above that he correctly identifies this key line. And he also feels that once price breaks below it and closes below it, he should be selling any re-test of the line from below. He sees it and places his orders into the market.

But there is one key ingredient missing: There is no price structure for him to hide his order behind. Instead, he decides to enter without a safe stop loss order and puts in a five-tick cash stop loss order.

More in Part 5 tomorrow…

I wish you all good trading!

Best,

Timothy Morge

timmorge@gmail.com
www.medianline.com
www.marketgeometry.com

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