Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Loss in "Emotional Capital" Can Lead to a Crisis in Confidence (Part 5)
12/05/2008 12:01 am EST
Once his limit sell order is filled, anxiety returns. He is short this market again—at a worse price— and this time, he doesn’t have the protection of hiding behind the limit sell orders at a swing high or market structure. Price sells off three ticks and he starts to feel the anxiety disappear.
But then price comes right back to his entry price. He knows he is using a cash stop loss order. He really doesn’t want to take a five-tick loss. Before he thinks much about it, he has entered an order to buy his short position back at break even. And in the blink of an eye, he’s flat.
And then the market turns back down, making new lows for the move.
Price quickly breaks below the down sloping Median Line, a strong sign of weakness.
He hasn’t had enough punishment yet. He’s seen all the moves and all he has to show for his keen vision is a small loss on the first long bond trade.
He sees a potential high-probability trade unfolding right in front of his eyes. It’s an entry I teach called “Zoom and Re-Test.” When price accelerates through the Median Line (the Zoom), it should come back to test the Median Line within three to five bars (the re-test). If you can also identify a quality stop loss area, you sell the re-test and place your stop loss order and hang on for the ride.
He saw price zoom the Median Line. He watched as price re-tested the Median Line from below. Then he entered an order to get short only if price re-tested the Median Line. He was so tired and so emotionally drained, he identified the wrong bar to sell. He should have gotten short at the first bar that tested the Median Line after the Zoom; there is no need to wait for a second test unless it has been more than five bars between the Zoom and re-test.
And of course, there was no market structure for him to hide his stops beyond.
But he put a sell order into the market.
For better or worse, the market did not rally high enough to fill his poorly placed sell order. Prices sold off further from this point, eventually reaching the area where he should have been taking his profits from the first short bond trade (he would easily have gotten more than $1500 per contract). Of course, he missed the entire move down. And he finally shut his screens off and went out to clear his head.
Where did he go wrong? His first inclination was to identify an area in this market to initiate a short position. I find that a trader’s first plan is generally the best. Early in the trading day, you have the most focus and you haven’t spent any emotions on the markets. You are at your best at that point.
Rather than sticking with his original plan, he spent some emotional capital and focus chasing a long trade in the bonds. And he never got back in step with the market after that initial trade. He correctly identified each high-probability shorting area, yet walked away with nothing to show for other than a small loss from the long trade. He was quite lucky he didn’t lose a great deal of real money. Although he saw the turning points in the market crystal clear, he was stumbling along blindly, getting out of his positions because of fear. This is a sign he was emotionally bankrupt.
Don’t trade when you are not 100% recharged. When you trade with real money in the markets, you need to remember you are trading against the smartest and best traders in the world. If you have been staring at a screen for two or three hours, get up and take a nice 15-minute break! Clear your head, find your focus and get your edge back. Then come back and look for a high- probability trade entry.
I wish you all good trading.
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