Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
When the Trade Comes to You, What Will You Do?
08/06/2010 12:01 am EST
I recently went to watch my 13-year old nephew, Joey, play in a baseball tournament. Every parent/grandparent/uncle is quick to brag about their son/grandson/nephew’s athletic ability, and I am no different. Joey is an exceptional baseball player. He is exceptional in that he is a switch hitter with power from both sides of the plate. Besides that, he has an amazing ability to draw walks because is so patient at bat. He has roughly 150 at bats with 40 walks and an on-base percentage of .600. When I asked him how he was able to be so patient and draw so many walks, he said with a profound simplicity, “I don’t swing at crap. It’s not that hard.” (I could write an entire article about that as it pertains trading!)
Joey’s baseball abilities don’t surprise me. My dad played baseball through college and then played one year of minor league baseball. My brother held the record at his college for the most home runs in a season for more than two decades. He also held the NCAA record for hitting four consecutive home runs in one game (as he tells it, the fifth one went foul). So to see Joey’s athletic ability flourish on a baseball field does not surprise me in the least.
On the weekend that I went to watch Joey’s game, my dad also came to see his grandson play in this baseball tournament. My dad, always the coach, watched as Joey tried to field a hard groundball hit to him at second base. With a runner on first, Joey bobbled the ball just long enough to disorient him as to where he should throw the ball once he regained control. The runners were safe at first and second. Just then I heard my dad ask under his breath, “If the ball comes to me, what am I going to do with it?”
“If the ball comes to me, what am I going to do with it?” Wow, that took me back in time! I had not heard that question in over 30 years. My dad used to continually remind my two older brothers and me to ask ourselves that question on the baseball diamond with every pitch that was thrown against our opponents. And now he was asking it, albeit under his breath, to my nephew, his grandson.
The intent of the question is to keep the player focused and ready for action at a time when heightened anxiety can overwhelm thinking and interrupt successful execution, like when Joey bobbled the ball for a split second. That one moment, not much more than a blink of an eye, created sufficient confusion in Joey’s mind to prevent what could have been a successfully executed double play. A momentary mental rehearsal before the pitch may very well have changed the outcome of the play.
In the current electronic trading environment, it is equally important that we ask ourselves a like-minded question throughout the trading day. “The (electronic trading) environment created is one of a very spastic nature where we move in a direction very quickly…You tend to blow through your risk parameters very quickly” (Collins, Daniel. More volume doesn’t equal liquidity. Futures Magazine. February 2010, Page 56). In the electronic trading realm, the market can move very quickly, even in very liquid contracts. Now more than ever, we need to be continuously attentive. We need to ask ourselves, “If the ball comes to me, what am I going to do with it?” I’d like to look at two benefits of asking ourselves just such a question throughout the trading day:
· Greater attentiveness to an existing position
· A heightened state of readiness to enter a trade
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Greater Attentiveness to an Existing Position
Let’s face it; we all know that it can be tedious sitting in front of our trading screens all day long. One thousand and one things grab our attention and can pull us away from managing an existing trade. We need fresh ways to keep focused on the market. A new approach can be to ask yourself applicable variations of the question, “If the ball comes to me, what am I going to do with it?” You can ask, “If the (stock/product) gets below (price), what am I going to do with my position?” or “If the (report) comes out higher than expected, what am I going to do with my position?” These types of questions will prepare you ahead of time for a spastic move in the market. As you mentally run through a few scenarios, you prepare your mind for action.
Let me present a real-life scenario and ask if something like it has ever happened to you:
I was in the process of accumulating a long position in the euro/dollar after a head-and-shoulders bottom. I intended on being long 20 contracts and was able to accumulate eight contracts at the price I wanted over the course of a day. My profit objective was 30 points higher. I went to bed that night with my buy order in for the remaining 12 contracts and a stop in place for the eight that I was long. When I woke up early the next morning, the market was 40 higher. It had been 47 higher at one point, but I did not have a sell order in. Who would have thought that the euro/dollar, which typically have a seven- or eight-point range, would rally over 40 points overnight?
Instead of getting out of my eight contracts that I was long and above my already generous profit target, I searched the chart for an even-further-out profit objective. When the market dropped below my profit target, I held firm that, “It’ll come back to the highs.” You have a pretty good idea how this ends, don’t you? I let the market run back far enough such that an $8,000 profit turned into a $3,000 profit. $5,000 slipped away because I did not know what to do when the ball came to me.
Incidentally, this story exemplifies why I tell my students that they need to have an accountability partner (AP) who will not be influenced by the dollar figures. If you choose an AP whose response to this story is, “Wow, you made $3,000 dollars overnight?” then you need to find a new AP.
Of course it’s impossible to come up with every variation of the question “If the ball comes to me, what am I going to do with it?” But certainly included in the list should be, “If my position blows through my distant profit target, what will I do?” To prepare for a spastic move in the market, this is the type of question you can ask yourself throughout the day to stay engaged.
If you are one who does not automate stop-loss orders, but rather, you manage them in real time, you especially need to ask yourself, “If the market gets to (level), what am I going to do with my position?” or “If the (report) comes out above/below (figure), what am I going to do with my position?” Your answer to this question will help you to stay in tune and aware of your plan. This will prove especially helpful when sudden market movement heightens your anxiety and can disorient you just long enough to keep you from successfully exiting your trade at your loss parameters. The hardest trade to manage is a losing trade. Asking yourself the “If the ball comes to me” question will help you to keep your trading plans before you and prepared to manage a losing position.
A Heightened State of Readiness to Enter a Trade
The answer to the question, “If the ball comes to me, what am I going to do with it?” can prove to be the groundwork for your next trade entry. As you answer this question, you identify and plan a course of action, a checklist if you will, that you will execute once the ball comes to you from an unexpected move in the market.
Just as the unexpected rally I described caused me to forgo my trade exit strategy, an unexpected move in the market towards your trade entry level can scare you away from executing. If you have been patiently waiting to get short the market at a particular level above the current price action, a sudden move up to your level can cause you in a moment to question the validity of your entry point and scare you into thinking the market will blow right through it. The reality is that the speed at which the market reaches your entry point is not an indicator of the validity of that point. If the answer to the question, “What am I going to do when the market gets to 98.75?” is “Get short,” then the speed at which the market reaches 98.75 is completely irrelevant.
In a previous article I wrote titled “Simplify Your Trading,” I talked about the power of a checklist when entering a trade. In his book titled The Checklist Manifesto—How to Get Things Right, author Atul Gawande confirms a checklist’s power as a strategy for successful execution. A checklist helps to alleviate the anxiety associated with all processes, including the trading process, and keeps you in step with your rules for market engagement. And when you ask yourself throughout the trading day, “What am I going to do when…?” you bring your attention back to your checklist for the answer.
In the New Testament, the apostle Peter speaks to a readiness of mind that comes from mental preparation. “Therefore, prepare your minds for action; be self-controlled” (1 Peter 1:13). While the context was different, the principle remains the same. As we intentionally prepare our minds for action, we become self-controlled in the face of adversity. A written set of rules and principles, even checklists, and questions like “If the ball comes to me…” that we review on a regular basis, help us to prepare our trading minds. These rules are far more likely to be successfully executed than a set of rules that we only glance at from time to time. It is in times of both boredom and excitement that you are most at risk of shunning your trading plans, intentionally or unintentionally.
Add this fresh approach to your trading; throughout the trading day, ask yourself the question, “If the ball comes to me, what am I going to do with it?” Prepare the answer(s) to the variation(s) of this question such that you create a trading checklist. Review the checklist to keep you focused and ready for action for those times when you are at risk to from either boredom or excitement during the trading day.
By Bill Provenzano of ChristianTradingCoach.com
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