Sunday, July 6, 2008

Some Trading Lessons from the Second Quarter

As I like to do every quarter, over the last hour or so I went back and looked at my trades from the second quarter of 2008 to see what I did right, what I did wrong, and what I can improve on for the rest of the year. If it was a good enough idea for Jesse Livermore to do this, I know it is something that can be beneficial to me as well, and I think it is something all traders should do if they are looking to improve themselves and get better.

I looked at all the trades I put on for this quarter and was about even in terms of the number of winning trades versus losing trades (50.5% winners vs. 49.5% losers). This includes my regular and IRA accounts, so the numbers may be a little better in my main account that I focus on. It has been hard to trade in the IRA this year without being able to short and having to wait for trades to clear before using the proceeds again. My average gain for the winners I had was 7%, and the average loss for losers was 3.3%. I am happy about being able to keep my percentage loss very low on average - the highest lost I had was 6.7%, and I only seven losses over 5%. If I can continue to do this, I will be successful as a trader.

I am not as happy with the average percentage gain, only because I missed out on some big gains in stocks that I either got stopped out of too early and did not get back into, or stocks that I sold or covered too early, settling for a small gain and then watching the stock move without me. Here is a chart of three stocks I got stopped out of but did not go back into when there was a chance to do so, along with the possible gains I missed out on.

Here is a chart of eight stocks I got out of too early, along with the possible gains I missed out on.

After looking over everything, I think I can take four main lessons from the last three months that hopefully can help me for the rest of the year. They are...

#1) The market can do whatever the heck it wants to do and I need to remember that.

It can go lower and lower and lower regardless of how oversold it is, and it can rally even when things look terrible economically. I think one of the main reasons I got out of some of the above trades early is I figured the market was so stretched the past week or so that it couldn't possibly go lower and that it was bound to have a bounce that would take me out of the shorts I had anyway. That bounce may still and probably will happen, but it has obviously not been the case yet. If I do a better job of keeping an open mind toward what the market may do, and not try to anticipate its movements as much, perhaps I will do a better job getting the most out of my positions and also avoiding taking positions that I shouldn't take.

#2) Defined selling rules instead of relying on emotion and gut feel is a must.

One of the main reasons I get out of trades early is I still have not totally conquered my fear of losing the gains I have once a trade goes my way. As I believe Jesse Livermore stated in "Reminiscences..", I "fear my profits will disappear instead of hoping they will grow". If I use more rigid and defined selling rules, I think I can work to overcome this problem. Selling is always the most difficult part of trading, at least in my opinion, and letting emotions come into play certainly doesn't help this matter.

As of now, my plan is take more partial profits instead of selling or covering all at once. I don't know why I have a problem doing this, but it is one of my goals to do it more. I plan on taking half my position off the table when I get a gain over 20% or more, using technicals and my gut to decide when to take the partial gain. I won't always get a 20% gain, so this isn't a magic number - I may take half off at 5% or 10% if the technicals merit. For the other half of the position, I plan on using the 9 day moving average as the stop loss point and then simply seeing what happens. On most of the strong momentum plays I follow, this moving average seems to work like a charm. If a stock breaks below it, then it is likely in store for a more severe pullback. FSYS is a perfect example of this MA working very well. It is not perfect, because you will occasionally get stopped out early. In that case, I can always just get right back into the position if I deem necessary. That takes me to my third lesson.

#3) Don't be afraid to get back into a position if you get stopped out.

I don't know why I have a problem with this - perhaps when I get stopped out too early I get frustrated and don't want to even look at the chart again for a while. By the time I do, the perfect chance to get back in has passed and I am looking at another big gain missed. The chart above with LEH, BOOM, and PCLN are all examples of this idea. I am never going to be perfect as a trader, and I will mistime a lot of trades. There is nothing wrong with that, as long as I realize it and don't let my ego keep me out of trying a second or third time to get that timing correct.

My preference is to keep my losses very small - I don't give positions much room to go against me. That is what I am comfortable with and it works well for me. Sometimes it backfires, but as long as I can remember this lesson, it shouldn't hurt me as much in the future. I am not as confident in using this idea for getting back into positions I took profits too quickly in, but it may work there as well.

#4) Stick to your strong suits as a trader.

This final lesson sticks out to me as I noticed when going through my trades that a vast majority of my losses (the bigger ones over 4%) where when I tried to buy a pullback or dip on a stock. For some reason, I am just not very good at it. Hopefully, my skill in this aspect will improve, and it is something I will try to work on, but if I am not successful at it right now, why I am doing it in the first place? I still try to catch every little turn in the market, and this is usually where I have problems. A little of this goes back to having the patience and discipline to sit tight and stay out of things when there is not an obvious advantage. If I see a major turn in the market, then I should try to make a move, but not at every little swing. I am just not good enough to do that. My guess is that few are.

That's it. I don't know if any of these observations can help you, but I hope they can help me. Defining your weaknesses is the first step to improving them into strengths, and that is what I aim to do. Being up over 50% in my main account in a very difficult environment, I am certainly not too disappointed with how I am doing this year. I always want to improve if I can, however - all great traders do, and that is what I aim to become. My goals for the next three months is to follow my selling rules, follow trades better that I get stopped out of in case another opportunity arises in them, and to not let any of my strengths (cutting losses, recognizing patterns) turn into weakness due to laziness or lack of discipline. I don't know if the market will allow me to return 25% this upcoming quarter, but that is what I am aiming for. Best of luck this week, and feel free to share any lessons you have learned this year or any goals you have for the rest of the year in the comments section. I am always interested to hear from and learn from any readers I have out there. Take care.


Troy said...

AWESOME IDEA...keep up the good work.

Take a look at PAL

Anonymous said...

Hi Mac,

I appreciate the candor in your posts - I am tired to read others that compulsively claim unerring insight.

I have finally gotten to the point where I only trade end-of-day (though I am known to "sneak a peak" from time to time). I want to reinforce the idea of developing a trading system and STICKING WITH IT.

That's the ONLY way you're going to be able to evaluate its performance. Sure, over time you can tweak it. But give it a chance to do what it can do first. Take some lumps - it will probably pay off in the long run.

I also agree with you to avoid anticipating the market. Shoot, I can come up with all sorts of 'fundamental' reasons for everything under the sun. And, to my mind, they're all logical.

Only problem is: they're not real. What's real is the bouncing around of the stock prices. The other thing that's real is your trading system (if you honor it and don't cheat on it all the time).

And yes, you can adopt a plan that sharply limits entry losses. But my experience suggests that also limits overall gains.

Just a few thoughts.

Terry Steichen

Mac said...

Thanks for your comments - some very good points and thoughts shared.

I know several traders that only trade at the end of the day and I may eventually get to that point as well. I can see where it would eliminate a lot of the problems I currently deal with.

Mac said...

Troy - thanks for your comment.

As for PAL, the chart doesn't excite me, but additionally I don't know why anyone would be interested in going long anything right now with this market. You are just setting yourself up for trouble. We may be approaching an extreme situation where a total washout might make going long a smart decision, but we're not there yet. Going long during a bear market is usually a recipe for disaster. Cash is a much better option in my humble opinion. Best of luck though - you have to make your own investment decisions.