Friday, February 20, 2009

Learning From Good, Losing Trades

The top chart (click for detail) is a three-minute chart of the ES futures. You're at the 13:12 PM CT bar and you observe that we're in a downtrend. The trend of the NYSE TICK has been down; VWAP (40-period MA) has been downtrending and price remains below the 761.75 level from which a high volume decline launched at the 11:48 AM CT bar. The market has bounced, volume has pulled back on the bounce, so you decide to sell in anticipation of at least a test of the day's lows. At 759.25, you're risking 2.50 points in hopes of making at least 6.75 points on a retouching of the day's low. Not the worst trade idea one could generate.

Now we advance one bar and we see in the bottom chart (click for detail) what happened. The market has screamed upward on volume that has more than doubled the expanded volume on the market decline. Whether it's the President reassuring the market about bank nationalization or a surprise news or earnings announcement, these rogue events are apt to occur from time to time.

You've had your stop in place and your risk/reward set, so you're blown out of the trade well before the three-minute bar is complete. It's frustrating, but hardly something that needs to ruin your day or week. You compose yourself, pull back from the screen briefly, and return to watch and size up your opportunity.

Another trader did not set a stop. He watches as the bar expands away from his entry, hoping for a pullback to break even. The market marches ten full S&P points against him before the hour is up. That can easily wipe out a day's or week's worth of effort, leaving him in a bad mental state to start next week.

A third trader sees the stop hit on expanded participation from large traders. The market is now soaring above the point where significant selling had begun, so the trader concludes that this is a major shift in demand. We've seen the day's low, he concludes. He waits for the first pullback in TICK, notes the reduced volume on the pullback, and buys the market around 765. He is rewarded with a near-immediate gain that more than offsets the loss on the first trade.

The failing trader does not set or honor stops and is left with a deteriorating position. The good trader sets a stop and limits his loss. The excellent trader extracts information from the losing trade to generate profits.

A losing trade is not necessarily a bad trade. When markets don't pay you for a good trade, they are telling you something important. It's difficult to listen, however, if you're holding the loser or consoling yourself about the loss. It's the trader who quickly accepts the loss that is able to stay market-focused, learn from the reversal, and find the next opportunity.



Tyler said...

Mr. Steenbarger,

Excellent post! It is sometimes difficult for me to regain my composure after a losing trade. But, you are right, it gives an opportunity for another trade.


Trader M said...

I wrote about this exact event today too!

adan said...

very nicely presented, thank you!

IDkit aka Ana said...


I want to share an intraday trade I took on Feb 19 on ES.

As the gap did not close at least 50% from the previous day's close to the open of Feb 19 after 60 mins, it gave me a chance to short ES.

I entered at 789.75, with a target of 782.75, and stop of 792.75, giving an RR of 2.3 - which in spite of just 7 points target profit is a good exercise.

Mark said...

Excellent analysis Dr. Brett!

The event you describe almost caught me also as I was just about to go short on the Dow futures when a tremendous spike in net.cum moneyflow on the Dow gave me the heads up (see cyan line in:

I must say that in situations like this I tend to watch from the sidelines what's going to happen next, as I have seen the market to retract just as easy after such spikes, which could easily result in a double loss. It violates my rule not to chaise the market.

Lots of traders on assigned this sudden change in market direction to the "PPT" and I was wondering what's your point of view on this (if you have one that is)?



Joe said...

Dear Brett!

Yes, Yesterday was another great learning Day, especially for the losers.
As You pointed out, except for scalpers the Stop, the mental stop might Not be enough to react quickly enough for such changes without considerable losses.
I learned that lesson the hard way.

On the other point I did Not even contemplated to open a Short position, as I could see in my money machine that the Huge spikes going down on the Bid side, But the amplitude of those selling forces decreased every time (Even though was bigger than the Ask Volume spikes) but as You stated a couple of times, this was a prime example of the inefficiency, when the pervailing selling forces were unable to push the indexes further in the red.

I personally was in a nice Long position and enjoyed the ride, even though I entered a bit early around 13.00 PM ET.

I also condidered longer term market forces, and was willing to leave my position on that table with a bigger 4 - 6 % Stop in QLD for 2 - 3 days since I considered the market close to a local bottom and extremely oversold temporarily.

I played the NASDAQ100 following double Long ETF (QLD)

Joe from Hungary.

Mr. Pooks said...

I found myself in the exact trade as your hypothetical "trader #3". Prior to this trade, I had been calling the market action very well, and this strong reversal was my first loser after a streak of 7 winners. I had my stops in place, and got stopped out for 3 /ES. I then waited for a pullback, and quickly got back on the right side of the trade. I also went back and analyzed this losing trade, and noticed that we actually began a sideways consolidation pattern prior to the breakout, were sandwiched between vwap and intraday price resistance, and just made lower volume on the downbar prior to the break higher. In the future, I would plan on placing buy/sell stops above and below a similar consolidation move.
Thanks again for your astute analysis. I have been a diligent student of yours for the past several months. I only wish that I had discovered you earlier before I ripped up half of my original trading account!

Brett Steenbarger, Ph.D. said...

Thanks for the comments and observations. I'm generally skeptical of attributing market moves to PPT. It's usually the guys who caught on the wrong side of a rally that make that claim. Still, I have to acknowledge that an odd, persistent bid has come into the ES market when we've been poised to breakdown to new lows.


SHW said...

I cry foul as to not doing your homework ahead of time. The FOMC minutes were scheduled to be released today at 2:00pm ET and the release scheduling was easily found on any number of free trading info websites.

By exposing oneself to trading at a scheduled data release time, you are responsible for the losing trade, not 'that's the market sometimes.'

I say lack of market awareness , not 'shrugged shoulders/it happens' was at fault.

SHW said...

Please ignore and delete my previous comment. I found the post from your Twitter feed and didn't at all realize it was from Feb of 2009.