Friday, May 04, 2018

Turning Trading Mistakes Into Trading Successes

In an excellent post, Merritt Black, who coordinates the mentoring program for SMB Futures, illustrates how a trade that did not work out led to an especially good trade.  There are many worthwhile takeaways from this post.

First, if you look at Merritt's screenshots (he demonstrates trading ideas in a live chat), you can see that he is using Market Profile concepts (graphic displays of the accumulation of volume at key price areas) to identify key zones in which the market is establishing value.  The morning session had traded lower, we consolidated in a range at lower price levels, and then we failed to take out the upper part of that range.  That led to a good trade idea in which a trader could risk a move above that range to benefit from another leg down in the market.

The market indeed does move to a new low for the day and then promptly rallies hard back into what was the consolidation range.  We could not sustain the downside and now we're testing the upper end of that earlier range.  That leads to a long trade, as bears are trapped, which turns out to be the day's best trade.

Here are some worthy takeaways:

1)  Notice how Merritt uses volume-at-price to create objective measures of where the market is setting value over a given time horizon.  This provides a context for market moves, as we can determine where the market is breaking to new levels of value and where the market is returning to a value range.  This context is very helpful in framing risk/reward for trade ideas.

2)  Merritt's first idea, where he went short, made tremendous sense, but ultimately did not play out.  That could have been a source of frustration, but instead it provided valuable information.  The bears could not maintain the move down and that set up a trap to the upside.  By accepting the "mistake"--the trade that did not work out--as information, Merritt was able to formulate an even better trade in the opposite direction.  

3)  When trades are formulated well, they can still fail to work out.  Not all good ideas manifest themselves as winning trades.  That means that risk management is paramount.  If Merritt had risked too much on the initial breakdown trade, he never could have meaningfully exploited the reversal trade that followed.

There is, however, one larger takeaway.  Every day of trading provides a day's worth of review and learning.  Many people trade the markets daily; not many rigorously review each day's trade.  There is a reason sports teams watch videos of their games--and the games of their opponents.  In reviewing past performance, we learn key lessons for tomorrow's performance.  To paraphrase Coach Bob Knight, many people have the will to win.  It's the will to prepare to win that defines the ultimate victors.