Trading Lessons – The 3 R’s of Tough Trading Markets Part 2
Welcome to MarketPulse, Australia’s most insightful look into the markets and trading! In this week’s MarketPulse we’ll pick up a discussion we started a couple of weeks ago regarding the ‘3 R’s of Tough Trading Markets’.
The gist of the first article was that when the markets get tough, traders don’t get tough, they get out of the market! There are no prizes in trading for slugging away in a choppy market. Traders who trade in a choppy market…you guessed it: Get chopped up!
The ‘3 Rs’ refer to the three key things trades can do when markets get too tough to trade: Recuperate, Regroup, and Rethink. In the last article we discussed the need to recuperate. This week, we’ll look at another one of the other two ‘R’s’, Regroup.
Guess what. We were right!
Where we left off last time, we assumed that the trader had identified that prevailing market conditions were completely counter-productive to the likely success of their trading system and the disciplined application of it. They therefore decided to enact the first rule of tough markets trading: Recuperate.
Recuperate involves traders doing the sensible thing by exiting all trades which are causing them angst, trailing stops on those which were still doing well, and getting away from the markets altogether. The trader would not even glimpse the markets until both their emotional state, and the market’s emotional state, had returned to some semblance of ‘normal’.
Coincidently, the current market conditions provide us with an excellent real-life example of a ‘tough’ market. Volatility is way up, clarity is way down, and the emotion of fear has gripped investors all over the world. This is the perfect market to avoid.
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We postulated on May 5th that it would indeed be a good time to take a break and recuperate from what has been an exhausting rollercoaster ride in the markets. The ASX 200 at the time was trading at 4753. Today it’s trading around 4700 with nothing but chop in-between. A wonderful two weeks to be out of the market!
So, what do we do once we’ve recuperated? That’s the second ‘R’, the topic of today’s article, Regroup.
When it’s time to talk about trading psychology – it’s time to talk Tharp. Van Tharp.
Dr Tharp suggests that ‘emotional control’ is more important than ‘keener analytical skills’ (Market Wizards, Schwager, p. 420). Generally it is when our emotions are running out of control that we require taking a break from trading.
In our self enforced trading break, we should try to imagine all of the external factors which have lead us to making poor trading decisions. How do these factors then affect us on an emotional and psychological level? If we find that certain market factors tend to produce consistently poor emotional and psychological outcomes, you can be sure that poor trading outcomes aren’t too far behind.
When we are emotional in making a trading decision, we tend to make a poorer decision. By determining what the roadmap is for your trading failures, you will be better able in the future to identify and avoid ‘high risk’ situations.
To help identify when these high risk situations occur, it helps to do an audit of all of our trades. Separate them in to winning and losing trades. Try to think back to how the market was behaving around the time of each trade. Write down each of the external elements that may have been prevalent at the time and may have influenced your trading decision for good or bad.
For example, if you find that your losing trade entries were consistently made at times the market was highly volatile, or at a certain time of the day, or after a major announcement etc., it’s probably a good idea to refrain from making trading decisions at these times in the future.
As a more specific example – We find that three of our losing SPI trades occurred when we tried to buy the SPI after a sudden sharp drop in prices. We were only trying to scalp a few points on a bounce on each occasion, but each time, it turned out that the market continued to fall. Each time we didn’t use a stop, and it turned out that trying to scalp a few points ended up as a major loss.
We have found that trading in the craziness of the first 20 minutes of the session, or after a major news announcement on a company, consistently produces losing trades. We will now note each of these ‘high risk setups’ as confluences of negative influences on our trading. We simply won’t trade when these setups are in place.
As a more personal example, a little while ago, a company (let’s call it XYZ) made a dire announcement regarding its financial woes and opened down a whopping 60% – I can assure you there was a great temptation to ‘punt’ XYZ all day. There was bound to be many opportunities to scalp a few points each way. Right?
Maybe. I guess I’ll never know. I didn’t log into my trading account on that day. Nor did I log in the next day, or the day after that. You see, I simply didn’t trust myself not to look at XYZ, to not be tempted to ‘have a crack’ at picking the bottom, that is, to not stick to my trading system.
Based upon previous experience, I identified this scenario as a high risk time for me personally to trade – and simply stayed out of the market.
Would I have made a truckload by trading XYZ over those four days? Perhaps. But perhaps I would have lost a bundle as well. It simply wasn’t worth finding out. The risk to reward in such a scenario simply wasn’t there.
Incredibly, for my near one-week break from trading anything during the Australian day session, I am none the worse off. I can still function as a human being, none of my existing positions were adversely affected by my forced absence, and the market is still there! Hopefully, that’s enough proof for all of you that taking a break from the market will also have similar results.
Next week, the final ‘R’, Rethink. In the mean time, why are you still looking at the markets! Recuperate and Regroup!