Monday, March 12, 2012
A trader eventually graduates from having mostly losing days with a few winning days to the inverse: mostly winning days with a few losing days. But the losing days are likely to be disproportionally large. This happens occasionally due to the trader not being physically or mentally in top shape on that day due to lack of sleep, illness, relationship issues etc. But usually, this is because the trading system has a real weakness under certain kinds of price action that has been exposed by the market.
If you find yourself at this point, you are probably already a break-even trader. If you can tame or eliminate these disastrous days, you probably already made it as a consistent trader.
The first one or two disastrous days can be pretty devastating. This is because your initial success has encouraged you to increase size and your growing P&L has given you an enormous confidence boost. This probably meant you traded large size and re-entered every time you lost and at the end of the day were shocked to see a week or two's profits wiped out.
The very first thing you need to ask yourself is if you have lapsed into old habits. Confidence and a high win-rate can make you feel invincible like Superman and you may have lapsed into your old habits. Eventually Superman is taken down by Kryptonite. If your discipline has been good and you haven't yielded to the temptations of poor habits, there is a good chance that certain kinds of price action may simply destroy your success rate.
For example, today's wide slightly sloping channel is a kryptonite to AM trend traders such as myself. Narrow range days are also kryptonite for traders who like to take 2 points or larger on each trade. Overlapping signal bars are kryptonite for traders who like to enter on stops with a price action stop. Today was all three and if you know your kryptonite you can avoid it by not trading.
Similarly, trend days are kryptonite for traders who like to fade every breakout. Soft-trend days are kryptonite for traders who rely on only patterns for their trading decisions. Hard trend days are kryptonite for traders who take every reversal signal and so on.
The key is to know what kind of price action is unsuitable for your style and avoid trading on that day. Since realization comes too late, the best course of action is to exit after a certain number of losing trades on any day. Barring this, the second approach is to not take another trade for at least two swings after you are stopped out.
With experience, it may be possible to recognize the kind of price action and switch to a different style that's conducive to the current price action.