I thought I would put up a diary post detailing my thoughts and rationale for my trading over the last couple of weeks. This period has caused me much frustration and loss of profits, and may prove instructional to other traders about how personal biases, discretionary elements and other non-considered factors can get in the way of a seemingly well thought out trading plan.
As I stated in a previous post, my system gave short signals on all the major indices earlier this month, prior to the terrible events in Japan. In addition to having a lot of the stops on existing long positions triggered, I already had in place some short positions, and within a day of the indices showing these sell signals, I was fully loaded up on the short side up to my preset risk parameters.
As everyone knows, the markets fell quickly in a short space of time, before this sharp reversal took place. This reversal has triggered a number of stops on my own short positions, and also severely eroded profits in others, to the extent that I had my largest equity drop over the course of a week in a number of years.
The great thing about trading is that, no matter how successful you have been, no matter how experienced a trader you are, you can always do better (reading Market Wizards shows that even the best traders can and do make mistakes, after which they review what they did and resolve to avoid such a scenario again). The events of the last few trading days have caused me to look at whether there was anything I could have done differently, to avoid such a large equity drop.
No matter how systematic your trading strategy is, there is always an ultimate discretionary element. This can range from setting the overall and individual trade risk parameters, to the choice of markets or stocks that you enter into positions, to the selection of a particular trade from a number of potential candidates.
My system gave a general market short signal, and therefore gave me the green light to look for short positions. This I did, but I entered too many positions over the course of a few trading sessions. It would have been more prudent to have entered new positions over a longer period of time, as the overall market trend became more established.
Secondly, some of the positions may have been sub-optimal in that, although the criteria and short term patterns fully satisfied my scan and other entry criteria, there may have been significant areas of support/ resistance not too far away from my entry points, which, at best, would have slowed any short breakout in my favour, and at worst, would have been entry points for counter trend and swing traders. Although I do not specifically look for major areas of support and resistance (and indeed long established trendlines), in hindsight these perhaps should have been considered. For example, the FTSE 100 bounced off such a long established trendline at 5,500, which may have been the catalyst for the downtrend stalling and the subsequent reversal.
I also looked back at the downtrend in 2008, in which I did pretty well shorting stocks using my system. The difference here is that in 2008 the downtrend was already clearly established on a number of timeframes. My own trading system is towards the shorter end of the trend following timescale. If your timeframe was geared towards longer term trends (such as simply following the 200 day moving average for example), the short, sharp fall would have been considered a pull back within an existing uptrend. This reinforces the first point, in that I entered too many short positions too quickly.
Finally, I like to have one or two open positions in the opposite direction, as a hedge, in case the potential trend in the general market fails to develop as anticipated. This I did not do, partly as the stops in my long positions had been triggered over the preceding weeks as the market stalled, which encouraged me to look solely at short positions in the first place.
All in all, there has been a lot for me to ponder over the last few days. Of course, if events in Japan (and possibly Libya) had taken a different course, or had not happened at all, then the downtrend may have continued at a slower steadier pace, and the increase in volatility due to global news events would not have occurred. Such is the unpredictability of the markets. The other point to bear in mind is that, had I not had such rigid money management rules in place, then the losses may have been significantly larger.
I am back to being lightly exposed to the markets now, and will wait for the start of another developing trend in the general market before significantly increasing the number of positions in my portfolio, but will still be looking for good looking potential trades in the meatime, incorporating the lessons of the last couple of weeks.