Friday, March 22, 2013

Having the ability to trust your rules

Sometimes your best trades are those where you are able to adhere to your rules, and get out for a breakeven or a small loss, rather than hang on in the 'hope' that price will revert in the direction you want.

Below is a chart of UK stock Eurasian Natural Resources which demonstrates this. I opened a position in early February, and as you can see price initially moved nicely upwards, over the 400p level. Then price started falling so that, in a matter of days, I was stopped out basically at breakeven.

While disappointing, price had not moved in the direction I wanted, therefore I was taken out of the position. Good job too, as had I held on, I would have ended up with a loss. As we can see, the direction of the trend has completely reversed.

This is also an example as to why I never trade pullbacks or retracements. What one trader would consider to be a pullback, another would consider to be the start of a possible trend reversal. While the inherent logic of the system allows a certain degree of 'wiggle room' within the context of an existing trend, this particular chart shows that the trailing stop was breached, and therefore the trade was closed.

This is not a particular drastic example, in that price did not subsequently gap down or anything, but it demonstrates the principle of adhering to your rules (whatever they are). By accepting that the trade has not worked, I got out for no loss. Having confidence in my rules allowed me the accept that the trade did not work. Not only does this retain my capital for another trade, I avoided the potential for 'self sabotage' by hoping that price would revert back in the direction I hoped.

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