Some recent entries and current watchlist charts

I have a number of specific rules which govern the type of price set ups I look for. To help me identify these I have developed and refined scans over a number of years.

My original scan codes only identified price breakouts at the point they occurred. This meant I had to be in front of the screen and see these pop up in real time so that I could get in close to the breakout level. I've now been able to re-code these so I can identify these set ups prior to breakout.

This enables me to enter stop orders on a Good Til Cancelled basis on the market open.

Using volatility contraction to increase your profits

Often you see people talking about a winning trade, and how far in percentage terms price moved in their favour after entry.

But on its own, this doesn't tell you anything - to me, it is a worthless metric when evaluating performance.

As a trader, I'm far more interested in the size of the profit (or loss) generated when expressed in terms of R.

Donald Rumsfeld, Paul Tudor Jones, Facebook and Twitter

“I don't risk significant money in front of key reports, since that is gambling, not trading." - Paul Tudor Jones

When you are trading, the only elements you can control is when to enter a position, where you place your initial stop, your position size and the amount you are willing to risk.

Once you are in a trade, you have no influence over what will happen - the market (being other buyers and sellers) will determine future price direction, and consequently whether your position goes into profit or a loss.

You of course do have control over where you place your initial or trailing stop, but you do not always get out at those prices - particularly if you end up on the receiving end of a price shock and a resultant gap against you. As a result, there is always a risk that you can lose more than your initial risk on any trade.

Earnings releases are, in Rumsfeld-speak, a "known unknown". We know when they will occur, but we cannot predict or quantify their effect on price. Therefore, there is always potential downside risk attached to them. Some announcements may see price move in your favour, others can go against you.

This week we have seen two big-cap Nasdaq stocks suffer large price gaps following earnings releases. The charts of Facebook and Twitter are below.

My biggest loss in 4 years

So, let's not beat around the bush. This morning I suffered my largest loss on a single trade since the summer of 2013.

As of yesterday's close, the position was +1.13R in profit. Within a few seconds of the market open, I was stopped out for a -1.95R loss.

S*@t happens. Let's look at the chart:

Two stocks, two earnings reports, two different actions

Here is the story of two stocks which, this week, announced earnings. I had long positions in both these stocks coming up to the announcements however my treatment of the two trades differed. But first, I will explain my general approach to trading stocks and earnings.

Playing great defence

As a trader, I am always more concerned with how much I could lose on a trade than win. Good risk control certainly helps you with that, but there are some other ideas that can help you keep losses as small as possible. 

Here are some examples of playing 'good defence', as Paul Tudor Jones would call it, which have helped me as a trader.

Talking in terms of R - updated

Note: this post originally appeared in July 2014, and has been updated to reflect performance since then.

1R is the amount you risk on each trade. Profits or losses are calculated by taking the result and dividing by the initial risk. For example, if you risk £100 per trade, and you end up with a profit of £500, that's a +5R profit. If you lose £80, that's an -0.8R loss.

When you are wrong, don't stay wrong!

In this recent post, I referred to Ocwen Financial Corp, a US stock that had been on my watchlist, and which broke out to new highs just ahead of earnings, triggering a possible entry.

Now, as I have mentioned numerous times, I do not initiate positions just ahead of such releases - the potential for price gapping against me is a risk I choose to pass on. My own belief is that is gambling, not speculating.

In this particular instance, price did gap down, which, had I taken the trade on the breakout, would have caused a loss greater than my initial risk.

But what if you did take the trade?

A couple of missed trades

NOTE: This post has been updated below following today's price action.

Although I have not been in the markets recently, it hasn't been totally as a result of sitting on my hands. The process of looking out for good setups has continued, and as previously discussed, most of these haven't triggered an entry signal. However, there are a couple of trades that have managed to get away from us, for different reasons:

Marty Schwartz and the sunspot theory

Every so often you come across a post from a trader talking about a specific stock along the lines of "Is there a reason NOT to own XYZ plc?"

Whenever I see a question like that, it immediately sets off alarm bells, which more often than not are confirmed when you go and look at a price chart of the stock in question.

Always think about the risk!

Traders are essentially risk managers – your goal should be to ensure any losses incurred are kept as small as possible. While sometimes this means we possibility miss out on some profits, the overriding aim remains that of avoiding big losses.

We have had two instances this week where thinking more about risk rather than potential profits has proved beneficial to us.

Losses, your mindset and risk

Most unsuccessful traders fall into the trap of assuming that the next trade will be a winning one. They can only see the potential profits – not the potential losses and the subsequent reduction in their equity.

To avoid this mindset, I recommend assuming that every trade you take will generate a full 1R loss. I do this, even though 99% of my losing trades end up being closed for a loss smaller than that.

A couple of recent trades

Below are the charts for the two most recent trades that have been closed, both for a profit. I have highlighted the relevant entry and exit points.

First to go was Nordic American Tankers, and we can see price fell quite a way below my exit point before recovering back in recent days to around the level where I was stopped out. Once a trade is exited, subsequent price action is of no concern to me - I move onto other opportunities.

Trend following differences

I was asked the question last night about how I differ from other trend following traders.

The basic principles I (and many other trend followers) follow have been used by many successful traders going back decades - people like Ed Seykota, Jesse Livermore, Richard Dennis and the Turtle traders, as well as Richard Donchian, plus others. All have influenced my own approach to trend following.

Each had their own method of identifying when to get in and out of positions, their approach to risk, their chosen markets, their trade selection process etc.

What each trader does over time is evolve and refine their own approach, while keeping the same core concepts and beliefs as other trend followers. The differences come in how they implement those beliefs, along with the specifics of the parameters used.

Be objective and simplify

To paraphrase Monty Python, it may be stating 'the bleeding obvious' but trend following is a very simple concept. If a stock or instrument is going up, you go long. If they are going down, you go short. The only differences between trend followers as that they will have their own parameters which determine how early or late they get in and out of a price movement.