What are you going to do now?
This morning I woke up to the news that in the US the Dow had fallen 2.8% (387 points) overnight, along with falls in other markets. The ASX XJO, the Australian top 200 index has lost 3.7% today in a 229 point fall.
Having been a member of a private forum that focussed on put credit spreads, I know there are going to be many traders that will have found the last two weeks of trading particularly stressful.
The posts I dreaded reading from members of that forum time and time again after falls like this can be paraphrased in five words; “What should I do now?”
What you need to know about trading to trade profitably
If you are reading this post and asking yourself “What should I do now?” then my first answer is going to be a question in return:
“What the ______ are you doing trading with real money if you don’t know that answer?” (Feel free to fill in the blank with your favourite expletive).
Sorry to be so blunt about this, but trading isn’t a game, it’s a business.
If you were an employee you should be fired from that business for gross negligence.
All businesses have expenses and your trading losses should be thought of as an expense. View them as an expected occurence that is factored into your trading plan.
Which brings me to my second answer which is also a question:
“What does your trading plan tell you to do?”
Your trading plan should contain your exit and money management strategies that are designed to minimise your losses and protect your capital.
If your trading plan does not specify exactly how you should respond, then your plan is incomplete and you shouldn’t have been trading live.
You should never, ever, enter a trade without knowing what you are going to do in any given circumstance.
If you are a new trader you may be thinking to yourself “how would I be expected to know whether my plan covered all contingencies?”
Simple. If you had completed your back testing and paper trading over all market conditions then your testing should have picked up those flaws.
All too often I’ve read posts from people that have started trading a strategy without undertaking the preparation required, or taking the time to find out exactly what obligations they are taking on.
What they seem to forget is that whenever somebody makes money trading, then most of the time it means there is someone else on the other side of that trade that has lost money.
Losses happen. If you can’t take them, then don’t trade until you can. It really is as simple as that. You’ll thank me later for my honesty.
In the meantime if you are facing unexpected losses, and you do not have an exit strategy in your trading plan then you are in a very difficult situation.
So my third answer is “Can you talk to your broker?“. If you are using a full service broker then it is times like these you may be grateful for their viewpoint.
Don’t be surprised if they are harder to contact than usual, and be realistic in your expectations. Plan your call before making it and have some specific questions to ask.
For example, lets assume you have sold some put options:
* You may be at risk of exercise sooner than expected depending on how far in the money you are, but do you know how close that risk is?
* Do you know all of the many ways you can choose to manage that situation?
* If your puts are exercised, will you choose to purchase the stock with a loan and hold it until the price recovers, or have your broker ‘wash’ it (sell the stock at market)?
* Did you complete any margin loan paperwork when you opened your trading account so that you have that option available? (And so on..)
Lastly, I’d suggest looking at these recent price drops in context. Try looking at the longer timeframe charts, for example monthly and weekly charts if you usually use daily charts. Look at the overall trends.
If this is your first real experience with losses then there is a silver lining, and that is that nothing teaches you more about trading and yourself than taking a loss.
Some final tips:
* Don’t make hasty, ill-considered or emotional decisions
* Be wary of following the advice of ‘armchair experts’ on forums or other ‘gurus’
* Respond, don’t react. In other words use your brains not emotions. The easiest way to do this is to ask yourself if you would be doing anything differently if you were just paper trading?
* Focus on what you know, not on what you hope or wishh would happen
* Identify the real value of the markets you are in, and be aware that panic selling often drives price below where the true value is
* Be aware that savvy investors and bargain hunters will be looking to buy into good value.
* Don’t forget that fund managers have to invest the money somewhere, they can’t keep it out for too long
Good luck.
Brian Dibbins
Trade Profitably © 2006 - 2007
10th August 2007
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