Evaluating Bad Trades
No one is batting 1000 when it comes to trading the markets. Everyone makes mistakes. But what do you do when you make a bad trade? Do you chalk it up to bad luck, and then just move on to the next one?
Or do you evaluate your trading mistakes? And not subjectively or emotionally, but rather objectively and systematically, so you can truly learn something from them.
According to trading psychologist, Dr. Brett Steenbarger, there are a few key mistakes traders make in evaluating their trades. And according to Dr. Brett, among the most common, is being “too general and subjective.” Specifically, he writes:
“The trader doesn’t drill down to identify what he or she has done well or poorly in specific trades. The evaluation simply notes general problems like fear of missing or traded too small. The evaluation should not only identify specific mistakes, but also highlight specific ways of correcting those. That turns the evaluation into goal setting and planning.”
This is similar to a concept Michael Sincere notes in his list of 10 Common Trading Errors. Number 3 on his list is “Lack of Recordkeeping.” Specifically, the article suggests keeping a trading diary.
“the diary helps you achieve two goals. “The first is to make money. The second is to become a better trader. You might not succeed on the first goal, but you must absolutely succeed on the second goal. You should try to become a better trader after each trade…
“Show me a trader with good records and I will show you a good trader. Even if you’re losing money little by little, you’re learning from your mistakes. I believe money management and recordkeeping are even more important than technical analysis.”
Sincere’s article also notes the dangers of being too emotional–an element we have largely removed from our trading programs thanks to our objective and emotionless trading models. And we’ll have some specific examples of recent trades from our models later in this report.
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Expert Picks From The Models
Note: This week’s Stock Exchange report is being moderated by Blue Harbinger, a source for independent investment ideas.
Holmes: I recently bought shares of Guidewire (GWRE) on 06/05 for $91.26 and then sold on them on 06/06 for $95.56.
Blue Harbinger: That’s a nice quick round trip profit for you, Holmes. I suppose I cannot ask you if you evaluated your trading mistake on this trade because it wasn’t a mistake at all–it was a profit. But would you care to share why you bought and then sold? You’re a “dip buyer,” correct?
Holmes: Yep, that’s correct. I use a mean-reversion approach to identify stocks that have moved “abnormally” far from their recent price history. Guidewire did, and I also identified the additional conditions necessary for me to purchase. Sometimes market conditions may impact my trades, but since these mean-reversion stocks are often at a low recent price point, they are generally less impacted by negative market conditions. And in this case–not at all. In and out for a profit.
BH: Well, for what it’s worth, Guidewire has some powerful growth on its side, and I actually think it’s an interesting stock from a fundamental standpoint, for the long-term. Guidewire provides property & casualty insurance worldwide.
Road Runner: I recently bought Extra Space Storage (EXR) on 6/5. As you know, I like to buy stocks in the lower end of a rising channel.
BH: I do know that because you tell me that almost every week. And I actually think Extra Space Storage is interesting. It’s a Real Estate Investment Trust based out of Salt Lake City, and it’s a member of the S&P 500(NYSEARCA:SPY). It also offers a 3.3% dividend yield, if you’re into that.
RR: No, I am not into dividends. My typical holding period is around 4-weeks, although EXR does pay a dividend during that time period (it goes ex-dividend today, 6/13, and pays out on 6/28).
RR: The F.A.S.T. Graph and fundamental data are nice, but as we’ve discussed previously, I look for a certain type of situation (some call it a pattern, others may call it a setup, etc.) where the probability of a particular action is not a matter of chance (50/50) but has been historically noted to result in a greater tendency towards a particular outcome. “Trending in a channel” is one such situation. An equity will often “cycle” between the upper and lower bounds of that channel for substantial periods of time. My model design attempts to take advantage of this property by identifying stocks trending in an upwards channel and waiting until the stock price drifts to the lower bound, making it a candidate for purchase. These types of situations have a relatively high probability of positive outcome with a reasonable profit potential. EXR can be seen to be in this type of a situation. This is a short-term trade that has traditional shown profitability when the right conditions have been met. One way or another, I’ll be out of it shortly–usually after about 4 weeks.
BH: Thanks for that explanation. And how about you, Athena – do you have any trades to share this week?
Athena: I bought shares of (WP). How do you feel about that?
BH: I suppose it feels odd to have an objective non-human trading model ask me how I “feel,” but whatever. Why’d you buy this electronic payments services company? Are you finally hoping on the big “FinTech” secular trend, Athena? Here is a look at the Fast Graph.
Athena: No. Rather, I look for stocks having strong positive trends and then select only those with the very strongest trends (“king of the hill”), constantly replacing the ones with weaker trends. It should not surprise anyone that I bought Worldplay. A quick look at the chart makes the strength of the trend for obvious. And I generally continue to hold my positions until either the strength of the trend abates or a stock with an even higher trend strength comes along. I don’t have a set “holding period” for a position. I will exit only when either a stronger stock comes along or if market conditions dictate a strong potential for loss – capital preservation remains the key driver in all situations.
BH: Thanks Athena, that is interesting stuff and a nice trade. And how about you, Felix – anything to share this week?
Felix: No trades, but I do have a ranking to share. This week, I ran the stocks of the Dow Jones through my technical trading model, and my top 20 are ranked in the following list.
BH: I actually like several of the Dow stocks ranked at the top of your list. Personally, I own some shares of Microsoft, Visa, and Disney. I know you are a momentum-based technical model. Thank you for sharing. And how about you, Oscar–anything to share.
Oscar: Yes. This week I ran the stocks of our universe of “High Liquidity ETFs with price-volume multiple over 100 million per day” through my model, and my top 20 are ranked below:
Trading mistakes and/or bad/unprofitable trades are a part of trading. But the question is, do you learn from them? And we’re not talking about a subjective false narrative and/or “blame game” to make you feel better about your bad trade. We’re talking about systematically and objectively understanding your bad trades so you can learn from them. For example, based on the data we’ve improved a coupe of our trading models to better handle risk during v-shared sell-off and recovery scenarios. How do you evaluate your trades, and has it led to any improvements?
Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome. You can also access background information on the “Stock Exchange” here.
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