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WHEN RIGHT GOES WRONG - THE AFTERMATH OF THE BLOODBATH By ... Flipbook PDF
WHEN RIGHT GOES WRONG - THE AFTERMATH OF THE BLOODBATH By Colin Miller The market is boiling hot right now, and when I w
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WHEN RIGHT GOES WRONG - THE AFTERMATH OF THE BLOODBATH By Colin Miller The market is boiling hot right now, and when I was eyeball-scanning through all the stocks in the ASX that passed the "deaddays" filter, I was specifically looking for momentum style set-ups. I was particularly interested in up-sloping triangles, compression wedges, or flag patterns among stocks below $2.50 (for price-leverage). I was happy to find ROC as a good flag pattern candidate. My only regret was that I didn't find it two days prior while price was still contained within the flag parameters. My entry at 0.605 was late, however with an initial stop at 0.565, the trade metrics still provided for a 3 to 1 win/loss ratio.
I set a conditional 'rising buy' order to purchase ROC at 0.605 if the flagpole top was broken to the upside. This occurred as momentum continued, and I was placed in the trade. I felt confident when price closed at the top of its trading range on strong volume at 0.625. However I was left scratching my head after the next day for good reason, ROC fell like a rock, and landed below my stop loss even on a solid rise in the wider market that day. Had I missed something in my analysis or was this a low probability event? I sent an email asking Daryl for a more experienced appraisal, then got on with the job of extricating myself from this sticky problem. I had noticed that while price fell heavy and hard, it closed right on the upper edge of the flag. Perhaps the market may consider this an entry point? Also had I been using a CBL instead of the ATR stop loss as shown in chart 1, then the trade would still be in play. Finally, the market is particularly bullish at this moment. So with these thoughts in mind, my focus on an exit was tempered ─ rather than blindly selling on the open, I would instead employ Guppy's "Gap Defence" strategy.
You can read about the details of this strategy in Snapshot Trading, Daryl Guppy, 2002, p.193. The strategy was built around the problem of when price gaps below your stop loss causing much greater paper losses than your original trade plan had accounted for. This is a very bad-case scenario that will occasionally plague traders who trade long or often enough for it to eventually happen to them. The Gap Defence strategy is a better alternative to simply shutting your eyes, thinking about something else more pleasant, and clicking the "sell" button. In some cases a more dignified exit can be achieved. While my situation with the failed flag trade was not nearly as grave as all this, I decided to use the structured logic of the exit approach given my belief that perhaps an overly spooked market may have 'oversold' ROC that day. Blue-tacked to the wall next to my trading desk is a piece of paper printed with a dotpoint summary of the mechanics underpinning the approach. I find it comforting as well as convenient to know it is there within easy sight for that desperate, dark day when it will be required. When tragedy strikes you must be prepared or else an emotional melt-down is on the cards! Here are the points: 1. Watch and wait. 2. Mark the five-minute low. 3. Sell half the position if prices go below the five-minute low. 4. Mark the 30-minute low. 5. Exit the remainder of the position if the price drops below the lower of the five and 30minute lows. We use the actual 30-minute low in Australia. 6. Use a trailing stop loss for the rest of the day a. Start with a 5-minute bar b. Shift to a 15-minute bar c. End with a 30-minute bar d. After each period ends the trailing stop loss for the period is recalculated You can see in chart below the five minute low is marked with a horizontal orange line. In the case of ROC, price rallied off its open which was to become the day's low. This means that the orange line also denotes the 30-minute low. Had price continued to fall after the five minute low, then I would have exited half my position and then waited for five more 5-minute bars (to make up the 30 minutes). I would have then marked this 30-minute low as a final exit point for the remainder of my holdings.
Price held up and at this juncture I was at step six of the strategy and still in the game with my full parcel intact. I am using the CBL as my trailing stop, since my intra-day charting provider, IncredibleCharts, does not allow me to plot an ATR trailing stop like the GuppyToolBox does. The pink, then blue horizontal lines denote these CBL stop loss levels. They gradually ratchet upwards on the 5-minute chart. It was time to shift to 15-minute, and then 30-minute intervals. I am now working off the 30-minute chart shown below, and while not shown, the final closing price for the day was 0.585. I will continue to use the CBL trailing stop on the 30-minute chart tomorrow, and if the trade is still open the next day after that, for as long as it takes for the market to eventually take me out of the trade.
Sometimes after a position-trader has selected an opportunity by analysing the weekly and daily charts, the subsequent entry will be 'fine-tuned' by referring to an intra-day, shorter time-frame chart such as a half-hourly, 15-minute, or 5-minute chart. In the case of my failed ROC trade I have inversed this approach by fine-tuning my exit using intra-day time frames, and Guppy's Gap Defence strategy as the underpinning structure to this method. SUBJECT SUMMARY PROBABILITY AND ODDS The probability of an event occurring is the ratio of favourable outcomes to the total number of possible combinations. The odds of an event happening is the ratio of favourable outcomes to unfavourable outcomes. In the market these differences have important impacts. The total number of possible favourable outcomes in trade is finite. You can make a profit, break even, or lose money. The total number of possible outcomes – not combinations - is 3. There is only one favourable outcome so the odds are against you in every trade. The ratio of favourable outcomes is always 1:2. We offset the odds in trading by identifying the balance of probabilities – the total number of price combinations. The balance is most easily seen visually. We use a straight edge trend line. A stock that has been trending upwards for six weeks has a high probability of continuing to trend upwards tomorrow. The ranges of price combinations are skewed in an upward direction. A stock that has been trending upwards for 3 days has a lower probability of this trend continuing. The price of a stock today is not independent of the price of the stock yesterday. This is why coin toss analogies and random walk theory are so irrelevant to the market. Prices are not independent events. When you buy a stock your decision is influenced by the price that it traded at yesterday. The event – you buying a stock – is not independent of the previous event –someone else bought or sold the stock. Successful trading recognises the odds are stacked against us, so it looks for tools to identify situations where the balance of probability is tipped in our favour. When a trade is implemented, traders are alert for changes in the balance of probability because they know the odds are still stacked against them.