Staying the Course (Even When It Hurts)

It’s interesting that there are quite a few trading blogs out there devoted at least in part to the psychology of trading. Who knew we were all such nut-jobs? I was reading one today and it got me thinking about my mental track record so far.

First off, I’d like to give myself a pat on the back for sticking with the system the vast majority of the time. No matter what the trading system, I’ve done a pretty good job of staying with it and following the rules to the letter. My disciplinary success rate is definitely not 100%, but I feel pretty good about it. And I do suck at some stuff too, which I’ll save for later in the post.

Take for example an ill-fated trade with Weight Watchers International (WTW). A friend of mine had described a swing-trade system that took advantage of mean reversion to catch a bounce. Sometimes it turns into catching a falling knife. Which is what happened on this particular trade.

staying-the-course-(WTW)For this particular trading system, more often than not, the stock rebounds. It rebounds over 60% of the time in out-of-sample backtesting, and the forward-testing looked good too. But there are those other 40% of trades, and sometimes there’s a doozy. This one never turned around while I was in the trade, and finally stopped out with a >12% loss. Ouch!

It’s one thing to look at a chart from the past, and quite another to experience each red bar as it happens. Every day at the closing bell I would look at WTW and say “Really??! Aw c’mon already, turn the other direction!” And of course it did that the day I after I stopped out, at least for a short time.

Every day there was a temptation to get out. But I stuck with it, because I knew that if I quit before the rules said I should, I would invalidate the whole trade. It would then become not a statistic to apply to my overall system health, but some random trade I made for no reason.

The times I abandon a trade is when I don’t have confidence in the underlying system. There have been several times where I’ve either learned something new, or realized I’d made an error in my testing, and invalidated a system I had been trading. Or worse, I was trading a system based on discretionary reasons (i.e. “gut feelings”). Then I start to second-guess everything.

I can stick with a trade very well if I’ve got hard numbers to back it up. But if I doubt those numbers, or didn’t have the hard evidence in the first place, then I’m a wibbling bowl full of nervous jelly.

Some mental techniques I’ve learned along the way so far:

– If you’re trading on an end-of-day basis, don’t constantly watch the market. It will only cause you heartache. There are only two emotions you can realistically feel while a trade is open: mild anxiety or wild panic. So what’s the point in peeking? (I must admit I’m only partially successful at this part.)

– Trust your research. If you’ve properly tested your system with out-of-sample data, then it should continue to work a given percentage of a time. If over time the percentages of wins drops off, it’s time to pause the system until paper-trading shows good results again. But no single trade is going to tell you whether a system is broken (or working).

– Don’t bet the farm. You’ve heard that one before, I know, but it’s true. Losing $1000 hurts more than you imagine it will. Ask yourself “what amount could I stand to lose three times in a row and still continue trading?” Err on the side of small. Heck if your trade goes from a profit to a loss because your position size was small compared to commissions, it’s still a win. Because it’s a) a small loss instead of a big one and b) counts as a win in your live forward-testing. Get rich slowly, instead of getting poor quickly.

– When you exit a trade, don’t look back. Don’t look at what the price did the day after, or even a week after. MAYBE take a look a month or two later, but really, what good will it do? Doesn’t change a thing. If you stuck to your system, then all you can say is “well that one didn’t work out.” And if you didn’t stick with your system, then you’ll just be reminded how foolish you were.

So what do I suck at? Well I hinted at it above. I’m often too quick to try a new system with real money, when perhaps I should let it stew for awhile with paper trading before jumping in. I like inventing things and trying them out, so it’s difficult for me to NOT trade a new and promising system. Fortunately I’ve had enough sense to keep my positions small, so as not to get hosed.

What are some mental tricks/techniques you use to combat the wibbling-jelly feelings that trading the markets can sometimes cause? Leave them in the comments section!


Limit-On-Close Orders: Every Brokerage Should Offer Them!

One of my trading systems is a mean-reversion system that trades at the Close for both buy and sell signals. I.e. I buy if the stock is closing below a certain point, and sell if it’s closing above a certain point. Typically I can be in front of my computer near the closing bell, so putting in a Market-On-Close order is simple when the threshold has already been met and looks likely to sustain until the closing bell.

However this past Tuesday, I got bit in the butt (so to speak). I was long a particular stock and it was near my ‘sell’ threshold but not quite past it. I was unable to watch it through the last minutes of trading because of a prior commitment, and sure enough it popped up past my threshold at the end of the day.

I totally missed my sell signal as a result. And now the stock is down a few percentage points and I have no statistics for the likelihood of it recovering from this point.

Unfortunately the brokerage I used for this trade ( does not offer what is called a “Limit-On-Close Order.” This would have avoided a lot of grief.

A Market-On-Close (MOC) order is much more common. You ask your brokerage to sell or buy your stock at the end of the day, for whatever the closing price ends up being. A Limit-On-Close order is little more complicated, but hardly rocket science. An LOC simply states that if the closing price is at or above your limit (when selling), it sells for the closing price. If buying using an LOC, the closing price must be at or below your limit price to execute.

Could I have used a regular limit order? The difference between an LOC and a simple limit order is that a limit order can be hit any time during the day, and you will get your price—but no better. If your stock has shot up 3% and you think it might go further before the closing bell, you don’t want to put a limit order in for that 3% mark…it’ll sell right away and you won’t see any additional gains. The LOC order allows you to potentially gain some extra profits without having to sit watching the ticker all day.

[TradeKing just responded to my email as I’m writing this, coincidentally. They say they’ll consider it for the future. We’ll see….]

So TradeKing doesn’t offer this. I know many of the other brokerages only offer the basics such as limit, MOC etc. But there are at least SOME brokerages that offer LOC orders:

Interactive Brokers (but they require a big account)

Questrade (Canada)

Options House

It might be worth it for me to switch (again!) so that I don’t lose money on missed trades.

Do you know of any other brokerages that offer a Limit-On-Close order? If so, please leave info in the comments section. Thanks!

Rubber Bands (Mean Reversion Trading)

Pull back that price and then let go!
Pull back that price and then let go!

A couple of days ago I mentioned (here) that I had sold a couple of profitable stocks and was going shopping for more, as part of a discussion on the folly of a “buy and hold” strategy. After yesterday’s big tumble you’re probably thinking, “what, is he an idiot?” Or perhaps just shaking your head at my bad luck.

Well, not to fear! What I didn’t mention was that I was concerned the market was going to take a dive shortly. I have a market-breadth indicator inspired by the one Pradeep Bonde of stockbee uses. Three days ago the indicator went “beep!” (Metaphorically speaking.) This told me I needed to a) take profits on a few swing-trade stocks I had going, and b) prepare to go shopping for some mean-reversion plays when the market took a dive.

Then the next day the indicator went back to normal. Hmm. Was it a false alarm? Probably not, but I decided not to blog about it since a) I’m not in the prediction game and b) I don’t like to look stupid when I make incorrect predictions. I did however tell my 12 year old son, “son, the market is going to fall significantly in the next few days” (pretend you can hear me using my deep ‘Dad’ voice as you read that).

Yesterday I got to show him how amazing I am. Super Stock Dad as far as he’s concerned. Because sure enough, yesterday the market tripped over its own shoelaces and landed face down in the mud. I locked in some profit on a couple of trades, and bought another stock at the close after it had fallen significantly.

Basically there are two types of short-term trades: momentum trades and mean-reversion trades. Pradeep is a big fan on the momentum trade: when a stock has been moving up and then takes a breather, be prepared for when it shoots up again to make a quick profit.

Howard Bandy is more of a mean-reversion kind of guy. Mean reversion is the term for when a stock’s price moves abnormally far in a particular direction, and you catch it at the furthest extension from the ‘mean’ (i.e. the average the price was hanging around before) and ride it as it snaps back. Just like a rubber band.

When you yank that rubber band way back, the big question is whether it’s attached to something or not. If there’s no snap-back, then you just have momentum in the wrong direction!

In my many hours spent backtesting various systems and ideas, I have had very little luck with momentum systems so far. However, the mean-reversion systems are lookin’ tight, yo! In fact, my Band-to-Band system for which I sometimes post signals is basically a mean-reversion system, incorporating a confirmation signal. I’ve come up with some other systems that also look good, and that was what I traded at yesterday’s close.

Some momentum plays just never take off, and head the wrong direction. Some mean-reversion plays don’t bounce back, and keep heading the wrong direction. That’s just how it goes. Here’s hoping my rubber bands are attached at the other end.


Party Like It’s 2008…

So this weekend I was at a party, and several of us started chatting about the stock market. I didn’t start the conversation, because I don’t talk stocks with friends. Several people moaned about how they had really suffered in the 2008 crash. And one guy said “my account really got hammered, but luckily I didn’t sell or I would have taken an awful loss. The market came back so it all worked out fine.”

I had to bite my tongue pretty hard.

That’s like five years of his life where his portfolio did nothing. Or worse. Some of the companies he owned could have gone out of business during that period of time, leaving him with what experts call an “Actual Loss.” Imagine if he’d had a simple trailing stop loss of 10% or something…sure he would have taken a little hit at the end, but then he’d have all that cash freed up for when the market bounced back, compounding his way to riches…

But you know that, otherwise you wouldn’t be reading blogs like mine.

While I don’t like taking a loss any more than the next person, I do love to shop. And that’s what the stock market is, a place to buy and sell little tiny pieces of companies! Therefore I look forward to selling stocks, so that I can buy something else. “Buy and Hold” is a sucker’s game, and also pretty damn boring.

Think I’ll go sell a couple of profitable stocks today, so I can do a little shopping…

Rev your engines and grab your shopping carts, because it's time to go shopping!
Rev your engines and grab your shopping carts, because it’s time to go shopping!



Position Size Vs Commission Size: A Quick Visual

A few posts ago I wrote (here) about how your position size/commission size ratio can greatly effect your returns, and how I made the mistake of using a system designed for a much larger position size. Basically, the smaller your position, the bigger the commission amount has on your profitability, which means you can’t make money on tiny wins.

I thought I’d drive this concept home with some stunning graphs and charts.

Below you can see the results of a simple swing trading system that buys the S&P 500-based ETF (SPY). The first two graphs are unrealistic in that they don’t include commission fees. They’re pretty graphs, yes? Money keeps going up. I like when that happens, even if it’s pretend.

And note how the graphs are congruent, in that they’re the same shape with just different start points and endpoints. I’ve used two sets of position sizes: the first has an account of $100,000 and position sizes of $10,000, and the second one has an account of $10,000 and a position size of $1,000. None of these tests allow compounding.

no com,10k,100k
100,000 account, 10,000 position size, no commissions.
no com,1k,10k
10,000 account, 1,000 position size, no commissions.

And now we wake up from that wonderful little dream and pay some commissions to that nasty stock brokerage. How dare they make money on our money!

Here is the same trading system, using a $4.95 commission for each buy and sell. The graph is a little more ragged than the fantasy graph, with substantially less profit, but it still looks pretty good.

100,000 account, 10,000 position size, $4.95 commissions.
100,000 account, 10,000 position size, $4.95 commissions.

Alas, the same can’t be said for the smaller account. In fact, one could say the trading system “fell off a cliff”. A more technical way to describe this system is “broke”. Which also describes your account.

10,000 account, 1,000 position size, $4.95 commissions.
10,000 account, 1,000 position size, $4.95 commissions.

“Holy banana-pants, Batman!” you probably just yelled. (That’s what the kids say these days, isn’t it?)

So why does this swing-trade system suddenly suck? (Which is another technical term, used to describe a system exhibiting continuous adverse excursions). It sucks because it has a profit target of 0.2%. Yes you read that correctly. It has a wonderfully high hit ratio when large positions are used, and makes money the old fashioned way (slowly, a bit at a time). But when a small position size is used, those commissions often turn a win into a loss.

Let’s see, $1000 * .002 is $2, minus commissions both ways at $4.95 * 2 = $9.90, so that makes my profit…uh…negative $7.70 for a ‘winning trade’. Let the swearing begin.

Whereas the larger account would have made $20, and then spent $9.90 in commissions, leaving a small (but real) profit of $10.10.

In fact, this system only tips over into profitable territory (and we’re talking $11 profit over the entire 15 years of trading) at the $1300 mark for position size. I ran the position size as an optimization variable, and here’s a chart showing the results:

min pft

Commissions have a very real effect on the ability of a trading system to make money. And the smaller the position size, the bigger average return you need per trade to make it profitable. Which can most easily be achieved by using systems that hold positions for longer.

Does this mean as I get richer, my trades get shorter?

For those of you with $10k to invest per position, I’ll bet you’re chomping at the bit to get your hands on this trading system, right? Well here’s a link….