“Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
I am certain that many of you who have come across my online profile have come to the belief that I am/was full of shit at one point or another. If you haven't I admire your naiveté and thank you for your trust. Though I've encountered what most would quantify/qualify as "success" when it comes to trading and though I've been fortunate to never come on the negative end of the stick, this does not mean that I've never faced pitfalls. This also doesn't mean that I haven't faced my own level of disappointment and frustration. Most importantly, it doesn't mean, and for lack of a better term, the market hasn't made me her bitch from time to time.
The longer you stay at the trading game, the more you will be humbled. I liken the market to a game. You start at a particular level in this game. Some have a cheat code (more capital) some have to begin at the very beginning with very limited resources. Fortunately however, whether you're insanely wealthy or only have a couple hundred dollars to your name there are always opportunities.
Personally, I've been on both sides of the equation. I've seen a $200 trade blossom into $21,000+ in a matter of an hour. I've also had the misfortune of watching $9,000 evaporate into thin air on a bogus rumor. Both feelings, though unique on their own, are rooted one in the same. Euphoria and anger both different sides of the same coin. I'm going to share the most valuable lesson I've ever experienced as a trader; even though I didn't know it at the time.
The Loss
I'm not sure why you trade but I'm almost certain for most of you it's to earn income/make money. At least that's why I got back into trading. The ironic part is in order to make money, you gotta learn how to lose it. Sounds "bass aackwards" i know, but it's not. What I mean is you've gotta learn how to trade good setups. Setups that work in your favor. You've got to learn to know when to say "I quit" and tap out of these setups too. Without a plan or without defining a trade you'll simply compound your losses and wind up worse off than you were.
Like I said above, I've been lucky to stay ahead of the 8 ball during my career. But I've faced my fair share of set backs.
Below, I'm going to share with you the largest set back I've ever encountered and the lesson it taught me.
In late 2013 I discovered the power of leveraging weekly options into a trending stock. Previously I'd only traded commons or monthly options. Initially, I discovered this power with three very volatile stocks -- FEYE TWTR & TSLA.
More specifically, I was able to capitalize on riding TWTR for every one of its breakouts to fresh highs and compound my account quite rapidly. "Feeling like I was on a hot streak" I started to push my luck with TSLA. I attempted to replicate my process with TWTR in TSLA as it made a new high seemingly every single day. I continued to take on risk and leverage my positions for further upside gains. I was aggressive and continued to press my luck.
In early January 2014 I learned the most important lesson of my trading career. Don't fight the trend, and never average down a weekly losing position. As you can see from the chart below (one I've shared on multiple occasion) I learned (though didn't know that at the time) the hard way, that averaging down on losing positions will destroy you.
What that above chart doesn't express numerically is that I was able to 7x my account from the start of November simply by staying with the breakout trend and backing off when it failed. On the week of January 9th, while "expecting" TSLA to break out and continue higher after a "brief pause" I made the bullshit move of "averaging down my cost" thinking that I wouldn't need much of a move to get me going. What I failed to realize was that TSLA stalled against a major trend line and at a gap resistance and it subsequently was going to back test its previous breakout level. I was stubborn and it cost me. That mistake erased over a month and a half's worth of work, patience, and more importantly, gains.
My account went from 7x to a meager 2.5x.
COGNITIVE TUNNELING
Cognitive tunneling is a phenomenon in which a a psychological lack of attention takes hold without obstructing your individual vision. This phenomenon occurs and is defined as an event in which an individual can't see what's in front of them because of an unexpected circumstance. Specific examples of this occurs when people are so focused on one particular action that they fail to see the greater picture and subsequently cause damage to themselves as a result.
An example of this is a quarterback that is so fixated on threading a pass to a receiver that he completely misses the safety that's cheating underneath.
This effect is just how dangerous the markets can get. Sometimes, we get so fixated on a particular instance or result that we fail to see what's going on around us. In the above example, I was so concerned with my own personal position in TSLA that I neglected to see the bigger picture; TSLA rejected the gap and was failing. Though the following week was a tough one (especially since the following week TSLA broke above the previous failed breakout level and continued on to make new highs) it was a pivotal one in my trading career.
It was a stern reminder to never average down a losing position and to set a stop and respect it. It was also a reminder that I/we are never smarter than the overall group. That momentary pain, though brutal, turned out to be the most important lesson that I've ever learned.
Second Life
The most important lesson I received the week of Jan 9th was that capital preservation is the key to success in the market. Leverage only what you're willing to lose, and stay humble with the idea that you may in fact be wrong. Doing so will only allow you an opportunity to add another life to your trading career.
If you only take one thing away from this post please let it be this; set a max risk tolerance on every trade and respect it. Don't average your losers and don't assume you know more than the crowd.