My basic trading philosophy can be summed up by one simple quote:

"Trade the ticker, not the company" - Nate Michaud

Thursday, August 21, 2014

Analyzing My Worst Loss Yet

Hold and hope is not a strategy. I honestly have lost count of how many times I've told people this, yet it is the very situation I allowed myself to fall into earlier this year. The end result was this nasty $60,000+ loss:

Early in 2014, I was just beginning to trade listed stocks a bit more actively, and the setup that I decided to focus on was buying afternoon breakouts. I had a clear set of criteria for what I was looking for: I wanted the breakout to occur after 2:30, I wanted the stock to be trading well above its average volume, and I wanted the stock to have had at least one hour of consolidation since its last high. Below are a few examples that demonstrate the action that I was looking for:

On February 13, 2014, I believed that I found a similar setup in the making. The ticker was GENE, and it had a very strong morning, spiking to a high of $2.36 (twice) and then consolidating. Below is an image of what the intraday chart looked like by 12:30:

The setup looked great. All I had to do was wait for a breakout to occur after 2:30, like my rules dictated. There was only one problem - I wasn't going to be in front of my computer for most of the afternoon, because I was planning to spend it with someone very special:

Despite being in the middle of one of my best months ever, for some reason I REALLY didn't want to miss this play. So I made an impulse decision to put in a "Stop-Limit" buy order right before I left. I set the price range for my order from $2.37-$2.39. For those of you who are not familiar with this type of order, it meant that if GENE hit $2.37 (the new day high), my buy order would become active and purchase shares up to a limit of $2.39. As if one impulse decision wasn't bad enough, I made a second one. I decided to put in 40,000 shares for my order, a HUGE position size for me at the time. Even now, I don't think I ever play listed stocks this large. Once my orders were in, I walked away and went for a ride:

While I was off having fun, GENE's pattern was playing out. Since I had entered automatic orders before I left, I had very little control over WHEN they executed. My rules dictated that it had to be a late afternoon breakout because I had seen many early day breakout attempts fail. When I put my orders in, I HOPED that GENE wouldn't make its move until 2:30 or later. Unfortunately, this did not turn out to be the case. GENE tried to break out at 1:09, was quickly stuffed, and I was now long 40,000 shares in a stock setup that did not at all fit my criteria.

I do not recall exactly what time I returned home, but I know that it was before the market closed. By now GENE had faded under $2.10, and I had been down well over $10,000 unrealized on my position. GENE was bouncing a bit into the $2.20s again, and I decided that I should try to downsize into the bounce. Unfortunately, only about 2000 shares executed, and the stock began to fade again.

It was here that I got stubborn. I did not want to admit defeat and take a five-figure loss. I rationalized, "GENE is still up on the day! It could easily gap up and run more tomorrow!" So I took my 38,000 shares from $2.38ish overnight and decided to hope for the best the next morning, despite the weak close. Here is what GENE looked like at the end of the day:

The following morning, GENE did not offer any relief. The stock gapped down and never could break any higher than $2.05.

It spent most of the day in the $1.90s, and I knew that I was looking at about a $20,000 loss if I chose to cut it. Once again, I let my potential unrealized loss make my decision instead of what the price action was telling me. I looked at the daily chart up to that point and tried to form a plan:

My plan turned into one of "hold and hope." I HOPED that GENE's daily consolidation would form a higher base than the previous low. I HOPED that there would be another press release of some sort that would spike the stock back towards $2.50 so I could take a smaller loss. I never once formed a plan for what I would do if the stock just continued to fade. During these past six months, I just sat and waited for that spike I HOPED I would get to minimize the damage. Instead, I got this:

In hindsight, I probably should have cut the loss when GENE broke below the 52-week lows of $1.30ish. Unfortunately, all I could hear in my head was, "But that will be a $40,000+ loss!" So I kept waiting for some sort of spike. The closest thing I got was a press release and spike on July 7 back to $1.30, which, unsurprisingly, acted as resistance. I once again failed to cut the loss or even downsize. Only when GENE finally broke the new 52 week support of $1.00ish did I decide enough was enough, and I slowly cut my loss into the ensuing fade.

While I made mistake after mistake on this trade, I did do one thing well. I didn't average down. While this loss is my largest to date, it certainly wasn't catastrophic to my account. Where many traders blow up is by continuing to add to their failing position, all the way down to zero. Had I tried averaging down into this with the thought that it couldn't possibly go any lower, my loss almost certainly would have been twice as bad, if not worse.

It is okay to be wrong sometimes, and it is okay to make mistakes. What separates the successful traders/investors from the unsuccessful ones is their ability to learn from them. Don't sweep your mistakes under the rug and forget about them - analyze them and learn from them. The lesson here? Don't ride horses during trading hours.