Trading Lesson of the Week

Check back weekly for another free trading lesson:

Learn from My Trading Mistakes

In This Week’s Issue:

  • Stockscores’ Market Minutes Video – Trade with the Trend
  • Stockscores Trader Training – Learning from My Trading Mistakes
  • Stock Features of the Week – Abnormal Breaks

Stockscores Market Minutes – Trade with the Trend

Trading with the trend is so important for trading success but what trend you trade with makes a big difference. This week, I discuss this well known trading rule before doing my weekly market analysis and the trade of the week on NVDA. Click here to watch.

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Trader Training – Learning from My Trading Mistakes

I have traded for about 30 years and I still make lots of mistakes. The cruel thing about trading is it gives the test first and the lesson after. If we don’t take the time to analyze the lesson then the price we paid for failing the test is wasted.

Not all losses are mistakes and not all profits are the result of a good decision. Once the trade is over and the emotional attachment to it has passed, it is important to analyze and determine what was done right and wrong and what can be learned from it.

My mistake today was misreading the market at the open. Here is how it went.

Each morning before the open I look at where the S&P 500 is going to open and what that says about the kind of day it is going to be. It helps me to focus on whether I want to be predominantly buying stocks or shorting them. It is not a question of whether the market is going to open up or down but rather, whether the market is likely to move up or down after the open. There were a number of days last week where the market gapped down on the open but were still good days to be a buyer because the market moved up after the open.

There are two things that I consider; trend and emotion. To determine trend I draw a line across the bottoms and another across the tops. If the line across the bottoms is moving up from left to right, I have an upward trend and buying should work better. If the line across the tops is falling then I have a downward trend and shorting should work better.

The caveat on this relates to emotion. A market that is in an upward trend but gaps up significantly will have emotional buying that usually ends badly. This is an overbought condition that will likely lead to a pull back through the day.

A market trending down that gaps down on the open is probably trading on fear and has a good chance of bouncing back, making buys a lower risk trade despite the market weakness.

The market has been trending lower for 8 days and was gapping down on the open today to just below the low of the recent downward trend. My thought was that this meant it was oversold and likely to bounce back. I favored buys and avoided shorts on the open but intended to go short if the market bounced back from being oversold and then broke lower again.

My mistake was in the read of the intraday chart of the SPY. Yes, it was gapping down and yes it would open just below support. However, while the 8 day trend is down, the 5 day trend was more sideways with compressing volatility. That meant that the gap down on the open was a break in to a new leg of the downward trend after a 5 day pause. Since it was opening below the lows of the past 5 days, it was also breaking down through support.

This was a signal that the market was going to move lower through the day.

I bought a number of stocks on the open and despite the downdraft in the market so far today, they have not done that badly. The reason why? A stock that can show strength on a weak open has something which is strongly attracting buyers. Many of the stocks I bought today are Consumer Staples companies which tend to be a safe haven when the market is selling off.

The more painful mistake is in the opportunities that I missed as there are some big winners on the short side and in the inverse ETFs that go up when the market goes down. I took one of those trades (SQQQ which goes up when the Nasdaq goes down) but there were so many more to take. I passed on them because I mistakenly thought the market was going to bounce back from being oversold.

So that is what I did wrong but to really learn from the mistake, I have to understand why. With the benefit of hindsight, it is easy for me to see the signals I missed but what is it that clouded my vision when I was doing my analysis.

First and foremost is fear. The pain of a reversal from an oversold market is potentially worse than the pain from buying an oversold market. The buys I made are barely down despite my incorrect analysis. If I had shorted and been wrong, the losses would be greater. So, the problem is that I approached this morning with more of a focus on not losing than winning. This risk averse approach keeps me from big losses but it also keeps me out of some big profit days like being short today.

Second was focus. I had some issues getting my computer set up this morning which meant I spent less time on analysis than I normally would. I am not sure it would have made a difference but I do think that I failed to go through my analytical process well. I normally draw my trendlines and highlight compressing volatility on my charts and I did not do that this morning.

Now, on to the solutions. On the focus issue that solution is pretty simple – be better prepared and give my self more time.

On the fear issue, it comes down to doing the analysis and believing in it. Had I spent more time on my analysis I would have made a better decision but I would have also had more faith in it.

To summarize the solution, more Focus would lead to more Faith in the analysis and less Fear. That would have provided a lot more profit today.

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