Monday, June 29, 2009

My Penalty Box Trading Rule - Trading Tip for the Day

This is a rule I use to keep myself from letting my conviction get in the way of my discipline.

Here's how I play it:
Let's say I have conviction in a Trade. Remember I am talking about a trade (I define a trade as something with a time frame from one day to 4 weeks) not a longer term investment. I will discuss some of my rules I use for longer term investing in another post some time.

So again let's say I have a conviction trade and it goes against me the first time I put it on and I get stopped out. This will probably make me frustrated and think I should put it right back on the next time I like the action in that idea. I allow myself to put the trade back on ONE more time. If it hits my stop again I put myself in the penalty box for trading that security for two weeks. It's just my rule and two weeks is somewhat arbitrary, but for me it's enough time to let my "anger" release and not trade with fury against the market by going in again and again in the same idea that keep going against me. Because if you let yourself keep going after the same trade again and again and you believe in it but it keeps going against you, you may start doing crazy stuff like putting on more size to get even with Mr. Market. While occasionally you will catch it right and make your money back, more times than not you will get chopped out again as with bigger size your stop will likely be a lot tighter and likely to get hit and the the cycle could start again until you end up looking at your balance at the end of the trading day saying, "I am an f-ing idiot!". The thing is you would be right.

I know that this penalty box rule has saved me a lot of money since I implemented it. I use to have a hard time letting go of a conviction trade I had. This led to losses I should have never taken, but did because I wanted to prove to the market I was right. That attitude will cause you to take huge equity draw downs that will shake your confidence unnecessarily. Go into the penalty box because watching the trade go the way you thought after you're in the box is a lot better feeling than getting out of control with you emotions and losing both dollar capital and mental and emotional capital.

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