Trading Notes

Chapter 1: NEVER BREAK RULES

I learnt this the hard way… Broke my rule and closed 2 positions out of fear…. Ended up with a real loss of $10 (before commission) and a lost profit of $230…. While it is easy to think that one can keep their emotions in check effortlessly, the truth cannot be further.

It all happened on 5th Jan. Two of my positions XOM and OXY (both related to Oil) were precariously close to turning into losses. In fact, while XOM still has a profit of about $50, OXY was already showing a loss of $10. When I started to see the stock prices approaching, and then breaking my resistance, I could only think of reasons why those two trades are going to be lossess. Coupled with the fact that Isreal attacked Gaza, Russia and Ukraine had a dispute over natural gas pricing and transportation, and Santa Claus’ recent visit to Wall Street, I found enough reasons to believe that I should exit in advance. Maybe this was the market’s way of reminding me, I still have a long way to go, in terms of controlling my emotions.

It was a painful lesson.

- For OXY, I exited with a loss of $50, at the highest price for the day. In fact, it was the highest price till the day the options expired. I would have profited $110, instead of losing $50 if I stuck to my rules.

- For XOM, I exited with a profit of $40. However, like OXY, I exited near the peak, a peak that was never reached again till expiry. I would have profited $120, instead of $40.

Now, as I am typing this, a new position that I have is testing me again. APOL is rallying, while the overall stock market is falling. I can think of a 101 reasons why I am wrong about APOL, but I am not going to exit early. Only time can tell if this will be a winner.

I have to constantly remind myself:

I AM PLAYING A STATISTICAL GAME, I AM NOT PREDICTING THE STOCK’S DIRECTION.

By breaking rules, I will affect the odds of this game, and may end up losing money. This shall never happen again.

For the record, if I had not exited XOM and OXY wrongly, I would have only 1 losing trade in 3 months of my trading (i.e. about 8% losing trades). I guess the previous losing trade (GS) had an impact on my emotions. I kept thinking about the profits I had before Christmas, and was fearful of giving too much profits back. Ironically, it was this fear that made the feared scenario come true.

Chapter 2: Affirmations work!!!

Affirmation is probably the most useful tool to help me control my emotions. When I am overwhelmed by fear, I constantly repeat to myself:

I am a highly profitable options and forex trader

When I do that, my emotions become less intense. Sometimes, affirmations can almost create miracles. For instance, when a stock rallies against me, I would sometimes repeat to myself: “The price is going to close below $x today.” Surprisingly, when I check the price the next day, the stock will close exactly the way I wanted, even when that means the stock has to reverse a few dollars in my favor. Ok, I know that is most probably just a coincidence… but it doesn’t matter… all that matters is that affirmations help me control my emotions. When I let my emotions control me, it is always because my fears were stronger than my confidence in the powers of affirmation. Thus, I stopped affirming and started analyzing, trying to predict the stock’s direction and desperately praying for a crystal ball.

Chapter 3: Simple Support and Resistance can be very reliable

Look at the chart below. Another painful reason why I should not have exited OXY. I drew the resistance line before I entered the position. Notice how the stock reversed right after briefly breaching the resistance line. If only I had stronger faith in my resistance line…

OXY Chart

The same applies for XOM. Notice how it break above the 200-Day MA, only to reverse and fall back down.

XOM chart

Chapter 4: Fibonacci Wonders

GS chart

This chart shows how Fibonacci acts as a strong resistance. I did not consider Fibonanci when I sold the GS spread. On New Year’s eve, while I was celebrating the arrival of 2009, GS broke into my sold ‘territory’ and I was stopped out. I admit defeat for this, and am glad I was stopped out. After being stopped out, GS continued to rally about $10 before hitting the Fibonacci resistance. It stopped rallying right there and reversed course. If I had done aything wrong with GS, it is not rolling up and selling the spread at a higher strike price after being stopped out. But I couldn’t control my fear: Once beaten, twice shy. I think I can do that only after a few more months of trading.

Chapter 5: Leave a Buffer for Stock to Briefly Break Resistance or Support

I learnt this lesson from RIMM, a position that resulted in a loss of $120… The details are posted on my homepage… but for completeness.. I’m gonna copy and paste parts of it here….

“…. I learned an important lesson from my RIMM loss…. If you refer to the chart below, you will see that I identified a resistance of $60… and a 23.6% Fibonanci of $61.77… Selling the spread at 60/65 was a grave mistake… I allowed no buffer for the stock to briefly break the resistance… in fact, the Fibonanci resistance was above my sold leg…. I was too desperate to open a new positions… and that led me to sell poor quality spreads… perhaps I can say Greed was at play here… I dunno… but anyway, I’ve learnt my lesson… In future, I will always ensure that my sold leg is at least $1 above/below the resistance/support… That will give a comfortable allowance for the stock to temporarily ‘misbehave’…. Ideally, I want the sold leg to be above two resistance… so if it breaks both resistance, I admit defeat…. “

Notice how RIMM briefly broke the $60 resistance (it reached a high of $60.47) before retreating down… In fact, the next day, the stock gapped down more than 17%… the spread that I bought back at a loss for $2.21 was worth only 40 cents after the gap down…

Now, I’m going to ensure that I always allow a buffer between my resistance/support and my sold leg… This will allow the stock to briefly break my resistance or support without causing me to be stopped out…. Ideally, I want the stock to pass through two or more resistance/support, followed by a buffer, before hitting my sold leg….